For most sole proprietorships and small business owners, selecting a retirement plan that best fits ones retirement and tax objectives is an important decision that merits careful consideration. Both the Self Directed IRA LLC and the Solo 401K Plan offer individuals the ability to make traditional as well as non-traditional investments, such as real tax-free and without custodian consent.
The Self Directed IRA LLC “Checkbook Control” Structure
With the Self Directed IRA LLC, one will have all the tax advantages of traditional IRAs, as well as tax deferral and tax-free gains. All income and gains generated by the IRA investment will flow back to the IRA tax-free. By using a Self Directed IRA, Self Directed Roth IRA, or Self Directed Real Estate to make investments, the IRA owner is able to defer taxes on any investment returns, thus, allowing the IRA owner to benefit from tax-free growth. Instead of paying tax on the Self Directed IRA returns of an investment, tax is paid only at a later date when a distribution is taken, leaving the investment to grow tax-free without interruption.
For 2011, an individual is allowed to make a $5,000 IRA contribution ($6,000 if the individual is over the age of 50). The contribution can be tax-deductible or may made using after-tax dollars (Roth IRA) if the individual satisfies the income threshold requirements. Using a Self-Directed IRA LLC, the individual will have “checkbook control” over his or her assets allowing the individual to make traditional or nontraditional investments, such as real estate without any custodian consent. However, with a Self Directed IRA LLC, an individual would not be permitted to borrow money from his or her IRA pursuant to the Self Directed IRA rules under Internal Revenue Code Section 4975 and would be subject to the unrelated debt financed income (UDFI) rules on the amount borrowed.
The Solo 401k Plan
The Solo 401K Plan offers a self employed business owner the ability to use his or her retirement funds to make almost any type of investment, including real estate, on their own without requiring custodian consent. In addition, a Solo 401K Plan will allow the individual to make high contribution limits (up to $54,500) as well as borrow up to $50,000 for any purpose.
A Solo 401(k) is perfect for sole proprietors, small businesses and independent contractors such as consultants. A Solo 401K plan offers the same advantages as a Self Directed IRA LLC, but without having to hire a custodian or create an LLC. In the case of a Solo 401k Plan, the individual can serve as the trustee and plan administrator of the Plan allowing the individual to make any investment without seeking the approval of the custodian. In addition, the 401(k) Plan account can be opened at any local bank or trust company.
The Solo 401(k) plan is so popular because it is designed explicitly for small, owner only business. However, one is permitted to establish both a Self-Directed IRA LLC and a Solo 401k Plan. This situation typically arises when an individual has a Roth IRA and wants to establish a Self Directed Roth IRA LLC. Since one is not permitted to roll over Roth IRA funds into a Solo 401k Plan, it is necessary to establish a Self Directed Roth IRA in order to make real estate and other non-traditional investments using Roth IRA funds. Note – the determination of whether the individual can make contributions to each plan will depend on whether the individual maximized his contributions to the 401(k) Plan.
In conclusion, the determination of whether to use a Self Directed IRA and/or Solo 401k Plan as a retirement structure is largely dependent on whether one is self-employed, anticipates making annual contributions, has Roth IRA funds, and the type of investments being contemplated. Both structures offer wonderful tax and diversification advantages and should be given careful consideration when selecting a retirement strategy.