At one point in everybody’s life they have or will contemplate the dilemma of what retirement plan is best suited for them. There are over 45 million IRA today. However, that does not necessarily mean the IRA is the right retirement strategy. An IRA, governed by the rules pursuant to IRC 408, is the most common of retirement strategy simply because it is available to anyone that earns income subject to self-employment tax. In other words, any person that earns self-employment income may contribute to an IRA even though they may work for an employer that offers a 401(k) qualified plan. The determination of whether one can enhance their retirement savings with a Solo 401K wholly depends on whether that individual is self-employed and has a business. Note – a Solo 401K Plan is also known as an Individual 401K or a Self Directed 401K.
There are a number of significant advantages of establishing a Solo 401K over an IRA. Remember, that this option is only available to an individual that is self-employed or has a business with no full-time employees (an employee who works more than 1000 hours over the course of the year). In the case of an individual who is not self-employed, that individual may have the ability to contribute to an employer 401K qualified plan or SIMPLE IRA Plan, if such a plan exists. Alternatively, the individual can always make regular IRA or Roth IRA contributions each year.
The first major advantage of a 401K or Solo 401K plan over an IRA is in the area of annual contributions. While an IRA only allows a $5,000 contribution limit (with a $1,000 additional “catch up” contribution for those over age 50), a plan participant of a 401K or Solo 401K Plan can make annual contributions up to $49,000 annually with an additional $5,500 catch up contribution for those over age 50.
A second major advantage of a 401K or Solo 401K plan over an IRA is the ability to borrow retirement funds tax and penalty free. While an IRA offers no participant loan feature, the Solo 401k Plan allows plan participants to borrow up to $50,000 or 50% of their account value (whichever is less) for any purpose, including paying credit card bills, mortgage payments, personal or business investments, a car, vacation, or anything else. The loan has to be paid back over a five year period at least quarterly at a minimum prime interest rate (you have the option of selecting a higher interest rate).
Thirdly, unlike an IRA, Roth IRA or Self Directed IRA, with a Self Directed 401K Plan, the 401K bank account can be opened at any local bank or credit union. This benefit allows the Plan Participant (you) to serve in the trustee role. This means that all assets of the 401(k) trust are under the sole authority of the Solo 401k participant. A Solo 401(k) plan allows you to eliminate the expense and delays associated with an IRA custodian, enabling you to act quickly when the right investment opportunity presents itself. Making a Solo 401K Plan investment is as simple as writing a check.
Fourthly, like an IRA or Roth IRA, contributions to a 401K or Solo 401K plan are completely discretionary. You always have the option to try to contribute as much as legally possible, but you always have the option of reducing or even suspending plan contributions if necessary.
In addition, in the case of a Roth IRA or a Self Directed Roth IRA, those who earn high incomes are disallowed from contributing to a Roth IRA or, in most years, converting their IRA to a Roth IRA. The Solo 401(k) plan contains a built in Roth sub-account which can be contributed to without any income restrictions.
Moreover, like an IRA or Roth IRA, a Solo 401K or Individual 401K plan is easy to administer. There is generally no annual filing requirement unless your solo 401(k) Plan exceeds $250,000 in assets, in which case you will need to file a short information return with the IRS (Form 5500-EZ).
Lastly, for those looking to purchase real estate with their retirement funds, using a 401K or Solo 401K Plan will allow one to borrow non-recourse funds for the real estate acquisition and not be subject to any Unrelated Debt Financed Income (UDFI) or Unrelated Business Taxable Income (UBTI or UBIT).