The Self-Directed Individual 401(k) Retirement Plan

Also known as an individual(k) or solo 401(k) plan, this retirement account is designed for small businesses where the only employees are the business owners and/or their spouses. Examples for qualifying businesses could be sole proprietorships, partnerships, LLCs, and corporations, so long as you do not have any employees who work more than 1,000 hours a year and are over the age of 21.

This retirement account provides the greatest benefits for individuals with a yearly income between $57,000 and $165,000. However, if your spouse works with you and your compensation is greater than $100,000 a year, you may also enjoy the tax-sheltered advantages this plan offers.

Keep in mind that although you may qualify for this plan if you work with your spouse, common-law spouses do not count. You must be legally married and working together to contribute to an individual(k) retirement plan.

If you qualify for an individual 401(k) plan, below are the most important advantages you’ll be entitled to:

Higher contribution limits

Self-directed or not, all retirement plans are governed by the same rules set forth by the IRS—and this includes contribution limits. Traditional and Roth IRAs have a yearly contribution limit of $5,500, with a catch-up allowance of $1,000 if you are over 50. Individual (k) contribution limits are much higher.

With individual (k) plans, an individual may contribute quite a bit more to these plans and the total contributions include both employee and employer contributions. For businesses that qualify for an individual(k), the business owners are both the employee and the employer. For the year 2015, the contribution limits to the plan is $18,000 (with an additional $6,000 if 50 and over) of salary deferral (the employee contribution), plus a profit sharing match of up to 25 percent of your compensation (the employer contribution). You must ensure that the combined employee and employer contributions do not exceed $53,000 per person (or $59,000 if 50 and over).

Tax-sheltered retirement income growth

Larger contribution limits mean you are able to stash away more retirement funds each year. You also gain more capital in your individual(k) by doing so that enables you to acquire investments to continue building that income on a tax-sheltered basis. For example, real estate investments made in retirement plans do not incur the typical capital gains taxes upon sale. Instead, these earnings have the opportunity to grow exponentially inside the tax-sheltered account until the time you retire.

Roth 401(k) option

The individual(k) plan allows for contributions to be made with pre-tax dollars. Tax is paid when you begin taking distributions at retirement age. However, this plan has a Roth option allowing you to make contributions from your salary after tax—a huge caveat for most. Bear in mind that this only applies to employee contributions (salary deferral). All employer (profit sharing) contributions are made on a pre-tax basis.

The ability to acquire alternative investments

Self-directed individual(k) plans work the same way any other self-directed plan does in allowing account owners to control their own retirement funds. You are able to choose alternative investments based on your own experience and knowledge. While you are able to stick with the traditional stocks, bonds, and mutual fund route, you can also leap outside that Wall Street mindset and take on assets such as real estate, precious metals, oil and gas options, timberland—and so much more—to build retirement income.

Checkbook control of your retirement plan

The individual(k) plan allows account holders to be the trustees of their own retirement plans if they so choose. Many investors enjoy the freedom and flexibility the trustee position presents: a checkbook control feature enabling them to stroke a check for a prime investment immediately instead of waiting, giving them further control over their retirement funds.

Please note, being the trustee of your own plan requires diligent bookkeeping, reporting, and adherence to specific rules set forth by the IRS. Always consult with a tax professional or seek legal counsel when using retirement plans in this manner to avoid performing a transaction that could cause penalties, taxation, and even disqualification of your plan.

The ability to borrow funds from your retirement plan

Owners of individual(k) plans are able to borrow against retirement funds held in these accounts—in an amount of up to 50 percent of the plan’s balance or $50,000 (whichever is less). There are strict rules one must adhere to when doing so, including borrowing limitations and timely repayment. While this may seem a nifty little feature of these plans, be sure you are able to repay the loan within compliance of the rules. Otherwise, you may get yourself in trouble with the IRS and lose valuable retirement income.

If you have questions about this article or wish to learn more about self-directed individual(k) plans, please contact us.

About Jack Callahan

Jack proudly earned his bachelor’s degree in finance and multinational business from Florida State University and his law degree from the University of Florida College of Law. He established Advanta IRA in 2003 and has steadily nurtured and grown the company and the team every year since. Prior to founding Advanta IRA, Jack delivered specialized counsel to real estate investors, small business owners, and real estate professionals on tax, legal and financial matters. As an industry expert, Jack is a frequent speaker on self-directed retirement plans. He is an accredited continuing education instructor for the Florida and Georgia Bar Associations, Florida and Georgia Real Estate Commissions, and The American Institute of Certified Public Accountants.