How to setup a self directed IRA/401k

Question

I have a 401k from a previous employer and interested in the idea of using a portion of those funds for long term returns (buy and hold rental properties).  I have two questions.

1.  How does a self directed IRA differ from a self directed 401k (funds are currently in a 401k)?

2.  How do you set up the account?

Dmitriy Fomichenko · Answer

Jason,

In order to set up a self-directed IRA you need to identify a custodian allowing alternative investments. The next step is to rollover the funds from your 401k into this new account. And now you are ready to start making alternative investments.

A self-directed Solo 401k is designed for those who are self-employed or own a small business without full time employees, so if you don't meet those requirements this plan would not be for you. However if you are eligible - this plan is superior to SD IRA for several major reasons.

Your former employer 401k can be rolled over into either self-directed plan.

The topic of self-directed investing is a frequent discussion here on the forum so my suggestion to you would be to do a search using related keyword and you will find plenty of conversations to read and learn from.

George Blower · Answer

@Jason Turo

Following are the similarities and differences between the solo 401k and the self-directed IRA.

The Self-Directed IRA and Solo 401k Similarities

• Both were created by congress for individuals to save for retirement;
• Both may be invested in alternative investments such as real estate, precious metals tax liens, promissory notes, private company shares, and stocks and mutual funds, to name a few;
• Both allow for Roth contributions;
• Both are subject to prohibited transaction rules;
• Both are subject to federal taxes at time of distribution;
• Both allow for checkbook control for placing alternative investments;
• Both may be invested in annuities;
• Both are protected from creditors;
• Both allow for nondeductible contributions;
• Both are prohibited from investing in assets listed under I.R.C. 408(m).

The Self-Directed IRA and Solo 401k Differences

• In order to open a solo 401k, self-employment, whether on a part-time or full-time basis, is required;
• To open a self-directed IRA, self-employment income is not required;
• In order to gain IRA checkbook control over the self-directed IRA funds, a limited liability company (IRA LLC)  must be utilized;
• The solo 401k allows for checkbook control from the onset;
• The solo 401k allows for personal loan known as a solo 401k loan;
• It is prohibited to borrow from your IRA;
• The Solo 401k may be invested in life insurance;
• The self-directed IRA may not be invested in life insurance;
• The solo 401k allow for high contribution amounts (for 2016, the solo 401k contribution limit is $53,000, whereas the self-directed IRA contribution limit is $5,500);
• The solo 401k business owner can serve as trustee of the solo 401k;
• The self-directed IRA participant/owner may not serve as trustee or custodian of her IRA; instead, a trust company or bank institution is required;
• When distributions commence from the solo 401k a mandatory 20% of federal taxes must be withheld from each distribution and submitted electronically to the IRS by the 15th of the month following the date of each distribution;
• Rollovers and/or transfers from IRAs or qualified plans (e.g., former employer 401k) to a solo 401k are not reported on Form 5498, but rather on Form 5500-EZ, but only if the air market value of the solo 401k exceeds $250K as of the end of the plan year (generally 12/31);
• When funds are rolled over or transferred from an IRA or 401k to a self-directed IRA, the amount deposited into the self-directed IRA is reported on Form 5498 by the receiving self-directed IRA custodian by
• May of the year following the rollover/transfer.
• Rollovers (provided the 60 day rollover window is satisfied) from an IRA to a Solo 401k or self-directed IRA are reported on lines 15a and 15b of Form 1040;
• Pre-tax IRA contributions on reported on line 32 of Form 1040;
• Pre-tax solo 401k contributions are reported on line 28 of Form 1040;
• Roth solo 401k funds are subject to RMDs;
• A Roth 401k may be transferred to a Roth IRA (Note that from a planning perspective, it may be advantageous to transfer Roth Solo 401k funds to a Roth IRA before turning age 70 ½ in order to escape the Roth RMD requirement applicable to Roth 401k contributions including Roth Solo 401k contributions and earnings.);
• Roth IRA funds are not subject to requirement minimum distributions (RMDs);
• The fair market value (FMV) of assets held in a self-directed IRA is reported on form 5498;
• The fair market value of assets held in a solo 401k are reported on Form 5500-EZ;
• At termination, the solo 401k is required to file a final Form 5500-EZ and 1099-R; and
• At termination, the self-directed IRA is only required to file a form 1099-R.

Brian Eastman · Answer

@Jason Turo

This is a broad topic with no simple 3 sentence answer to your above questions.  There are several flavors of self-directed IRA/401k plans that can be used to invest in real estate.  Which will be best for you will depend on your circumstances and goals.

An IRA is an Individual Retirement Arrangement.  Such plans are typically good for taking existing IRA/401k savings and moving that to a vehicle you control for different investments.  IRA plans can be held by a 3rd party self-directed custodian (Think E*Trade with different paperwork) for investing in non-traditional assets.  The custodian will hold the funds, sign every document, cut every check, etc for the benefit of your IRA.  Alternately such IRA plans can be configured to provide you with direct control over the funds out of a bank account of your choosing via what is referred to as a self-directed IRA LLC or Checkbook IRA.  This latter model is generally more efficient for time-sensitive and transaction intensive assets such as real property,

A Solo 401(k) is similar to the above mentioned checkbook IRA, but is configured on a self-employed version of a 401(k) plan.  Such plans are available to those who are self-employed and have no full time employees other than their spouse.  The 401(k) has higher contribution limits than an IRA, so a self-employed person can add more of their income to the plan on a tax-sheltered basis each year in addition to have investment flexibility as a self-directed plan.  The 401(k) has some other advantages for those who qualify such as exemption from a small tax (UDFI) that an IRA will pay when using debt-financing such as mortgages.

There are several providers of such plans active here on BP.  Do some reading and then get on the phone to have an expert help you navigate your options.

Randy Rodenhouse · Answer

I spent many years reviewing the different plans and then wrote a short book on self directed investing using an IRA, solo 401k, etc.  I have a solo 401k (which has a Roth portion) and a Roth SDIRA and have purchased and sold RE, purchased notes and have done some private lending, etc.  I wrote a short book on it called "Stock Market Crash Diet" (go to Amazon and type my name Randall Rodenhouse and it will pull up)  which is a guide to alternative asset investing and explains all the different government sponsored retirement plans.  To me it is all about investing less in stocks bonds and mutual funds which I have no control over and more into RE secured investments.  Make sure your plan specifies exactly what you can and can't invest in.

Daniel Dietz · Answer

In all seriousness do a little more reading up on things, and then give a few of the people like the three guys above who participate her on BP a call and see who is a good fit and get a few references. The best day of my life in regards to this is when I quit trying to find a 'local' provider and found BP :-) !

There are LOTS of rules involved, but with guidance and self education it is not too hard to figure out.

We have both SDIRAs and SOLO401Ks.

Dan Dietz

How to setup a self directed IRA/401k

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