Solo 401k Benefits / Disadvantages
Rental Property Investor · Medford, MA · Member since 2016 · 288 posts · 171 votes
Hey folks,
Currently I am in an "early growth stage" as a real estate investor. I have three properties under my belt, and looking to grow much further beyond that. By day, I'm a video producer and operate a couple of LLC's doing production work and my only retirement setup at the moment is a Roth IRA. Interested in opening a Solo 401k. Obviously this would be beneficial in that I'm skirting some tax money until later in life and thus reducing my taxable income.
However, here's the rub.
I'm not rich. I don't have tens of thousands just laying around. I would LOVE to be able to borrow and take a loan out against the 401k which I know you can do.. BUT it's limited to 50% of the value (limit of $50,000 total). In essence, in an effort to save on taxes, I'm limiting the amount at which I can use my own funds to acquire properties.
Has anyone dealt with this conundrum and what are your thoughts on this situation?
Thanks!
@Christian Nachtrieb, hopefully some of the 'Pros' on here will chime in too. I personally use @Dmitriy Fomichenko at Sense Financial, and there are several other good providers here on BP too like @Brian Eastman and other that will chime in here.
In short, you can not to my knowledge do these at 'the big firms' - you need to use a specialized provider. I intentionally picked on from those who participate here on BP as I figured if they take the time to participate here, they will give *me* the time I need when I contact then too.
Co-mingling funds can get VARY complicated and I would NOT recommend it. Did it once and was releived to get out of it. You CAN borrow non-recourse funds (there is a list that float around here of providers for those) that typically require 35-50% down payment. We currently have loans on three properties (8 units).
One of the other restrictions is that you can not provide labor, like in the case of doing the work on a flip property yourself.
I think tonights BP Webinar is actually on Self Directed Accounts, might be worth a listen!
Dan Dietz
@Christian Nachtrieb, if I am following you correctly you qualify for a SOLO401K and are looking at using that for real estate investing?
Did you know that you can use that and/or a Self Directed IRA to invest DIRECTLY in real estate? I do both currently. There are some limitations compared to 'borrowing' from a SOLO401K, but it does let you put 100% (or close) of your funds to work.
One of the benefits to the SDIRA is that almost ANYONE can do it, regardless of self employment, etc.... The drawbacks of the SDIRA are the contribution limits and that IF you want to borrow non-recourse money there is paperwork and a small tax that apply.
The benefits of the SOLO401K are the much higher contribution limits, and the fact that you can be your own 'administrator' (not sure if that is the correct term) and that IF you want to borrow non-recourse money there is next to no paperwork, or tax, involved compared to the SDIRA.
Both of them carry the liability of making sure that you avoid 'prohibited transactions' and dealing with 'disqualified individuals'. I dont *think* those things pertain if you 'borrow' from your SOLO401K, but I'll let others clarify that.
Dan Dietz
Hey folks,
Currently I am in an "early growth stage" as a real estate investor. I have three properties under my belt, and looking to grow much further beyond that. By day, I'm a video producer and operate a couple of LLC's doing production work and my only retirement setup at the moment is a Roth IRA. Interested in opening a Solo 401k. Obviously this would be beneficial in that I'm skirting some tax money until later in life and thus reducing my taxable income.
However, here's the rub.
I'm not rich. I don't have tens of thousands just laying around. I would LOVE to be able to borrow and take a loan out against the 401k which I know you can do.. BUT it's limited to 50% of the value (limit of $50,000 total). In essence, in an effort to save on taxes, I'm limiting the amount at which I can use my own funds to acquire properties.
Has anyone dealt with this conundrum and what are your thoughts on this situation?
Thanks!
There are some compelling reasons to use a Solo 401(k) . . . .if your investment style fits the template. If you are a "steady eddie" investor and plan everything out and stick to your plans, it may well work for you.
You have to have faith in the government that they won't change the rules on taxation down the line. If you believe that things are as they always will be, (first you should look at the past and see if that is a reasonable assessment of what the future brings) then taking into account: limitations on what you can invest in, your Solo 401(k) "projected" growth, fees & hidden fees, you can't co-mingle funds, you have to carefully manage the process, future tax increases, tax law changes, a national debt that is north of $22 Trillion dollars, unfunded liabilities and and of course inflation, along with possible "bail ins" then you are well equipped to decide if that is a good choice for your style of investing.
However, If you are an "opportunistic investor" . . . . you jump at the opportunity when it arises, then you run into some conflicts. The amount you need for the opportunity may exceed the amount you have in the Solo and you've split your resources to the point where you can't do the deal. There is far less concern about violating Solo rules if you are investing outside a Solo, obviously.
I find that in my particular case, having unfettered access to cash has given me investment opportunities I couldn't have done in a Solo with the limitations they have. Since I hold my properties for a life time and my heirs will "probably" have an adjusted cost basis (if the rules don't change ;-) I avoid tax on the properties anyway. I cash flow my properties and I am not concerned about equity growth. I get great tax write offs, I live off the cash flow and I invest because I love the process and the challenges of finding great off market properties.
Your mileage may vary.
Hey @Daniel Dietz Actually I have heard of the Self Directed IRA but other than that small nugget (you can invest that money in real estate) I really have no idea how it works.
Can it be opened with one of the bigger brokerage houses like Ameritrade / Fidelity?
Let's say I only have $10,000 in there but I need $20,000 for an investment in a property.. can those funds co-mingle if one is coming from a non tax deferred account?
Thanks so much, I'll start looking more into that for sure.
@Christian Nachtrieb, hopefully some of the 'Pros' on here will chime in too. I personally use @Dmitriy Fomichenko at Sense Financial, and there are several other good providers here on BP too like @Brian Eastman and other that will chime in here.
In short, you can not to my knowledge do these at 'the big firms' - you need to use a specialized provider. I intentionally picked on from those who participate here on BP as I figured if they take the time to participate here, they will give *me* the time I need when I contact then too.
Co-mingling funds can get VARY complicated and I would NOT recommend it. Did it once and was releived to get out of it. You CAN borrow non-recourse funds (there is a list that float around here of providers for those) that typically require 35-50% down payment. We currently have loans on three properties (8 units).
One of the other restrictions is that you can not provide labor, like in the case of doing the work on a flip property yourself.
I think tonights BP Webinar is actually on Self Directed Accounts, might be worth a listen!
Dan Dietz
The big brokerages do not allow for investment into alternative assets such as real estate with their plans. If you setup a Solo 401k with a more flexible provider, you can get access to participant loans as well as invest into real estate and still have the ability to open an account for the plan with a brokerage. This will open your options up considerably.
It's usually best not to mix personal and retirement funds in an investment. Sometimes a participant loan can help you fund an investment outside of retirement funds. Also, the Solo 401k plan can utilize non-recourse loans to leverage its assets for an investment done inside the plan.
Generally, if someone is eligible for a Solo 401k it will be a better choice than a self-directed IRA. Here are some reasons why:
@Justin Windham That's super helpful thanks so much for laying that all out. I'm thinking Solo 401k might be the best option. Real quick, can you elaborate a little on one of your points? What are the additional tax benefits with investing in real estate with a Solo 401k and leverage?
When a self-directed IRA invests into real estate and uses financing, returns on the debt-leveraged portion of the investment are subject to unrelated debt financed income tax or UDFI tax. This is a type of UBIT or unrelated business income tax. The Solo 401k, on the other hand, is exempt from UDFI tax on leveraged real estate.
You might be misunderstanding the purpose of the 401k loan. It is designed to provide you with the access to your retirement funds in case of dire personal financial need. In a situation like this if you had an IRA the only way to cover the need is to take a distribution from your IRA, which would be subject to taxes and penalties, resulting in losing up to 50% of the amount you take out. 401k allows you to take personal loan from it without penalties or taxes, the loan has to be repaid back using amortized payment over period of 5 years.
However you don't need to take a loan to invest if you have a truly self-directed Solo 401k plan. You can invest all of your money (not just half) into virtually anything (must be aware of the prohibited transactions). When you make the investments it grows in a tax-deferred (or tax-free environment if you are using Roth).
Your Comment: "In essence, in an effort to save on taxes, I'm limiting the amount at which I can use my own funds to acquire properties."
That is correct. I ran a spreadsheet on my kind of investing and didn't help to have a Solo 401(k) with it's limitations and rules.
I think it boils down to how much you think you will need at retirement. A lot of financial planners say 4% yearly withdrawal is a safe number. So, if in the future you need $6,500 a month income you will need $2,000,000 @ 4% withdrawal in your Solo 401(k). (Ball park figures) The real question is "how do you get to that number most efficiently". If you run the numbers investing the max in your Solo 401(k) can you achieve the numbers?
@Account Closed Yea that's sort of what I was thinking. **Being able to achieve the returns necessary aside** ... I don't necessarily have the personality to be able to hold an asset like a stock for long term. I have an itchy trigger finger, part of the reason why I like real estate is because it forces me to do better homework and stick with it for the long term.
I guess my worry is, am I dumb for not "sheltering" money in a Solo 401k at all? Again, not making a crazy amount of money I earned $90k gross last year doing freelance / W2 money from my company.
@Account Closed Yea that's sort of what I was thinking. **Being able to achieve the returns necessary aside** ... I don't necessarily have the personality to be able to hold an asset like a stock for long term. I have an itchy trigger finger, part of the reason why I like real estate is because it forces me to do better homework and stick with it for the long term.
I guess my worry is, am I dumb for not "sheltering" money in a Solo 401k at all? Again, not making a crazy amount of money I earned $90k gross last year doing freelance / W2 money from my company.
I started out doing Fix & Flips and made a lot of money and since it is short term capital gains, I paid a lot of taxes. I was having fun but working too hard. Then I went to "cash flow" which is similar to Buy & Hold except instead of buying a property and putting a renter in and getting 1st month's rent, & deposit and hoping the house doesn't get torn up or have a vacancy, I put in Tenant Buyers who give me $20k to $25k down on a Lease Option. There is more to it but I get the $20k, 1st month's rent along with all of the tax write off's. I can then reinvest that money.
My model doesn't work well in a Solo 401(k), but because my taxes are favorable in this model, t doesn't much matter that it isn't in a Solo 401(k). I get depreciation, principal pay down, positive cash flow of usually about $500 or more per month per property, and the Tenant Buyer maintains the property (so, no toilets to worry about ;-). Each $200,000 property I do returns about $250,000 over 10 years. (I buy "off market" and usually have some immediate equity). Since I don't use real estate agents I can buy a property for a discount since the seller doesn't need to pay that fee and we split the savings. My only costs are Title & Escrow. No hidden fees like a 401(k). It's something like this: This is 7th frame of a comparison I did with two kinds of turnkey. The one on the left is based on Ohio and Memphis type Turnkey. The one I do is on the right and in Arizona. I'm sure it can be applied in all but the most expensive markets. CLICK on Image to Enlarge.