Solo 401k versus Self-Directed IRA

I get many questions about Solo 401k versus Self-Directed IRA. Here are tips to help you decide.

Solo 401k versus Self-Directed IRA

A Solo 401k is a great retirement plan for self-employed individuals or business owners with no employees or part-time employees only. After extensive research and talking to different companies, I recommend a Solo 401k over a Self-directed IRA for the following reasons:

1. Contribution is higher with Solo401K than SDIRA.

To me, the most important difference is the contribution limits. The max for a SEP-IRA is up to 25% of compensation with a cap of $49,000 for 2011. On the other hand a Solo 401(k) allows profit sharing contributions of up to 25% of compensation plus tax-deductible salary deferrals to the plan of up to $16,500 for 2011. The cap is the same at $49,000.

So while the caps are the same, you can make very little self-employed income and basically defer it all, which you can't do with the SEP-IRA. This gives you that added flexibility which is especially beneficial for those who have some self-employed income as secondary income and want to get the most tax advantages. For example, if you made $15,000 of eligible compensation, you could sock all $15,000 of it away with a Self-Employed 401(k), but only $3,750 with a SEP-IRA.

2. Solo 401k Allows for Loans

A Solo 401k loan is permitted at any time using the accumulated balance of the Solo 401k as collateral for the loan. Loans in a Solo 401k are permitted up to 1/2 of the total balance of the Solo 401k up to a maximum of $50,000.

3. Administrative burden is minimal.

There is no need to hire a custodian for a Solo 401k. While IRA & 401k plans are both technically trusts, only IRAs require a bank or trust company to serve the role of trustee. As a qualified plan, a 401k carries no restrictions on who can serve as trustee.

Trusts and trustees. 401(k) plans are funded through a trust established to hold and invest the plan's assets. At least one trustee is appointed to have responsibility for the activities of the trust and its assets. This is a serious responsibility with considerable potential for liability. Trustees might include the business owner, an employee, or a financial or trust institution.

4. Low set up cost since you do not have to pay the typical fees that you would pay to custodian and trustees. Solo 401ks are easy to set-up and inexpensive to maintain – Unlike larger 401(k) plans, there are no complicated administrative requirements. You have to file an IRS Form 5500-EZ when plan assets exceed $250,000.

5. Flexibility and speed in investing since you bypass custodian approvals

6. Plan can be set up by 12/31 but contributions can be made up to tax extension time depending on your entity structure

You can get more information about my Solo401k Program HERE

Here's a recent question from my blog:

QUESTION: How are tax liens investments being taxed? I am yet to speak with an accountant thus ask the question here to get an idea. I have bought the tax liens past summer. Most of them were redeemed within the first couple of months. On the rest I am hiring an attorney to proceed with the foreclosure. ?Anticipating they will get redeemed before the summer of next year (holding period is less than a year), am I going to pay a regular income tax rate on the collected interest? ?I understand the tax liens are passive investments in nature, but I am not sure if the 12-months holding period applies to them.

ANSWER: It depends on what you get at the end. In your case, because they are redeemed, then all you have is interest income which is passive income. If the properties are not redeemed and you foreclose, then it depends on your investment intent at that time. If you hold the properties, then it's passive but if your intent is to flip, then it is active subject to Self Employment Taxes.