You don't need an outside custodian, just a plan advisor. The paperwork isn't that hard. The cost difference wasn't comparable when I started. It will take more of your time, but not that much if you are interested enough to follow and understand the rules.
You do need a business, any ordinary business. The business doesn't have to be profitable every year, although the strategy is amplified when you have business profits and can defer more taxes by investing those to your Solo K. Probably the biggest hurdle is the business has to be owned by husband and/or wife with no employees. Or I think perhaps also for 2 partners, but still no employees. Our's is a very small part time consulting practice. It's always been profitable, but only 5-30K per year depending on the work available and our interest in working.
We started our Solo K after retiring from ordinary full time jobs in 2013, consolidating funds from several prior employer sponsored 401K's and our personal IRA's. Within a year, we had 12 rental doors, mostly single family with a couple duplexes, all acquired with no financing. Since then, we traded one that was exceptionally hard to manage for one that wasn't, sold one to a tenant and replaced it, and sold one for distributions.
The Solo K has worked exceptionally well for us, here are some thoughts for those who might do something similar:
- We were exceptionally lucky with timing. One of the SFH's purchased in 2014 for $65K, just sold for $320K. While we do spend whenever needed for good maintenance, roofs (we've done all but 1 now), HVAC, paint, flooring etc...we have not made any significant improvements. This sold house came with a kitchen that would have made any chef in the 1950's happy, I'm sure the appliances have all been replaced, along with the flooring, but it wasn't improved. That was probably a lost opportunity, had the house been improved, it would have likely sold for $400K. We will be looking at doing this different in the future.
- Financing. We have none. This breaks the often stated rule about using OPM, other peoples money. Very early on I looked real hard at doing just that. But you can't use traditional financing, it must be non-recourse. That raised financing costs from 3-4% to about 8%. It's essentially hard money, unless you have a rich friend. Afraid to ask what that number would be today, althogh the difference may be less now. At the end of the day, our analysis showed that financing would basically eliminate the income part of the equation and profit would only come from appreciation. In hindsight, another lost opportunity. But...still happy. There is far more risk with financing at those kind of rates, and after all, the plan held retirement savings we needed soon. But the deal breaker was work. We self manage, we didn't want to double or triple the amount of work necessary keep the operation running. Sure if I could have known for sure, we would see 400% appreciation over 10 years, I would have done things different. But you can't.
- Self management, to clarify, is basically advertising, showing property, selecting tenants, signing leases and hiring contractors to do repairs. It's not actually making repairs or improvements. That's not allowed since it's considered a "contribution" to the value of the 401K. Using a property manager has potential, but does reduce income. In our case, we were not happy with the gains seen in our traditional 401k holdings, and part of the transition to the Solo K, we wanted more hands on control of how our investments worked out.
- Finally, we went 100% invested residential rentals. While it's a good problem to have, since the Solo K has done so well, we are spending more in retirement than originally planned. Our mix of pre-tax to post-tax investments is out of balance. For example, we had several years with really small amounts of taxable income, should we have distributed more out of the 401K earlier and reinvested post tax? We didn't, and as a result our income tax bill has gone from near nothing to something we might have avoided. There are many moving pieces here, Social Security timing, transition from ACA to Medicare, how much of your wealth is to be left as a legacy and the investment strategy that keeps your investments in large unseperable chunks. There is a great tool to game alot of this out, I started too late to see all the benefit. Take a look at MaxFi if this situation looks like it might impact you.
