Solo 401(k) Plan: Self Directed vs. Custodial Account
“Planning is bringing the future into the present so that you can do something about it now.” ~ Alan Lakein
If you’re a real estate investor, you are quite likely to understand the importance of planning and then acting upon it. You might have funding in place for your next property or you probably have a list of sources/partners that you can bank upon.
So Far, so Good!
How do you plan to retire?
Do you have an exit strategy?
How would your portfolio appear if there was a real estate bubble burst like we witnessed in 2008?
A lot of real estate professionals might struggle to answer these questions. Really, what if’s can be extremely horrifying! However, instead of feeling terrible, you might as well use these questions as catalysts for creating an exit strategy or initiating a retirement plan. (How to choose real estate exit strategies for retirement)
For the sake of having a complete picture, let us find out how is the rest of America doing in retirement. A study conducted by the Board of Governors of the Federal Reserve System discovered that as many as 31% of the Americans had no retirement savings or pension plan in place for retirement, as of 2013. To make these figures even worse, the median retirement account balance for households aging 55 to 64 was $14,500 only! Isn’t that a bit disturbing?
There’s no doubt that you can live off the real estate portfolio you have created over the past couple of years or even decades, but there’s no harm in having some extra padding. Is there? After all, not every single one of us will retire with a 500-property portfolio.
Solo 401(k) Plan for Retirement
If you are a regular BP member, Solo 401(k) plan could be a familiar term, especially if you’re active in the forums. However, if you are not familiar with the option, Solo 401(k) is a qualified retirement plan for self-employed professionals, sole proprietors, and owner-only businesses, allowing them to save strategically for their retirement.
Why did I say‘strategically?’ Unlike the traditional retirement plan, the IRS allows you to self-direct investments in your Solo 401(k) plan, although the option may differ from one provider to another. Before going deep into this concept, let’s look at some of the best features of Solo 401k plans.
- Annual contributions of up to $59,000
- Participant loan of up to $50,000 or 50% of account balance*
- Self-direct your retirement plan**
- Roth option available
- Checkbook control***
- No minimum annual contributions
* May vary depending upon the plan provider
** Traditional custodial institutions generally don’t offer this feature
*** Available with selected self-directed plan providers
Should you choose self-directed Solo 401k or big banks’ Solo 401(k) plan?
Considering the higher contribution limits and Roth option, this might just be the answer for high-income realtors. Here’s a big question:
Do you want to self-direct you Solo 401(k) plan’s investments or choose from investment options offered by major financial institutions?
In order to answer that let us find out more about the custodial Solo 401k plans offered by traditional financial institutions.
What features you might miss with custodial accounts?
- No Participant loan: A quick online research will show that most of the major institutions do not offer a participant loan.
- No Self-directed investments: Financial institutions limit investment options to stocks, bonds, mutual funds, and other financial products they offer.
- No Checkbook control: You will not get the checkbook control feature. Every transaction needs to be approved by a custodian and may lead to additional delay and/or transaction fees…
What features you will receive with a truly self-directed Solo 401(k) plan?
- Participant loan: You can borrow up to $50,000 or 50% of your account balance, whichever is less. This is a particularly beneficial feature for owner-only businesses and self-employed professionals. No credit check, no minimum credit requirement, and an affordable interest rate (prime rate plus 1%).
- Self-directed investments: You get the liberty to invest your money in non-traditional investment options, including real estate, precious metals, mortgage notes, tax liens, tax deeds, private financing and similar custom options.
- Checkbook control: You are in complete control with checkbook feature, allowing you to make investments at your discretion. You won’t have to seek custodian consent and investing would be easier than issuing a check.
Think about: Financial institutions offer traditional investment options only and charge a fee every time you make an investment. With self-directed investments, they might lose their recurring fees, which is among the primary reasons why they offer $0 accounts.
While for professionals with a limited understanding of investment tools, Solo 401(k) plan offered by traditional institutions might work, but it will certainly not offer the flexibility sought by experienced investors.
Considering these points, you are free to make a choice, but keep in mind that every dollar you spend on fee could be $10 in three decades (at an annual interest of 8%) because of compounding interest. Pick your plan carefully!