5 Advantages of a Self-Directed Solo 401(k) Plan for the Self-Employed

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The Gig Economy is coming of age. With it, a new generation of workers has come to light, one that is made up of self-employed professionals and freelancers. A survey conducted by the Freelancers Union and Upwork states that as many as 54 million Americans did freelance work in 2015. That is around one-third of the U.S. labor market.

Does that not sound like a shift in the American working landscape?

Well, it is a major change and one that should grow at an exponential rate.

Self-employment — sounds like freedom from the 9-to-5 routine? It is freedom of a sort. One that allows you to choose your hours and whom you work with. But every freedom comes at a cost. In this case, it is to be responsible for your future.

Unlike their employed counterparts, self-employed workers do not have an employer-sponsored retirement plan. Some may see this a downside. But if viewed through the correct lens, it could speed the self-employed toward a fulfilling retirement. Sounds too good to be true!

Hold on, let us unveil the secret…

Self-Directed Solo 401(k) Retirement Plan

There it is! A single retirement/investment vehicle that could put you ahead of your employed peers, if you are ready to comply.

What is it? How does it help me, a self-employed professional?

A self-directed Solo 401(k) plan is a qualified retirement plan aimed at self-employed professionals, allowing them to make solid contributions to their retirement.

The only prerequisites for opening a self-directed retirement plan are:

  • Presence of self-employment activity (part-time or full-time)
  • Absence of full-time employees

Five Features That Give Self-Directed Solo 401(k) Plans an Unfair Advantage

1. Higher Contribution Limits

Did you ever wish you could put more toward your retirement? The average IRA allows annual contributions of up to $7,000 (including catch-up contribution), making it somewhat hard to build up retirement funds quickly.

Self-directed Solo 401(k) plans stand apart, allowing you contribute up to $63,500 annually (including catch-up contribution).

Wait! What? Are you sure?

Yes, that's correct.

A higher limit allows you speed up your retirement savings. If you have a plan to retire at 35 or 40, this might just be the way.

2. Alternate Investment Options

How many times did you plan to invest in something other than stocks and bonds but were limited by the investment choices in your retirement plan?

The traditional retirement plans restrict your investment options to stocks, bonds, and mutual funds. Did you ever think why it is so? First, these financial institutions (the brokerage) make money when you choose their products. They do not have any incentive to offer you other options.

Self-directed Solo 401(k) retirement plans, on the other hand, offer a plethora of investment asset classes to choose from. You can invest in:

All you need is to know these asset classes well. Then you are ready to start.

3. Complete Investment Discretion

When self-employed, you are used to a degree of freedom. You can choose your clients, your work hours, your workspace. You can also put effective strategies in place.

But when it comes to investing for your retirement, you suddenly find restrictions everywhere. Sometimes it seems as if you need at least a dozen permissions to invest your own money.

Self-directed Solo 401(k) retirement plans take that restriction away. You are in full control of your investment vehicle. You choose whatever assets you feel are right for your portfolio.

You have checkbook control over your retirement funds. This allows you to make investments via a check. Custodian consent is not needed. You do not pay a processing fee for every transaction. Just start with a financial strategy that suits your goals, and begin investing.

4. Participant Loans

While freelancing has its perks, it also has its own set of drawbacks. For instance, a tough credit approval environment.

A Zillow report states that the self-employed tend to receive 40% fewer quotes than salaried workers when applying for a mortgage. The report puts lower credit score and extra paperwork as the main reasons for fewer quotes.

As freelancers or self-employed professionals, financial ups and downs are common. You cannot predict how a season is going to end for you!

Self-directed Solo 401(k) plans are here to rescue you!

They allow participant loans of up to $50,000 or 50% of your retirement account balance. Whichever is lower. Also, nobody controls how you spend that money. You can use it to pay for college, buy a new house or even grow your business.

Let’s look at the features of a Solo 401(k) participant loan:

  • Loan of up to $50,000 or 50% of the account balance per plan participant
  • No credit requirements
  • Low interest rates (prime rate + 1%)

5. Roth Saving Option

How about a retirement free of income taxes? Isn’t that what each one of us could wish for?

Well, now you can fulfill that wish with a Roth Solo 401(k) plan. Yes, you read that right. Self-directed Solo 401(k) plans can have a Roth component. This allows you to contribute post-tax dollars to your account. You can contribute up to $26,000 (including catch-up contribution) to your Roth Solo 401(k) plan in 2020.

Further, any gains on your investments within a Roth Solo 401(k) plan are tax free. Say you bought a house with your plan. You then had it leased with a consistent rental income and later sold it with a significant appreciation. You pocket all the returns, tax free!

3 Rules You Must Know About Solo 401(k) Plans

  • Prohibited transactions: The IRS is strict with the way you handle your retirement funds. Prohibited transactions must be avoided. The IRS states, “[A] prohibited transaction in an IRA is any improper use of an IRA account or annuity by the IRA owner, his or her beneficiary or any disqualified person.” The penalty is that your plan is likely to be cancelled and lose its tax-deferring status. There may also be other penalties or charges.
  • Maintenance of your plan: Any income that comes out of the assets of your Solo 401(k) plan should go straight into the plan. Any costs involved with these assets should be borne by your plan.
  • Use of credit/financing: The only eligible credit source for a self-directed plan is a non-recourse loan. A non-recourse loan is one that takes the core property as the collateral and does not require any personal guarantee. In the case of a default, the lender’s claim is limited to the property itself. This safeguards the plan owner. You cannot use your personal funds to buy a house or private equity within your plan. The good thing is that there are a number of non-recourse lenders ready to offer the necessary financing.

Much like self-employment, a self-directed Solo 401(k) plan allows freedom in pretty much every respect. With a sound investing strategy, it could help you retire rich and let you keep your money for yourself.

Editor's Note: Dmitriy Fomichenko is the founder and president of Sense Financial Services LLC, a boutique financial firm specializing in self-directed retirement accounts with checkbook control. He began his career in financial planning and real estate investing in 2000. He owns multiple investment properties in various states and is a licensed California Real Estate Broker. Over the years, he has instructed hundreds of investment and financial planning seminars and has mentored thousands of investors.

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