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Solo 401k Educational Blog by MySolo401k.net
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Why Use a Solo 401k Plan instead of a Self-Directed IRA?

by Mark Nolan on 05/14/12

It makes more sense to Open Solo 401k (also known as Self-Directed Solo 401k or Individual 401k) over a Self-Directed IRA in all cases except two, which we will discuss later.  For now we will detail why Solo 401k easily trumps the self-directed IRA.

Solo 401k allows for higher annual contribution 

Solo 401k allows for higher annual contribution limits then self-directed IRA. For instance, for 2012 the owner-only business owner can contribute $50,000 and an extra $5,500 if age 50 or older (know as catch-up contribution) for total possible contribution of $55,500. On the other hand, the self-directed IRA maximum contribution for 2012 is $5,000 or $6,000 if you include the $1,000 catch-up amount. Visit Solo 401k Contribution Limits to learn more.

Solo 401k allows for higher Roth Contributions

For 2012 the self-employed business owner can contribute up to $22,200 to Roth Solo 401k. Specifically, $17,000 if under age 50 and an additional $5,500 if age 50 or older. The maximum Roth contribution for a self-directed IRA (Roth IRA) in 2012 is only $5,000 plus catch-up amount of $1,000.  Visit Roth Solo 401k to learn more.

Solo 401k allows for Participant Loan (borrow from Solo 401k)

If you borrow from your Self-Directed IRA, it will be deemed a taxable distribution. However, the owner-only business owner can borrow from his or her Solo 401k through what is known as a Solo 401k Participant Loan without having to pay distribution taxes or penalties. The maximum Solo 401k Loan amount is 50% of the participant’s solo 401k balance not to exceed $50,000.  The minimum Solo 401k Loan amount is $1,000 and multiple loans are allowed, you just can’t exceed the mentioned maximum limit when combining all Solo 401k loans.Visit Solo 401k Loan to learn more.

You can serve as Trustee of your own Solo 401k

The rules permit the business owner to Trustee his Solo 401k assets, meaning that you don’t have to use the services of a custodian to hold/safe keep the Solo 401k investments.  As a result, holding and investment processing fees are greatly reduced or completely eliminated, and processing times greatly reduced since you don’t have to submit investment processing directions to the custodian.  While a self-directed IRA has option of forming an LLC to reduce custodian involvement, the custodian ultimately has control over the self-directed IRA pursuant to IRS regulations. Therefore, the self-directed IRA participant will ultimately pay higher investment and processing fees when compared to the Solo 401k which does not require a custodian.

Solo 401k is not subject to UBIT

Unlike a Self-directed IRA which is subject to payment of unrelated business income tax when it utilizes debt financing to invest in real estate, a Solo 401k is generally not subject to payment of UBIT when it incorporates a nonrecourse loan to invest in real estate.  To learn about UBIT, visit Solo 401k UBIT. To learn about Nonrecourse loan, visit Solo 401k Nonrecourse Loan.

Solo 401k may not be subject to annual reporting

A self-directed IRA is subject to annual reporting (Form 5498) regardless of account value, whereas a Solo 401k may not be subject to annual reporting.  Solo 401k only requires filing of Form 5500 EZ once the total account value exceeds $250,000 and when you terminate the Solo 401k.  Visit Form 5500 EZ to learn more.

Lastly, the only two instances where a Self-Directed IRA is recommended over a Solo 401k are:

First Instance: At Death Roth Solo 401k Distributions Must Commence

When the Solo 401k participant deceases, the non spouse beneficiary is required to begin making distributions (Required Beginning Date) by 12/31 of the year following the Solo 401k participant’s death, and must continue making distributions every year until the account has been fully distributed. Not so with a Roth IRA. The non spouse beneficiary is not required to make distributions. One way to alleviate the Roth Solo 401k non spouse beneficiary from having to take annual distributions is to rollover the Roth Solo 401k funds to a Roth IRA before the participant deceases. To learn more about decedent distributions, contact MySolo401k.net.

Second Instance: When self-employment ceases, Solo 401k must be terminated

Unlike a Self-Directed IRA which is not subject to the self-employment rules, a Solo 401k must be closed once the self-employment business for which the Solo 401k was established through ceases. However, you have option to either directly rollover/rollover the Solo 401k to an IRA or another active 401k, or to take a full distribution, which may subject you to taxes and penalties. Contact MySolo401k.net to learn more. 

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