Self-Directed Solo 401k vs. Self-Directed IRA


Both the self-directed solo 401k and the self-directed IRA fall under the retirement accounts classification of the internal revenue code (IRC) which, among other things, means they are both afforded tax favored status.

What is a Self-Directed Solo 401k?

Besides having the option to self-direct it, a solo 401k plan is a defined contribution plan that covers only an owner (or owner and spouse) or partners (or partners and spouses).

What is a Self-Directed IRA?

IRA is an acronym for individual retirement arrangement for an individual’s benefit. The IRA can be self-directed similar to the solo 401k plan but self-employment income is not required in order participate in an IRA.

Self-Directed Solo 401k vs the Self-Directed IRA

Following are the similarities and differences between the solo 401k and the self-directed IRA.

The Self-Directed IRA and Solo 401k Similarities:

  • Both were created by congress for individuals to save for retirement;
  • Both may be invested in alternative investments such as real estate, precious metals tax liens, promissory notes, private company shares, and stocks and mutual funds;
  • Both allow for Roth contributions;
  • Both are subject to prohibited transaction rules;
  • Both are subject to federal taxes on the pretax funds portion at time of distribution;
  • Both may be invested in annuities;
  • For both, creditor protection is based on the participants state of residence not under federal law;
  • Both allow for nondeductible (after-tax) contributions;
  • Both are disallowed  from investing in collectibles (e.g., artwork, rugs, antiques, gems, stamps, alcoholic beverages, etc.; and
  • Neither may be invested in your own Retirement funds business startup.

The Self-Directed IRA and Solo 401k Differences:

  • In order to open a solo 401k, self-employment, whether on a part-time or full-time basis, is required;
  • To open a self-directed IRA, self-employment income is not required;
  •  A limited liability company (self-directed IRA LLC) is used in order to gain checkbook control over the self-directed IRA;
  • The solo 401k allows for checkbook control so an LLC is not required;
  • The solo 401k allows for personal a loan known as a solo 401k participant loan;
  • It is prohibited to borrow from your own IRA;
  • The Solo 401k may be invested in life insurance;
  • A self-directed IRA is disallowed from investing in life insurance;
  • The solo 401k allows for high contribution amounts (for 2020, the solo 401k contribution limit is $57,000 or $63,000 if age 50 or over, whereas the self-directed IRA contribution limit is $6,000 or $7,000 if you’re age 50 or older);
  • The solo 401k business owner can serve as trustee of the solo 401k;
  • The self-directed IRA participant/owner may not serve as trustee or custodian of her IRA; instead, a trust company or bank institution is required;
  • When distributions commence from the solo 401k a mandatory 20% of federal taxes must be withheld from each distribution and submitted electronically to the IRS by the 15th of the month following the date of each distribution;
  • The self-directed IRA is not subject to upfront federal tax withholding;
  • Rollovers and/or transfers from IRAs or qualified plans (e.g., former employer 401k) to a solo 401k are not reported on Form 5498, but rather on Form 5500-EZ, but only if the air market value of the solo 401k exceeds $250,000 as of the end of the plan year (generally 12/31);
  • When funds are rolled over or transferred from an IRA or 401k to a self-directed IRA, the amount deposited into the self-directed IRA is reported on Form 5498 by the receiving self-directed IRA custodian by May of the year following the rollover/transfer.
  • Rollovers (provided the 60 day rollover window is satisfied) from an IRA to a Solo 401k or self-directed IRA are reported on lines 4a and 4b of Form 1040;
  • Pre-tax IRA contributions on reported on line 19 of Schedule 1, which is an attachment to Form 1040;
  • The tax deduction of pre-tax solo 401k contributions depends on the type of self-employed business sponsoring the plan–for example, if the self-employed business is a sole proprietorship, the pretax contributions are reported on line 15 of Schedule 1;
  • Roth solo 401k funds are subject to RMDs;
  • A Roth 401k may be transferred to a Roth IRA (Note that from a planning perspective, it may be advantageous to transfer Roth Solo 401k funds to a Roth IRA before turning age 70 ½ in order to escape the Roth RMD requirement applicable to Roth 401k contributions including Roth Solo 401k contributions and earnings.);
  • Roth IRA funds are not subject to requirement minimum distributions (RMDs);
  • The fair market value (FMV) of assets held in a self-directed IRA is reported on Form 5498;
  • The fair market value of assets held in a solo 401k are reported on Form 5500-EZ;
  • At termination, the solo 401k is required to file a final Form 5500-EZ and 1099-R; and
  • At termination, the self-directed IRA is only required to file a form 1099-R.

About Mark Nolan

Each day I speak with energetic entrepreneurs looking to take the plunge into a new venture and small business owners eager to take control of their retirement savings. I am passionate about helping others find their financial independence. Having worked for over 20 years with some of the top retirement account custodian and insurance companies I have a deep and extensive knowledge of the complexities of self-directed 401ks and IRAs as well as retirement plan regulations. Learn more about Mark Nolan and My Solo 401k Financial >>

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