Top Self-Directed 401k Investments & Rules

A self-directed 401k also known as a solo 401k is a popular retirement  plan for the self-employed with no full-time W-2 employees. What makes the self-directed 401k so popular over other self-employed plans (e.g., DBP, SEP IRA and SIMPLE IRA) is the ability to easily self-direct it into both traditional investments (e.g., stocks and mutual funds) as well as alternative investments (e.g., real estate, notes, tax liens, cryptocurrency, metals and private placements). A self-directed 401k is also the top retirement account of choice for investment diversification.

These top self-directed 401k investments and top 5 (five) rules will get you started in self-directing your self-employed 401k plan. 

The most popular self-directed solo 401k investments include the following: 

 

Real Estate

Holding real estate in self-directed 401k plan is a popular long-term investment. The 401k investor’s objective is receipt of rental income and appreciation of the property’s value. Like equities, the biggest risk associated with real estate investments are changing economic conditions.
 
Here are some important rules to understand when investing a self-directed 401k in real estate. 
  • The 401k participant cannot live in the property or rent it to herself, her business or other disqualified persons such as her parents, kids and grandparents, etc. 
  • When the property is solely owned by the self-directed 401k plan, all expenses must be paid using 401k funds, and all income must flow back to the 401k plan. 
There are generally 4 (four) methods of investing in Real Estate using a self-directed 401k.
  1. Outright purchase – just  401k funds are used to invest in real estate resulting in the self-directed 401k owning the property free and clear.
  2. Debt Financing – the 401k obtains a non-recourse loan and uses the borrowed fund along with existing self-directed 401k funds to purchase real estate.
  3. Limited Liability Company (LLC) – the 401k invests (purchases member units) in an LLC on its own or with other investors. This results in the property being  owned in the name of the LLC not the self-directed 401k plan. 
  4. Partner (Tenants in Common) – the 401k plan invests with other investors or alongside the self-directed 401k account holder; tile to the property is divided between the investors based on the amount invested by each party.

Learn more about the above various self-directed 401k real estate investment methods HERE.

   Precious Metals

  • Self-directed 401k funds may be invested in certain gold, silver, and platinum coins, certain bullion, and coins issued under the laws of any state.
  • 401k investors diversify into precious metals because they think the value of metals keeps up or exceeds inflation rates.
  • Generally, only about 10% of self-directed 401k funds are invested in metals since they don’t produce current income like rental properties, and the metals market tends to be sporadic.
Following are some of the Important rules to understand when investing a self-directed 401k in precious metals.
  • Determine types of allowed vs disallowed metals that may be held in a 401k. VISIT HERE to see a list. 
  • Minimum Fineness Required:  Gold = 99.5%; Silver = 99.9%; Platinum = 99.95%; and Palladium = 99.95%
  • Store the metals with an approved depository taking institution including a bank safety deposit box. 
  • The safety box can only be used to hold assets of the self-directed 401k plan such as the metals and documents in connection with other investments held in the 401k plan such as recorded deeds for real estate.
  • Self-directed 401k investments have to be segregated (held separate and apart) from your personal or business assets.   
  • Broker/ Dealer invoice for the purchase of the metals is issued in the name of trustee and the self-directed 401k plan, so as follows for example: Jane Do, Trustee of XYZ Town Trust.

Safety Deposit Box QUESTION:

Should the fee for a safe deposit box be paid directly from the Solo401k checking account or from outside the plan?
 

Since the safety deposit box is for storing the solo 401k assets including metals, the solo 401k would pay the safety deposit box fees. 

Visit here for more information regarding investing a self-directed 401k in precious metals. 

Promissory Notes

When a self-directed 401k invests in promissory notes, the 401k assumes a lending roll similar to a bank that loans out funds. Therefore, the 401k must make the investment with the intent to receive a return; after all, the purpose if investing the self-directed 401k is to grow it for use at retirement age.

Here are important rules to understand when investing a self-directed 401k in promissory notes.

  • Don’t confuse the promissory note investment with the self-directed 401k participant loan option. When a self-directed 401k invests in a promissory note, the borrower is an unrelated third-party not the self-directed 401k participant. Whereas, when the self-directed 401k participant borrows from her 401k, this is considered a 401k participant loan. You can learn more about these differences here
  • The promissory note can be structured as secured–generally by real-estate, inventory or precious metals–or it can be structured as an unsecured note. If the note is unsecured, the interest rate the self-directed 401k receives is generally higher because of the higher risk. 
  • The self-directed 401k promissory note investment cannot be to a disqualified person. A disqualified person includes the self-directed 401k participant, her business, her spouse, kids, parents, to name a few. For a full list, go here

To learn more about investing in promissory notes under a self-directed 401k plan, go here

Private Placements

  • Another top self-directed 401k investment include private placements or private company investments. 
  • A method of investing a self-directed 401k  passively in a private company is by purchasing equity as long as company is not the self-directed 401k participant’s own business or a business controlled by her relatives such as her spouse, parents and children.

Here are important rules to understand when investing a self-directed 401k in Private Placements.

  • Title to the equity investment is taken in the name of the self-directed 401k plan. 
  • If the self-directed 401k plan invests in a business that offers goods or services (an active business), the gains are subject to unrelated business income tax UBTI; however UBTI does not apply to passive, private company investments.

Visit here for more information regarding investing a self-directed 401k in private placements, and go here to learn about investing another type of 401k plan knows as a ROBS 401k in your own C-corporation.   

These top 5 self-directed 401k investment rules will get you started in self-directing your self-employed solo 401k plan. 
 

Rule 1 (One): Understand the allowed self-directed 401k investments under the IRS Rules.

  • There are relatively few limits on the types of investments that are permissible under a self-directed 401k plan.
  • Solo 401k plans cannot invest in S-Corp stock, collectibles, such as art, antiques, gems, coins, or alcoholic beverages, and they can invest in certain precious metals only (e.g., American gold and silver Eagle coins minted after September 30, 1986))  if they meet specific requirements. (IRC Section 408(m)). All other types of investments are allowed.

Rule 2 (Two): Make sure the self-directed 401k plan allows for the particular investments.

  • Once you have an idea of the types of investments that you would like to make under the self-directed 41k plan  or prior to opening the 401k plan, make sure the plan provider’s self-directed 401k plan allows for the type of investments that you are planning to make.
  • Not all self-directed 401k plans allow for investing in real estate, for example.
  • While self-directed 401k plan providers are permitted to impose restrictions on investments, the 401k law does not prohibit investing in the following types  of investments listed above as well as other investment types such as tax liens, cryptocurrency, annuities, Futures, life insurance, and equities. 

Rule 3 (Three): Understand who is a disqualified person for purposes of placing self-directed 401k investments.

  • The IRS prohibits transactions between self-directed 401k plans and certain individuals known as “disqualified persons.”
  • A disqualified person is the self-directed 401k participant, or anyone who has control over the assets or who has the ability to influence investment decisions.
  • Members of the self-directed 401k participant’s family (i.e., a spouse, an ancestor, any lineal descendant, or any spouse of a lineal descendant) also are considered disqualified persons. 

Rule 4 (Four): Understand roundabout prohibited transactions.

  • Under the self-directed 401k prohibited transaction rules, a disqualified person may not indirectly do what cannot be done directly.
  • If a self-directed 401k transaction directly violates the prohibited transaction rules, simply altering the transaction to remove the disqualified person from the direct involvement is insufficient. In other words, merely insulating that person from the transaction and enlisting a third party does not make a prohibited transaction permissible. 
EXAMPLE: 
 
Jason’s parents own a primary residence and they want to retire, so they sell the house to Jason’s self-directed 401k plan. The purchase of the home by Jason’s self-directed 401k plan is a slam dunk prohibited transaction because the solo 401k owner’s parents are disqualified parties, and the self-directed 401k plan cannot have a sale between itself and such a party. So Jason’s parents sell the house to Jason’s friend Sal, a person unrelated to Jason. Sal and Jason, however, have agreed that Jason will have his self-directed 401k immediately purchase the house from Sal after the transaction between Jason’s parents and Sal is completed. This type of situation illustrates an indirect prohibited transaction where a disqualified person attempts to circumvent the prohibited transaction rules by bringing a third party into the transaction. 
 

Rule 5 (Five): Consider not doing the investment or get an Advisory Opinion. 

  • If you think the self-directed 401k investment may be prohibited, either don’t proceed or apply for an individual prohibited transaction exemption.
  • The Department of Labor (DOL) grants advisory opinions if the transaction is allowed.

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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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