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The Advent of the Self Directed Solo 401k


Self-Employed Workers Find a Better Retirement Plan.

MINYANVILLE ORIGINAL Recently, America's investment fire was stoked with the revelation of Mitt Romney's self-directed IRA. Estimates place it somewhere between $20 million and $100 million, and it has sparked an interest in self-directed IRAs in general. Less known, however, is its sister platform: the self-directed Solo 401k. This is a retirement plan that is reserved for self-employed individuals, and aims to give them corporate-like retirement benefits without the hassles of corporate-level paperwork.

Traditionally, the only retirement plan available to self-employed workers was the SEP IRA. The SEP IRA follows all the rules of a standard IRA, but possesses an elevated contribution limit. Currently the annual limit stands at $50,000 (as opposed to a regular IRA, which punches in at $5,000). The Solo 401k retains the elevated contribution limit, but also adds a host of additional benefits. These benefits turn out to be uniquely suited to self-directed investments. As most self-employed workers are more amenable to charting their own route, the self-directed Solo 401k can quickly seem like a made-to-order investment platform.

Here's a quick listing of the specific benefits which would most appeal to the proactive investor:

1. Minimal Fees

An IRA, no matter what flavor it takes, must be held by a third party custodian. Depending on your custodian and account type, this could cost quite a lot in fees. Transaction, asset, and management fees are among those most commonly charged. With a self-directed Solo 401k, these fees disappear. Because the plan is set up as a dedicated trust with a checking account, there is no third party. Hence, you don't have to pay any third party fees.

2. Roth Component

A SEP IRA is limited to Traditional (i.e., pre-tax) contributions. A Solo 401k can be set up as either a Traditional plan or as a Roth. As many investors in alternative assets prefer the Roth, the Solo is the only way to go.

3. Plan Maintenance

One of the more daunting aspects of retirement plans is the specter of prohibited transactions. If an investor makes a mistake and commits a prohibited transaction, the results could be devastating. In an IRA, there is a 10% penalty and full account distribution. That means that all tax deferred benefits are lost, and the IRS will demand payment immediately. In a Solo 401k, the results are not nearly as severe. The 10% penalty still has to be paid, but the plan itself stays intact. Reverse the transaction and you're up and running again.

4. Personal Loan

In an IRA, any personal benefit taken from the account is considered a prohibited transaction. In a Solo 401k, the plan holder may take a loan from the plan up to $50,000. There are no restrictions on how this money can be used.

5. Real Estate Investing

For those investors looking to place their retirement funds in real estate, the Solo 401k offers a unique tax advantage. This is because it is not subject to the tax known as UDFI (Unrelated Debt Financed Income). When a self-directed IRA invests in real estate and it uses leverage to do so, the percentage of profit that can be attributed to the borrowed money is taxable right now. The reason for this is that the borrowed money is not considered retirement money. Rather, it's considered outside funds that are co-investing with the retirement funds. The Solo 401k, however, is not subject to UDFI. It practical terms, that means that the Solo 401k can invest in a property with 100% of the profits being fully tax deferred. The plan can make a down payment with retirement money and take a mortgage on the rest, and still not have any current tax obligations.

On the American retirement landscape, the SEP IRA still has the name recognition as the quintessential self-employed retirement account. Current trends, though, indicate that the Solo 401k is quickly gaining ground and will eventually become the plan of choice.

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