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A Complete Guide To Self-Directed 401(K) LLC

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Jonathan Feniak, Esq., MBA

By Jonathan Feniak, Esq., MBA

    Consider a self-directed individual retirement account if you’re planning to build savings beyond the traditional retirement plan. It is designed for a self-employed sole proprietor, a corporation, or an LLC. You can get in from almost all financial institutions and invest in the form of bonds, stocks, mutual funds, real estate, profit-sharing plans and many others.

    These plans are directed to people who are looking for alternate investment plans for their retirement savings while giving more freedom to invest.

    What is a Self-Directed 401(k)?

    Also called a solo 40(k), it is a saving account geared towards self-employed and small business owners who don’t have full-time employees working under them. According to these retirement plans, individuals can contribute a portion of their income along with the matching contribution on behalf of the company.

    They are popular among startup owners as it gives them more freedom to control their funds and select an investment plan of their choice. Moreover, investors can also use alternative assets to build their retirement savings as you have a large pool of options to choose from.

    Why are Self-Directed 401(k) LLC called Alternative Investments?

    In most ways, these plans are similar to a conventional IRA, encouraging Americans to invest in their retirement savings. But it differs in the mode of investment; by 2019, IRS permitted self-directed IRAs to invest in property, developmental land, cryptocurrency, natural resources, precious metals, LLC memberships, and livestock.

    Setting up a self-directed 401(k) allows you to make a direct investment by giving you full control of your checkbook. Now you don’t need the financial institution to get approval and a written check for your investment as you can make your own financial decisions.

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    Benefits of Self-directed 401 (k)

    It allows entrepreneurs to create their own retirement plan and invest in an LLC. Earlier, they were associated and designed only for employers and traditional brokers. Relatively new, setting up the account is super easy, fast and lucrative. It only takes two weeks to start investing in your retirement savings. You can even convert your existing 401(k) retirement plans into the self-directed one to avail of various benefits, such as:

    • Lowered taxes
    • Investment freedom
    • Improved asset protection
    • No fees for custodians or trustee’s permission

    Why Do People Invest in Self-Directed IRA?

    It attracts a wide array of investors due to a number of reasons:

    1. First and foremost, it diversifies your investment portfolio by allowing you to split savings into a traditional IRA account and a self-directed one.
    2. It supports investors who are willing to invest in items other than stock or bonds
    3. Having expertise and interest in non-conventional investments such as cryptocurrencies and/or precious metals

    Moreover, a self-directed IRA offers the same benefits as a standard IRA, but precious metal investors can invest long-term, pre-tax money in a traditional IRA and pay the due taxes after retirement. Although a self-directed IRA is beneficial, it doesn’t support individual investors, and therefore, you need to establish your own company. Independent investors can handle the buying and selling decisions on their own, but they need a professional custodian or trustee to manage the account. Typically, it’s an investment firm or brokerage who acts as a custodian or trustee.

    Furthermore, self-directed IRA and self-directed 401(k) are quite similar but have stark differences. For instance, a self-directed IRA requires a custodian to take buying selling decisions, whereas that’s not the case for the latter.

    Similarities between Self-Directed 401(k) and Self-directed IRA

    Typically, a custodian is the one who controls and manages assets in the account and plans its sale and purchase. If you’ve self-directed 401(k), you’ll be managing all these activities yourself instead of cording with an LLC.

    Moreover, the contribution limit for self-directed 401(k) is $19,500 plus a $1000 catch-up fee, the same as that of self-directed IRA. In addition, both the accounts' withdrawal rules are the same as you are liable to pay a 10% penalty on withdrawing the amount prior to 59 ½ years of age unless there is an exception.

    The required minimum distribution age is 72 years, earlier, which was 70 ½ in the year 2019. Those who select Roth* as an option for self-directed IRA or 401(k) don’t require minimum distribution age.

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    What are Roth 401(k) Options?

    1. Tax-free earnings
    2. Co-mingle Roth and non-Roth contributions
    3. Convert employer benefits to Roth

    Why is Self-Directed 401(k) Plan Strong?

    1. Higher contribution limit compared to traditional IRA
    2. Employer profit-share is tax-deferred
    3. Purchase the lucrative real estate and avoid unrelated taxes
    4. Freedom of choice
    5. Complete control of funds

    Are There Any Risks Attached to Self-Directed IRA or 401(k)?

    Although self-directed retirement plans give the freedom of choices, they have their own risks. Typically, it is suitable for people who are pro at investing and can compete well with professionals. According to IRS, self-directed IRAs are prone to fraud, high fees and fluctuating performance.

    In addition, investors have to be careful with the complex IRS rules subjected to a self-directed IRA account. Violation of the regulations can lead to a complete ban or disqualification. These rules include:

    • Directly receiving money from an income-producing property in your self-directed retirement plans
    • Using registered real estate as a collateral asset for a personal loan
    • Using the assets for personal gains
    • Borrowing the self-directed IRA money to pay off your personal loan obligations
    • Lending your money or asset to a disqualified person*
    • Letting disqualified person* to reside or use the registered property
    • Selling the held property to a disqualified person

    *Disqualified person is typically a fiduciary who serves the plan. The entities have financial interests in the assets held in the savings account and include your spouse, heirs, beneficiaries, custodians, and any company in which you hold 50% share and yourself.

    If any prohibited transaction takes place, then the self-directed account is automatically exempted from its tax benefits. Besides, all the invested money will receive treatment as a taxable distribution, and as a result, you’ll end up with a huge sum of the tax bill. You can learn more about the steps to keep your business entity compliant, such as correctly filing your articles of organization and obtaining an EIN on our blog.

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