Working for yourself has plenty of benefits, but one thing that independent contractors, freelancers, and small business owners miss out on is employer-sponsored investment options.

This is particularly true regarding a 401k, which offers significant tax benefits over traditional investing strategies.

Fortunately, an individual 401(k), also known as a solo 401k, allows the self-employed to leverage many of the same benefits that come with employer-sponsored retirement plans.

Investors looking for more control over their retirement efforts can do so through self-directed 401k plans. Here are several benefits associated with self-directed investment accounts, so you can decide if a self-directed 401(k) is right for you. 

What Is a Self-Directed 401(k)?

A self-directed 401(k) is an employer-sponsored retirement plan designed for businesses that only employ the owner, their spouse, or any affiliated business partners. 

You may even have heard a self-directed 401(k) referred to as an Individual 401(k), solo 401(k), or self-employed 401(k). 

Like a self-directed IRA, self-directed 401(k)s provide the same investor freedom, allowing you to invest in alternative assets like real estate, private equity, precious metals, and much more. Similarly, self-directed 401(k)s also have the same contribution limits as a standard 401(k) and IRA, and similar withdrawal rules. 

While some benefits may seem obvious, there are several reasons a self-directed 401(k) is beneficial to individuals and self-employed entrepreneurs. 



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9 Benefits of a Self-Directed 401(k)


1. Greater Control


If you want to have greater control over the money that you will use to retire, a self-directed 401k plan, like a self-directed IRA or SEP, is a great choice. These types of accounts automatically put the control back in the hands of the investor.  All you have to do is write the check, and your custodian will help you move your funds into your targeted investment. 

Immediately, you’ll be struck by the level of freedom a self-directed 401(k) provides, allowing you to plan accordingly for your short and long-term goals. 


2. Diverse Investment Options


Diversification is key when creating a successful investment portfolio and the freedom of a self-directed 401(k) allows you to diversify easily.  When you invest through a traditional 401k, your options are limited to stocks, bonds, mutual funds, etc. However, with an individual 401k, you can invest your money in different verticals, like real estate or commodities. 

Diversify your portfolio by transferring funds using a rollover IRA or 401(k) into your self-directed 401(k). 


3. Liquidity


Ideally, you won’t need to draw from your retirement savings, but sometimes it’s necessary. If you plan on using your retirement savings to finance home purchases, education expenses, or other investment opportunities, then a 401k can be a good choice.

Many investment options, including IRAs, penalize investors who make early withdrawals. With an individual 401k, however, you’ll be able to take a loan against your savings without worrying about taxes or penalties. Quicker access to your money is a great reason to direct your 401k. 


4. No Business Structure Requirements


Though many self-employed individuals will formalize their business structure and register as an LLC, partnership, or S-Corp, others will not. To be eligible for an individual 401k plan, investors must be able to prove that they earn a self-employed income, but there are no formal business structure requirements. 

Sole proprietors can easily take advantage of this type of investment vehicle. This concept opens up the world of self-directed 401k plans to more people. 


5. Tax Advantages


Any savvy investor knows the importance of legally taking advantage of existing tax laws. Fortunately, self-directed 401k plans come with a litany of tax benefits. Being able to keep more of your money legally is a great reason to choose a self-directed 401k. 

When you make contributions to an individual 401k, you can choose to do so on a pre-tax basis, reducing your taxable income for the year in which the contributions were made. However, an individual 401k also offers a Roth component. Roth contributions are made after taxes, meaning there is no upfront tax advantage, but you will be able to make tax-free withdrawals in the future.

6. Limited Eligibility Requirements


A self-directed individual 401k has few eligibility requirements. As long as you can prove that you earn an income as a self-employed individual and that you have no employees other than your spouse, you will likely meet the eligibility requirements.

This takes out a lot of the “red tape” associated with investing in a 401k through an employer.


7. UDFI Exemptions


If you plan to use your investment to buy real estate, an individual 401k can help you avoid what’s known as unrelated debt-financed income (UDFI) taxes.

UDFI tax law can be complicated, but when it comes to an individual 401k, any gains or income made through a real estate investment can be reinvested into your account tax-deferred.

This is a distinction worth noting as gains from real estate financed through an IRA can potentially be taxed under UDFI.


8. Rollover Provisions


When you work for an employer, they probably have strict rules in place that dictate how and when you can cash out your 401k.

In many cases, you’re not allowed to access those funds until you leave the company. At that point, these employers will allow you to roll over your existing retirement account into your new retirement account.

It’s not uncommon for investors to have more than one retirement account, but do you have a 401k from a previous employer or an existing IRA or SEP?

In many cases, you can roll other retirement investment accounts into your individual 401k plan. This makes it easier to leverage your entire savings, whether in the form of a much-needed loan or take advantage of another investment opportunity.


9. Easy to Administer


Retirement shouldn’t be hard, but investing can be complex, particularly when it comes to annual filing requirements.

Fortunately, individual 401k plans make it much easier as there are no annual filing requirements unless your plan exceeds $250,000. And, even if your assets exceed that amount, your filing requirements are typically limited to a single form, IRS 5500-EZ.

Just because you’re self-employed doesn’t mean you need to miss out on the many benefits a 401k can offer. Individual 401k plans are easy, affordable, and flexible, allowing you to save for the future you want. There’s no one-size-fits-all approach to retirement, and that means you deserve a plan that works for you. A self-directed individual 401k offers just that.


Individual 401(k) Prohibited Transactions


It is important to note that there are some transaction types that are prohibited with a self-directed 401k. One of the most governed types of investments is real estate.

While you can invest in real estate through your self-directed 401k, you should know the laws of how doing so are written. 

For example, selling existing properties to your solo 401k plan is illegal. You are also not allowed to use any property your self-directed 401k plan owns as security for a loan or your personal residence. Luckily, self-directed 401(k) rules are pretty universal, whether you’re purchasing real estate in Denver, New York, or Lincoln, NE with your retirement account.

Various types of collectibles are also forbidden investments.

Works of art, antiques, stamps, gems, and certain types of metals are considered prohibited transactions. You must familiarize yourself with these prohibited transactions so you can ensure that you are operating legally. 


Is a Self-Directed 401(k) Right for Me?


Your 401(k) is the money you will use to live on when your working days are over. Obviously, you must have access to the amount of money you need to enjoy your “golden years.” 

If you are going to self-direct your 401k, you must be savvy with different types of investments and be capable of quality money management.

Suppose you are an organized individual who is capable of managing investments, monitoring the market, and taking other steps to protect your money.

In that case, a self-directed 401k is an excellent choice for you or your spouse.

For help setting up a self-directed 401(k) through a trusted custodian, contact Horizon Trust today. We are experienced custodians specializing in all retirement accounts, including 401(k)s, Roth IRAs, SDIRAs, and any other account.