Self-Directed IRA and the 401(K)
Ahhh, retirement. The notion of reaching the day when you can trade in your work clothes for resort wear and never look back is what keeps many of us going. The sad reality for many Americans, however, is that they’ll be working well past age 65 because they simply don’t have enough funds saved to retire. With so many retirement savings vehicles out there, it makes sense for investors to make use of every tax-advantaged option available.
One of the most common retirement plans is the 401(k). This is an employer-sponsored plan whereby employees can elect to have funds taken from their paycheck and deposited into their 401(k) account. An employer can choose to match these contributions up to a certain percentage of the employee’s salary or make profit sharing contributions. Contributions to a 401(k) are tax-deductible, but they are subject to annual limits.
Employees can then invest their funds in the plan’s available investment options. The big advantage here is that funds are removed from your paycheck pre-tax and then grow tax-free in the account until they’re withdrawn in retirement. Many 401(k) plans also offer a Roth option for tax-free earnings.
A self-employed individual may create what’s called a Solo (or single member) 401(k). Solo 401(k) plans have the same tax advantages and contribution rules as traditional 401(k) plans, but they provide the trustee of the Solo 401 (k) with checkbook control as well as the choice to invest in alternative investment, such as real estate or private equity. They are designed only for small business owners and their spouse with no other full-time employees. The same benefits apply, including tax-deferred or tax-free earnings and contributions, that are in most cases tax-deductible. With real estate and other alternative investment experience, the Self-Directed Solo 401(k) can give you more investment power, too. The account has higher annual contribution limits, (2019 contribution limits, $53,000 or $59,000 depending on your age). This could help to grow your retirement funds at a much faster pace.
Employer sponsored plans can be a great way to save for retirement, (especially where the employer is matching the employee contribution).
As an investor, you may see the value in contributing to multiple retirement accounts. Self-Directed IRAs, such as Traditional or Roth, can be great options to complement your existing retirement plan and round out an effective retirement savings strategy. A former employer 401 (k) plan is a way to fund a Self-Directed IRA, including a Solo 401(k), if you were to qualify.
You can open a Self-Directed IRA and make investments at any time, whenever you’re ready to invest. Employees, however, typically have a waiting period before they can participate in a 401(k) and can only make investment changes as often as an employer allows. 401(k) plans are usually more expensive than Self-Directed IRAs due to various recordkeeping and administrative fees. Furthermore, while a Self-Directed IRA owner can continue to invest within the account until age 70 ½, you must be an employee in order to invest in a 401(k). If you were to part ways with your employer, you may no longer invest in the 401(k). You could, however, rollover a 401(k) to a Self-Directed IRA to continue investing those funds.
Where the Self-Directed IRA really stands out with its numerous investment options. In a 401(k), the employer chooses the investment options for its employees, often just a handful of mutual funds. With a Self-Directed IRA, the owner has complete control over investment decisions and can invest in conventional assets like stocks, bonds, and mutual funds as well as alternatives like real estate, precious metals, and private equity. This gives Self-Directed IRA owners the ability to invest in areas where they have expertise and provides much needed diversity to help protect retirement funds from market fluctuations.
Can They Work Together?
IRAs and 401(k) plans are not mutually exclusive. Not only can you have both, doing so allows you to capitalize on each one’s advantages and provides a greater level of diversification to help protect your hard-earned money from almost anything our unpredictable economy might throw your way.
If your employer offers a 401(k) plan, it makes sense to use it. With relatively higher contribution limits and an employer match, 401(k) plans can provide a great retirement nest egg. Self-Directed IRAs offer a number of advantages over 401(k) plans, however, and having both types of plans working for you can be a great way to achieve your retirement dreams.