What do you do if you’re self employed or you want more than what your employer’s 401k plan offers? You apply for a self directed 401k.
A self directed 401k (also called a solo 401k) is the do-it-yourself version of a 401k retirement plan.
The major advantage to a self directed 401k is that you can control where and what kind of investments you want to put your retirement money into.
Who Can Participate?
To participate in a self directed 401k, you need to either be self employed or have an HR department that will give you the option of setting up your own plan. Fortunately, if the plan becomes available to one employee, then it must be offered to all of them.
Most of the time a self directed 401k is a good fit for the self-employed such as consultants, contractors, sole proprietors etc.
How Does a Self Directed 401k Work?
Just like a regular Traditional and Roth IRA or 401k, you can setup your self directed 401k to be either a Traditional type (money goes in before taxes, grows tax free, and then gets taxed upon withdrawal) or Roth (money goes in after taxes, grows tax free, and then does not get taxed upon withdrawal).
Note that you can split contributions between the two types of accounts.
How Much Can You Contribute (as of 2013)?
An employee contribution of $17,500 plus an additional profit sharing portion up to 25% of your compensation. The total may not exceed $51,000.
These limits double if both you and your spouse take income from the business
There are also catch-up contributions of $5,500 for you and your spouse each
When Can I Take the Money Out?
Just like a regular 401k plan, you can’t withdraw your money from a self directed 401k until age 59 1/2.
If you withdraw your money early, you’ll have to pay the 10% early penalty on top of income taxes for the withdrawal.
The only way to avoid this penalty is if you plan to use the money to:
- Purchasing your first home
- Experience a sudden disability
- Pay for higher education expenses
- Prevent eviction or foreclosure.
The 10% penalty can also be waived for certain “hardship withdrawals” such as permanent disability or large out-of-pocket medical expenses.
Also similar to a regular 401k, you are allowed to take out a loan against yourself. This amount may be up to half the total balance (but not exceeding $50,000)
The loan has to be paid back over a five-year period at least quarterly at a minimum prime interest rate (you have the option of selecting a higher interest rate). There is no pre-payment penalty.
- Cash (CD’s, money market)
- Mutual funds
- ETF’s (Exchange Trade Funds)
- Real estate
- Precious metals
- Private investments
- Peer to peer lending
You cannot invest in collectibles such as rugs, works of art, automobiles etc.
- Charles Schwab
Make sure you find a provider who offers you a wide selection of investment choices.
Note that special setup and brokerage fees may apply for these unique types of accounts. When you’re shopping around for someone to start your plan with, pay attention to these fees and expenses.
You can also expect to keep more documentation than a typical 401k for justification when you file your taxes.
Are My Investments Guaranteed?
No. All investments carry some inherent risk; some more than others. No matter if you are investing in a regular 401k, self directed 401k, or any type of investment, you should educate yourself on the general risks of each type of fund and carefully consider them before investing your money.
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