A properly prepared and established Solo 401(k) Plan for your small business provides tremendous investment flexibility and countless advantages over more cumbersome retirement savings alternatives.
In these times of uncertain markets, widely fluctuating investment values, and distrust of so-called financial professionals (who invariably are attempting to sell a product) one of the main advantages of a Solo 401(k) is that it allows individual businesses people select, control and manage their own retirement investments, saving potentially thousands of dollars in various account charges and transaction fees. In addition, as banks and large institutional lenders continue to tighten their lending standards, more and more people are looking to private sources for their for their financing needs. A properly established and maintained a Solo 401(k) retirement plan allows a participant essentially to lend and invest the funds as a bank or financial institution might for a variety of purposes consistent with IRS guidelines.
The three questions we are most frequently asked are: “Why should I set up a Solo 401(k)?”, “ What is involved in setting up a Solo 401k?” and “How difficult is it to maintain and administer a Solo 401(k)?” There is a considerable amount of confusing information on the Internet and elsewhere being provided, and these questions deserve straight answers. In this, the first of a multiple part series of articles, we will use a real life example to walk through the process and illustrate what is involved.*
A woman with a successful interior design business recently contacted us. She had an existing retirement IRA account with approximately $200,000 in it, consisting of cash and mutual funds, and was dissatisfied with limited choice of investments and the way the investments were performing . The funds were held in an account with a well-known national brokerage company and she was being charged various “fees” merely to have the funds in the account.
She explained that in the course of her interior design business she had started to come across many rental properties recently selling for what she believed to be very reasonable prices. She owned other rental properties and felt that a small, income-generating rental property would be a sound investment for her retirement portfolio. She had located a particular property for sale that she believed was substantially under valued and wanted to make an offer on it. After being advised by the brokerage company holding her IRA that it was not able to hold real estate investments, she contacted us.
Our first step was to meet with the client, discuss her business, review her current retirement plan, and get a clear understanding of what her objectives were. We discussed her familiarity and experience with owning and managing real estate, her accounting and record keeping practices, and the various options available to her. One option was to establish a Self-Directed IRA (SDIRA). Several trust companies specialize in administering such accounts. However, one drawback with an SDIRA is that virtually all SDIRA trust companies charge “transaction fees” (in addition to other account maintenance charges) each time a document is reviewed or signed, or a check is written or received into the account. It is essentially a record-keeping fee. While this can be a valuable service in some cases, because real estate investments can often have many monthly transactions (particular rental properties), over time transaction fees can substantially diminish the overall return on an investment.
After taking into consideration the amount of the fees that she would have incurred over the life of the ownership of the property versus the projected rental income and appreciation the property was expected to generate, we determined that the client could save considerable money by establishing a Solo 401(k). Because the client was able to administer the plan and keep appropriate transaction records herself, in this instance, the establishment of a Solo 401(k) Plan would achieve significant savings over a Self-Directed IRA. She would also retain the ability to delegate those functions to a professional trustee / administrator downstream if she wished.
* Some details in the example have been altered to protect the privacy of the client.
IRS CIRCULAR 230 DISCLOSURE: To ensure compliance with requirements by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.