If you're self-employed with no employees, a solo 401(k) can do much of what a self-directed IRA does, including lending on real estate. It can also let you put more money in each year.
Here's how the two compare.
Who can have one
- Self-directed IRA: anyone with earned income, or anyone rolling over old retirement money.
- Solo 401(k): business owners with no full-time employees other than a spouse. That includes freelancers, consultants, and many real estate investors.
How much you can put in
A solo 401(k) usually allows much more. You can contribute as the employee and add more as the employer, so the yearly limit is many times the IRA limit. An IRA has a much smaller yearly limit. The IRS sets both each year, so check the current numbers.
Control
With most self-directed IRAs, a custodian signs for each investment. With a solo 401(k), you're usually the trustee. You can often write checks from the plan's bank account, much like a checkbook IRA. More control also means more responsibility for following the rules.
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Roth options
Both can have a Roth side. Many solo 401(k) plans let you make Roth contributions, with no income limit on the Roth part. Roth IRA contributions do have income limits.
Borrowing from your account
A solo 401(k) can let you borrow from your own plan, within IRS limits. An IRA can't.
Paperwork and cost
A solo 401(k) needs a plan document, and once the plan is over a certain size, a yearly IRS filing. A self-directed IRA usually just has custodian fees. Either way, compare providers.
Which one fits?
- Self-employed and want to put in more each year? Look at a solo 401(k).
- Moving an old 401(k) or IRA with no new business income? A self-directed IRA is usually simpler. Here's how to roll it over.
- Have employees? A solo 401(k) isn't an option.
Both follow the same prohibited transaction rules. Lending to yourself or family is off limits either way.
Common questions
Can a solo 401(k) lend money on real estate?
Yes. A solo 401(k) can invest in private loans and mortgage notes if the plan document allows it. The same prohibited transaction rules apply.
Can I have a solo 401(k) if my spouse works for my business?
Yes. A spouse who works in the business can join the plan. Other full-time employees generally make you ineligible.
Is a solo 401(k) better than a self-directed IRA?
For a self-employed person who wants to put in more each year, it often is. For someone rolling over old retirement money with no business income, a self-directed IRA is usually simpler.
Written by Larry Hoffman
Managing Member of LJH Investments, LLC in Madison, Indiana. In real estate since 2006, with 300+ mortgage notes bought. Author of Mailbox Money Retirement.
General education, not tax, legal, or investment advice. IRA rules are strict and change over time. Confirm everything with your custodian and a CPA or tax attorney. All investing has risk, including loss of principal.