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7 min read

Rocket Your Dollar Ep. 4: The Self-Directed Solo 401(k)

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For individuals with self-employment income, the Self-Directed Solo 401(k) is the premier retirement account available today. Secure your retirement with unlimited investment options, high contribution limits, and ultimate flexibility.


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Thomas Young: Today we're going to talk about the Solo 401(k) and we're going to go through a comprehensive guide about what it is, who qualifies for it, how you can use it, and the flexibility available to you with the Rocket Dollar flagship product. So a little bit of the background of the Solo 401(k). Before Rocket Dollar came about and before there was this sort of fintech resurgence in retirement products, Solo 401(k) was an investment vehicle that was complicated to open and expensive. Usually what you would do is you'd go to an attorney, an attorney that specialized in opening these sort of accounts and they would go through the process of creating the trust, which a 401(k) is always a trust, and you would complete about a binder full of paperwork and you would then be turned away.

You would be able to manage it on your own, which is a good thing or a bad thing. For most people, it's a bad thing because it's tedious, cumbersome, and if you ever get audited by the IRS, you'd then have to produce every record of every transaction under the trust. You'd have to go to a bank and open up your own bank account for a trust, which is not always easy to do because most bankers don't know how to open trust accounts, which is unfortunate, but that's the way it is. Because of the prohibitive cost, you really had to have a very high balance in your 401(k) to justify the expense of opening one of these things up. Other places like vanguard have offered Solo 401(k)s in the past, but like most IRAs or 401(k)s, they would let you into their menu of funds that you can invest in, but if you wanted a checkbook control Solo 401(k), it's always been complicated and expensive.

So that speaks a little bit about why more people aren't using the Solo 401(k) to diversify their portfolios. So it was really because it was expensive, there wasn't a lot of knowledge around it. It was sort of, if you were lucky enough to have an attorney that knew about it, that's how you'd find out about it, but there was no one really out there evangelizing these products and talking about why they were so powerful. They were kind of a well-kept secret. Like we talked about in previous episodes, large financial institutions have their ways of making money and that's by selling you their funds. So, they don't profit when you use your retirement dollars to do real estate or private companies, they have no way of collecting fees and so they have no real reason to sell you these things.

Traditionally, financial advisors weren't necessarily shortchanging their clients on options. It's that, because the financial advisors are trained by the big firms, they're doing their jobs. So if your financial advisor didn't tell you about it, it's likely that they don't know that this exists. They're trained to recommend certain brokerage accounts and certain products that get you where you need to go, but not where you want to be. So, what this all comes down to is that with a self directed Solo 401(k) through Rocket Dollar, and there's a couple other providers out there that that will get you where you need to go, but with Rocket Dollar, we've made it easy to open the Solo 401(k), have the self-direction option, which all of our 401(k)s come with, and now it's easy to tap into opportunities that your brokerage or your financial advisor won't necessarily tell you about, like real estate or private companies or private equity, things like that.

By creating a self directed Solo 401(k), you unlock the power of the retirement account to do what you need to do to get where you want to be and to take advantage of the opportunities that you want to participate in. So let's talk a little bit about the rules and why there are some qualification criteria for getting a Solo 401(k) versus the IRA that we also offer. So, the big qualification question for opening a Self-Directed Solo 401(k) or any Solo 401(k), even if you go through a brokerage, and that is self-employed income. If you have a one-person business that's you and your spouse and you make some sort of self-employed income, you qualify. The reason you can't have employees, which is one of the qualification questions, is because if you as a business owner have employees and you don't offer them a 401(k) plan, but you have one yourself, the IRS frowns upon that because they want you to extend the same sort of benefit that you're getting as a business owner to your employees, at which point you would go through one of the traditional 401(k) providers or Sub Ira providers in the marketplace, of which there are many. If you do have employees and want to set up a 401(k) plan for your employees and for yourself, give us a call and we'll help you and guide you in the right direction. It's just not what we do.

Self-employed income, no employees, you qualify for the Solo 401(k). Why would you want a Solo 401(k) versus a self-directed IRA? There's a couple of reasons. One is that the contribution limits are much higher. So if you make most of your income from your self-employed income or you're a one person business, maybe you're a consultant, you can contribute high amounts. The amounts go up pretty much every year, but right now we're at ... The contributions for 2019 are, you can defer up to $19,000 of your pre-tax income. Double that if you're married and your spouse is a participant in the business. If you're over 50, you can do an additional catch-up contribution of $6,000 for a total of $25,000 straight deferred. Then there's some profit sharing piece that allows you to get up to $55,000 in your plan. So that's a huge amount that's taken off of your tax bill versus the $6,500 that you can put into an IRA. With the Solo 401(k), there are no income limits the way there are with the IRA. So, that's one of the big pieces.

The second one is that the Solo 401(k) has a little bit looser laws around prohibited transactions. IRAs tend to be a little bit more stringent around prohibited transactions. For example, in an IRA, if you make a prohibited transaction, there's risk that the entire account can be distributed. With a Solo 401(k), if you make a prohibited transaction, the only penalty is on the transaction amount. So say, for example, I make $1,000 prohibited transaction. I invest maybe with my wife's father, right? who's a prohibited person. I invest $1,000 in his company, which would constitute a prohibited transaction. My penalty is on that thousand dollars, not on the whole account. So then I would be liable for the income taxes on that thousand dollars and the 10% penalty. So it would be maybe a $500 mistake versus the risk of distributing the entire IRA. So, just a little bit looser, doesn't mean that we should take it less seriously, but if a mistake were to happen, you're not in that much trouble.

Then the other piece that people really like about the Solo 401(k) is the ability to take a loan directly from the plan. The IRA does not offer this, but with a Solo 401(k), if you need access to basically a line of credit, you can lend yourself tax-free, penalty-free, half the value of the plan up to $50,000. So a great example of one of our clients that called me and was telling me about this was his wife wanted a new car. Instead of going out and getting a car loan or going through a bank, he took a loan from his Solo 401(k) for the amount of the car, went and paid cash for the car and then has five years to pay his plan back. So he basically financed the car that he bought for his wife directly out of his Solo 401(k). So it takes a little bit of the headache of doing things out of it because you can just pay yourself back and, as long as you pay yourself a quote unquote "Reasonable rate of interest," which is usually prime plus one, you have five years.

That's a really great option for people that ... especially self-employed, sometimes you need access to a little bit of capital, maybe to put a little bit of fuel in your business, go on a vacation that you want to lend yourself money for and then pay yourself back, whatever it may be. It's just you become your own bank and that's a great and powerful tool that the Solo 401(k) has.

The big takeaway is that by creating a Solo 401(k) investors can not only place their retirement funds in traditional assets, but they can take advantage of opportunities outside of traditional stocks, bonds, mutual funds, and real estate, private equity, Crypto, whatever it may be, and then you can manage those investment opportunities with checkbook level control, which allow for easy access so you can double down on an investment that's doing well, cash out, money goes right back into your account without going through a custodian or without paying any more fees. It's just in and out like a regular checking account and it really eases the anxiety about what things are going to cost, what it's going to look like, how fees are going to eat into your investment returns, the amount of investments that you make because you're not being feed on a per asset basis or on a year leap fee per asset. So you can spread your bets across as many assets as you want or opportunities that come across your desk.

That's a brief overview of the self directed Solo 401(k) and how it's different from other 401(k)s and other Solo 401(k)s from bigger providers. At the end of the day, self-direction can mean varying levels of freedom, and we believe that you should be able to take as much control as allowed by the IRS in a retirement account, so that you can do what you want when you want, without having to pay extra or ask for permission to make a certain investment. We really are against paperwork, so the less paperwork we can provide you, the happier we'll be. Save some trees while we're at it. 

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