YES! But, if this is the case, why don’t you have these other 401(k) investment options made available to you as part of your 401(k) plan? Well, there are many reasons, both fair and unfair, but you can probably assume that the primary reason relates to the fact the financial service companies cannot easily make money off investments made into non-traditional assets such as real estate. Yes, the greed factor does raise its head at some level. However, in fairness to such companies, it may be practically difficult for these types of investments to be offered efficiently.
Which leads to a logical question. Does any 401(k) plan have 401(k) investment options that are unlimited…only limited by IRS and DOL Prohibited Transactions regulations? Can you have the freedom in a plan to invest in practically any asset class you desire?
YES! But, your availability to exercise this freedom may be dictated by how the 401(k) plan is established and what 401(k) investment options you have as dictated by the plan documents. Yes, you heard that correctly. IRS regulations do not dictate to a 401(k) plan sponsor what 401(k) investment options must be offered by the plan, only what investment options are NOT permitted within the plan. As such, many financial services companies will establish 401(k) plans that limits a participant’s investment options to the world of stocks, bonds and mutual funds.
You may sense that while the IRS may permit you to invest in a more expansive menu of assets, the 401(k) plan you participate in may limit your options…and you would be correct. As the saying goes, “it is what it is”. But, are there avenues by which you can secure more freedom and flexibility in what 401(k) investment options you have (and being realistic at the same time!)?
YES. Keep in mind that a 401(k) plan is a 401(k) plan, but how it is established and what it permits (within IRS rules, of course) is what can make one plan different from the next.
Company-Sponsored 401(k) Plan — This is what most people associate with a 401(k) plan as a W-2 employee. You have your company, employees and a 401(k) plan for its employees to participate in. These plans typically will be offered through a financial services company with the sponsoring employer identifying a Trustee who is ultimately responsible for the plan. Most of us have participated in such a plan and, for a variety of reasons, self-direction is not permitted. Therefore, employees are limited to the normal menu of stocks, bonds and mutual funds.
Can a company-sponsored 401(k) plan permit investments into non-traditional assets….yes, but you don’t often see it. For those who are business owners (with employees) the option exists to include non-traditional assets as part of the 401(k) investment options. However, for a number of reasons, the owner will rarely be presented this option, let alone be able to seriously consider the pros and cons of such an offering.
Individual 401(k) Plan — So now consider that you are not a W-2 employee, but rather a self-employed individual with no “common law” employees. You may not be familiar with your self-directed options and you proceed to open your 401(k) plan at a financial services company like Charles Schwab. Since it is a Schwab-sponsored plan, your investment options will, understandably, be limited to the financial products they offer. Again, in this scenario, you will not be permitted to self-direct.
So, you can see with these first two options you will not, realistically, have the option to self-direct. Are there other options available to you that would provide you the opportunity to self-direct?
Individual Self-Directed 401(k) Plan — Now consider a scenario in which you are self-employed with no common law employees . You ARE familiar with your self-directed options and want to be able to invest in non-traditional assets. You now have the ability to establish a plan with 401(k) investment options that will permit you to invest in any class that the IRS does not specifically prohibit. Of course, all IRS and DOL regulations must be complied with, but you have the freedom and flexibility to invest as you see fit….as the Trustee of the 401(k) plan.
Is self-direction for everyone…of course not. However, for an individual who is self-employed and does have an interest in non-traditional investing, a self-directed 401(k) plan is a plan that may be for you. Better yet, these plans can be established so that the Trustee can invest in both traditional and non-traditional assets all from one account. You control the retirement checkbook.
As always, the information provided is educational in nature. It is not intended, nor should it be interpreted as, any form of tax, legal, financial or investment advice. You must always consult with your respective professional in all such matters.