I have often said to individuals, if you qualify or can legitimately qualify for a Solo-K plan tied back to a self-employed business, do it! Of course, there are considerations you will need to make as to whether your business will be structured as a sole proprietorship, LLC, S-Corp, C-Corp or partnership; however, in almost all cases, the Solo-K will outshine any IRA product, self-directed or not. It is not that the IRA is bad…just consider yourself fortunate if you qualify for the Solo-K!
Score: Solo-K – 0, IRA – 0
Let’s look at some of the benefits:
No Custodian Relationship — Unlike an IRA, including a SEP IRA or SIMPLE IRA that are employer-sponsored IRAs, all are IRA products and, under law, must be held under custodianship of an IRS-approved custodian. This doesn’t mean you cannot self-direct…it just means that you will have have the additional expense and compliance layer associated with an IRA.
In contrast, you are the legal Trustee of your Solo 401k and, as such, do not have the expense or additional compliance responsibilities with your Solo-K that you have with your IRA.
Score: Solo-K – 1, IRA – 0
Higher Contribution Limits with the Solo-K!
For those familiar with SEP-IRA contribution limits, some will make the argument that the SEP-IRA can potentially contribute as much as to their SEP as someone under the age of 50 can contribute to a 401(k) (the SEP-IRA does not have the catch-up provision for individuals over 50).
On paper, yes. However, the Solo-K can achieve a higher level of contributions with less income. This can actually add up to a sizeable amount in any year, let alone over several years or decades.
Score: Solo-K – 2, IRA – 0
Huge benefit for those who prefer Roth. Your SEP-IRA or SIMPLE IRA are pre-tax IRA contributions. With your Solo-K, you can make your elective deferral contributions in either a Roth or Pre-Tax manner….or both! You simply do not have this ability with your IRA.
Score: Solo-K – 3, IRA – 0
I won’t give the Solo-K plan another point on this benefit, nor will I for the IRA, either. Yes, you can convert your traditional IRA into a Roth IRA. And you can convert some or all of your IRA. But, if you did not convert the entire balance (especially if you were self-directing both), you would still have two IRAs (Traditional and Roth), with the expense of 2 IRA accounts held through the custodian.
In contrast, with the funds in your Solo-K, as long as your plan permits (our plan documents permit if you wish), you can convert pre-tax funds to Roth…in toto or a portion of the funds. You will keep the now-converted Roth funds in a separate account within the Solo-K, but you have the ability to execute this conversion easily and have all the funds (i.e., Roth, Traditional) in your Solo-K, able to be used for your investment wishes.
Score: Solo-K – 3, IRA – 0
No UDFI for Leveraged Investments
A properly-structured Solo-K will not incur a UDFI (Unrelated Debt Financed Income) tax on any leveraged real estate investment gain….an IRA will!
In truth, the UDFI tax may or may not be significant based on the investment numbers; however, with the Solo-K, there will be no tax. Big or small, wouldn’t you prefer no tax?
Score: Solo-K – 4, IRA – 0
Simply stated, the IRA family of products do not allow for participant loans. Your Solo-K does! Of course, there are pros and cons of whether one should take a loan as there are IRS rules on repayment and you have a legal obligation to repay….but the fact of the matter is that you have the ability/freedom to take a loan from your Solo-K, where you do not have loan options with your IRA.
Score: Solo-K – 5, IRA – 0
I am not aware of many people who would intentionally violate an IRS Prohibited Transaction with either their IRA or 401(k). However, sometimes, innocent mistakes can occur.
While an IRA and Solo-K must both to adhere to such regulations, the penalty for having an adjudicated PT within your IRA is a stiff penalty. Full distribution of the IRA plus a 10% penalty if the PT occurred prior to age 59 1/2. In contrast, the penalty structure is certainly not as drastic with your Solo 401k. Because the Solo-K is an employer-sponsored plan, the penalty structure is not nearly as onerous as that of the IRA.
Score: Solo-K – 6, IRA – 0
Annual Reporting Requirements
The IRA custodian holding your IRA must file Form 5498 each year to report the FMV of your IRA and, if applicable, any new contributions or distributions. Not that this exercise is onerous, but it is just one more step that must occur in the proper reporting of your IRA to the IRS. In contrast, IF your Solo-K does not have any distributions and/or the FMV is under $250,000, there is no reporting of any kind necessary from the plan (and you as Trustee) to the IRS.
Score: Solo-K – 7, IRA – 0
Are there circumstances, unique to your situation, where the IRA may be better for you vs. a Solo-K….yes, potentially. The most common situation that would/could occur is if you already have a Roth IRA. Under current law, a Roth IRA cannot be rolled over to a 401(k) plan. By process of sheer elimination, you would need to resort to establishing a self-directed Roth IRA.
Traditional Investments — Easier for the Solo-K
Let’s face it…your interest in setting up a self-directed IRA or Solo-K is because you do want to invest in non-traditional asset investments (e.g., real estate). However, I always use a $1,000,000 example: if at any given time (e.g., not using all the funds in the plan at the same time; wanting the option of being able to invest into traditional investments from the same plan), you want to also have one account where you can have one plan checkbook and the freedom to do any investments from one account…you can with the Solo-K.
Brokerage Firm Options
PGI works with brokerage firms such as Schwab, Fidelity, TD Ameritrade, E*Trade, etc. so that you can open your account with one of these firms. Please keep in mind, your plan is not sponsored by these companies and they have no responsibility for you plan and do no IRS reporting.
However, what it does give you is one account where you can invest into both traditional and non-traditional assets. It really is the best of both worlds. You have a plan checkbook/wiring access for your traditional assets, and the ability to invest into traditional assets as well (e.g., in-between non-traditional investments).
For full transparency….there is one national brokerage firm that will house an IRA LLC….TD Ameritrade. But….
Score: Solo-K – 8, IRA – 0
As you can see, there are some extensive benefits to the Solo-K. It does not mean the self-directed IRA, IRA LLC or IRA Trust does not provide significant self-directed benefits to the individual; rather , if one qualifies for the Solo-K , it should be the self-directed vehicle of choice.
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.