Retirement accounts are a scary topic.
Why? Because the unknown is terrifying. Many of us don’t know much about the options in our retirement account. Heck, sometimes I forget if I have a traditional or a Roth IRA … and how they differ.
If you’re in the dark about your current retirement accounts, you probably don’t know much about a far less common option: the self-directed 401 (k).
Self-directed 401 (k), however, are unlikely to remain a mystery for long. As of 2017, 18% of Vanguard’s defined contribution plans offered self-directed options. The bigger the plan, the higher this percentage. So, if you haven’t got the chance to open one, you can do so soon!
What is a self-propelled 401 (k)?
Scott Kallish, Financial Advisor at FMB Advisors, a financial advisory practice of Ameriprise Financial Services Inc., gave me a basic definition of a self-directed 401 (k):
“A 401 (k) is a very regulated retirement account that has to adhere to strict guidelines and guidelines
Calculations, ”said Kallish. “Some 401 (k) may contain a self-directed component or a” brokerage window “in which the 401 (k) participant[s] may take upon itself to place all kinds of investments beyond anything the 401 (k) plan sponsor has approved for the 401 (k). “
You may already know that traditional 401 (k) gives you a range of investment options – namely mutual funds, stocks, and bonds.
Self-propelled 401 (k) give you many more options. You can invest in a variety of things through the brokerage window.
Do you want to own real estate? With a self-guided 401 (k) you can.
Would you like to be like Ron Swanson in Parks and Recreation and invest in gold? You can also put gold in your self-directed 401 (k).
The decisions go on and on. (More on the limitations later.)
Think of retirement accounts like eating out in a restaurant.
Setting up a traditional 401 (k) is like ordering from the menu in a restaurant. The food is good but you limit yourself to what is on the menu.
Choosing a self-paced 401 (k) is like visiting an international supermarket to decide what to eat. You can buy all the ingredients you need to make your own dishes and the wide variety of foods will make your meal a lot more creative!
Am I eligible for a self-propelled 401 (k)?
If you create a plan through your employer, your eligibility will depend on their standards.
As a rule of thumb, you must be at least 21 years old and have worked at least 1,000 hours per year for your employer for a certain number of years.
Most companies only allow employees who have been with the company for a while and already have a solid 401 (k) plan to create a self-directed 401 (k) plan.
While this may seem unfair, taking control of your own investments is a huge responsibility. The idea is that if you are loyal to the company and have experience with your retirement account, you will be rewarded with the broker window.
How does a self-propelled 401 (k) work?
A self-piloted 401 (k) might sound too complicated to understand. But the rules are actually surprisingly simple.
“The IRS cleared adopting a traditional 401 (k) plan and adding a self-directed broker window to create a self-directed 401 (k) plan,” said Kallish.
A 401 (k) with a self-controlled component follows the same rules as any other 401 (k). For example, if you have a self-directed plan, you still need to stick to the same annual contribution limit as someone who has a traditional 401 (k). That means you can contribute $ 19,000 in 2019.
While there aren’t actually different rules for self-directed plans, there are some additional rules and details for the broker window.
First, you can’t invest in collectibles. If you’ve thought about investing in a quality sports car or artwork with your self-guided 401 (k) plan … Sorry!
Second, you cannot use your investment to work with a “disqualified person”.
What exactly is a disqualified person? Let’s say a plan participant buys a condo and lets his daughter live there, or buys part of a business that his grandfather owns.
This would be illegal as family members cannot live or work in the assets of your 401 (k) broker window.
Third, borrowing money, either directly or indirectly, is prohibited. For example, under the 401 (k) self-directed plan, a mother cannot sign a loan guarantee for her son.
Fourth, you cannot get any direct or indirect benefit from your self-directed plan. You cannot receive commission on the sale of a property on your own plan.
However, if you own a small business and manage your own self-directed 401 (k), you have even more flexibility. Basically, you can legally invest in anything but life insurance!
Yes, you read that right. You may be able to set up a self-directed 401 (k) even if you don’t have an employer to go through.
How can I start my own self-guided 401 (k)?
People who want to open a self-directed broker window through their company can go through their company’s process. What if you are self-employed or own a small business of your own? How can you open your own self-controlled 401 (k)?
First open a Solo 401 (k). Note that you can only open this account if you are a business owner with no employees.
Then set it up so that your Solo 401 (k) has a broker window for self-directed investments.
Do you own your own company but have employees? Opening a self-directed Solo 401 (k) is then not an option. (Unless your only employee is your spouse! You have to love a void.)
You can open a self-directed Solo 401 (k) through an investment broker like loyalty, Here you will find a wide range of investment options.
However, plan carefully. It is important to decide which investment broker is perfect for you and your company. Vanguard, Charles Schwab and E-Trade also offer individual 401 (k) packages, among other things. Fees, investment options and rules vary from company to company.
It all depends on your priorities! Check out an incredibly comprehensive look at the Solo 401 (k) plans of various investment brokers at The Biglaw Investor.
Contribution to your self-driving Solo 401 (k)
You have chosen your investment broker. They helped you set up an account. So how do you actually contribute money to your self-driving Solo 401 (k)?
- First, determine how much you want to contribute to your account annually. Most companies have a tool that can help you make this decision, such as: B. the practical contribution calculator from Fidelity.
- Most investment brokers require you to fill out a salary cut-off form. This document will record how much of your salary you plan to contribute each month. Some brokers offer other options. For example, if you have a self-directed 401 (k) with Fidelity, you can just print out and fill out a form and mail it in with a check every time you want to contribute.
- If you already have a retirement account, you may be able to transfer your wealth to your self-directed 401 (k). You should check with both the company that manages your original retirement account and the company that controls your self-directed 401 (k) to review both sides’ rules for asset rollover.
What are the pros and cons of opening a self-guided 401 (k)?
Retirement accounts are very complex, so the pros and cons for Pages and Pages can go on. But we’re going to keep it simple and only cover the main points.
The benefits of a self-guided 401 (k)
- First, you have much more control over your investments than with a traditional 401 (k). If you have a lot of experience and knowledge, you may not want to be limited by your company’s investment opportunities. You can put all your knowledge to good use and make the most of your money!
- My favorite pro? Self-piloted 401 (k) are portable. “You can extend it if you change jobs instead of creating a new plan for each employer,” says Kallish.
If you think you will be changing jobs soon and / or frequently, this portability can save you a major headache every time you get a new job.
The disadvantages of a self-piloted 401 (k)
- You know the freedom and control that comes with a self-directed plan that so many love? It can also be a scam. Back to the restaurant analogy: the thought of choosing and preparing a meal from the plethora of choices in the international supermarket may feel so overwhelming that it sounds infinitely easier and safer to sit down at a table and order a menu. And if you don’t have a lot of investment knowledge, there’s plenty of room for error.
- As mentioned above, when your plan is provided by your company, the company will decide who is eligible and who is not. Being at your mercy can be annoying and viewed as another disadvantage.
- Last but not least, there is potential for fraud. Individuals running Ponzi programs sometimes target self-directed 401 (k) participants as they may not be known. In fact, it got so bad a few years ago that the Securities and Exchange Commission (SEC) alerted an investor to possible fraud.
The easiest way to avoid fraud is to use an established 401 (k) company that has been in the business for a while with a highly rated track record and few (to no) complaints. The 401 (k) company must also consider the broker window for self-directed investments in the 401 (k) plan. They can regulate your investments and protect you.
Will this be the year you open a self-guided 401 (k)?
Laura Grace Tarpley is a freelance writer and editor for FluentU. Follow her on Twitter @lgtarpley.