How To Use a Self Directed 401k Plan For Retirement

How To Use a Self Directed 401k Plan For Retirement

I’ll never forget the email I received from a new Passive Investor Club member who had recently discovered the possibility of using their “locked up” retirement account money to invest outside of the stock market.

After graduating from dental school, his retirement plan looked like everyone else’s:

  1. Set up a 401k
  2. Invest monthly (max it out)
  3. Get ready to retire with millions in 40 years!

At the time, he didn’t realize that he’d only learned about one way to invest for retirement. It’s the traditional (accumulation) model that the majority of financial institutions teach.

Something else he never considered was that as he got closer to retirement age, the stock market returns would begin to dictate when he could actually retire.

How many times have you heard someone say, “Man, I was planning on retiring this year, but I lost too much in the market. Guess I got to keep working a few more years.”

Who wants to spend their entire career working hard only to face that kind of uncertainty, right?

For me, I got a big wake-up call years ago while skiing. I fell and injured my wrist, which made me question how I was earning money. If I couldn’t treat patients, then I couldn’t feed my family.

That’s as risky as not having life or disability insurance with a family depending on you. But now that I’ve learned there are other options for investing for retirement, I’ve come to realize that what we’ve been led to believe is downright risky.

Instead of guessing if I’ll have enough money when I retire, I feel much better KNOWING that I’ll have adequate funds, as we’re investing for TODAY and not 40 years from now.

Because we know what our living expenses are, we’re able to invest in cash-flowing real estate to replace them while continuing to appreciate in value. It’s not too difficult to grasp.

My job isn’t to sway you to invest in one model or another (I’m NOT an investment advisor or tax advisor). I want to give you additional information about alternative assets and investment CHOICES so you can decide what’s best for YOU.

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Most people rely on employer-sponsored retirement plans or conventional individual retirement accounts (IRAs) to invest for retirement. However, a self-directed 401k or self-directed individual retirement account (IRA) could potentially be a good choice for those wanting greater control over their investments.

In this article we’ll discuss self-directed 401(k) plans, including what they are, how they operate, who qualifies, the kinds of investments that are offered, and the benefits and drawbacks of utilizing them as an investment vehicle.

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What is a Self-Directed 401k?

A self-directed 401k is a qualified retirement plan that allows the account owner to choose and manage their own retirement funds. Unlike traditional 401ks, where the investment options are limited to mutual funds, stocks, bonds, etc., these plans allow participants to invest in a wider range of assets, including real estate, private equity, precious metals, tax liens, and more.

A self-directed 401k is governed by the same rules and regulations as other types of 401k plans, which means that it provides tax benefits and tax advantages to the plan participant.

Contributions to a self-directed 401k:

  • are tax-deductible
  • grow tax-free until they are withdrawn during retirement

However, it is important to note that there are strict rules around the types of investments that can be made within a self-directed 401k to maintain its tax-advantaged status.

How Does a Self-Directed 401k Work?

A self-directed 401k works similar to any other 401k plan, except that the participant has more control over which investments they’d like to invest in.

Plans are set up with a financial institution, such as a bank or a brokerage firm, that offers self-directed services. 

*As a side note, we use and recommend the IRA Club for our self-directed retirement account.

These types of institutions serves as plan’s trustee and holds the assets on behalf of the participant.

After the plan is established, the participant can direct the trustee of the plan to invest the 401k funds in the investments of their choice.

It’s important to note that you can incur penalities if you use funds for personal use or benefit before reaching retirement age.

Eligibility Requirements

In order to be eligible to start a self-directed 401(k), you must have received taxable income during the current fiscal year. This income is your responsibility and not that of an employer. A small business owner who is a sole proprietor, independent contractor, and freelancers typically fit this condition. Spouses may contribute if they work for the business.

These plans are an alternative to regular 401(k) plans that employers may offer. In this situation, a self-directed 401(k) would also be administered by the plan administrator.

Self-directed 401(k) plans can be funded in one of three ways:

  • Transfers: moving funds from previous 401(k)s, SEP IRA, Simple IRA and traditional IRAs; Roth IRA can’t be transferred
  • Profit sharing: obtaining a direct share of profits; up to 25% of the sponsoring entity’s profit
  • Contributions: postponing income into the account

Self-Directed 401k Contributions

Employee contribution

As an employee, you can choose to make an employee contribution, also known as an elective deferral, to your Solo 401(k). For 2023, the maximum contribution limit for the employee contribution is $22,500 for those 50 and under.

For those who are 50 and older, the elective deferral limit is $30,000 and can be made in pretax or Roth accounts.

Employer contribution

The employer contribution (aka the profit sharing contribution) has a limit of $43,500 for 2023 and applies to individuals of any age. This is calculated as a percentage of earned income unlike the employee deferral contribution which is a dollar-for-dollar contribution.

Employer profit sharing contributions can be made up to 20% of your self-employment income (net Schedule C) or 25% of your W-2 income. But keep in mind these can only be made as pretax and not as Roth contributions.

Investment Options For Self-Directed 401ks

One of the main benefits of a self-directed 401k is that you aren’t limited to the typical options (stocks, bonds, mutual funds, etc.) offered by traditional 401(k) plans.

Some of the alternative investments options are but not limited to:

  • real estate – can’t be used for personal use
  • syndications
  • loans
  • precious metals (i.e. gold, silver, etc.)
  • oil and gas
  • tax liens
  • small business startups
  • stocks, bonds, mutual funds
  • cryptocurrency
  • private equity
  • CDs
  • land
  • commodities and futures
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Benefits of a Self-Directed 401k

#1. More investment choices

As previously mentioned, these accounts offer a wide range of choices to invest for diversification. Not only can you invest in stocks, bonds, and mutual funds, you also in non-traditional investments like real estate or commodities.

#2. Greater control

Self-directed 401k plans allows the owner (you) to also become the trustee which is responsible for funding the investments. This is also called checkbook control.

As trustee of the plan, you no longer have to get approval for each and every investment you’d like to make. Basically, you’re in control over your money.

#3. Tax advantages

Similar to traditional 401(k)s, self directed plans offer several tax benefits such as tax deductible contribions.

There’s also a Roth component. The contributions are made after taxes which doesn’t give you an upfront tax advantage. But it does give you the ability to make tax-free withdrawals in the future.

#4. UDFI exemptions

Self-directed 401k plans can help you avoid unrelated debt-financed income (UDFI) taxes if using for real estate.

Make sure you check with your CPA or real estate attorney regarding this process as it can become complicated. Income generated from real estate can be reinvested back into your account tax-deferred.

This is different when it comes to investing in real estate financed through an IRA as gains can potentially be taxed under UDFI.

Self-Directed 401k Prohibited Transactions

If you plan on using a self-directed 401k to invest in real estate, it’s important to receive guidance to help you avoid making a prohibited transaction.

While you can invest in rental property through self-directed accounts, it’s important to follow the laws that allow you to do so.

For instance, you’re not able to use property a self-directed plan owns as security for a loan or your personal residence. 

Also, there are several types of collectibles that are prohibited to purchase with retirement savings such as:

  • Artwork
  • Gems
  • Antiques
  • Rugs
  • Wine and/or other Alcoholic Spirits
  • Collectible coins
  • Stamps
  • Non-fungible tokens (NFT)


1. What’s the difference between a self-directed IRA, traditional IRA or Roth IRA?

A self-directed IRA gives you more ways to invest, such as in real estate and private businesses. On the other hand, traditional and Roth IRAs usually only let you invest in the stock market. 

2. Can I have both a self-directed IRA and a traditional or Roth IRA?

Yes, you can have more than one type of IRA account. However, you need to make sure that your total contributions don’t go over the IRS limits for annual contributions.

3. Is it possible to transfer a managed 401k to a self-directed 401?

Yes, it’s usually possible to move money from a 401k that is managed to one that’s self-directed. You may need to do a rollover or transfer between the accounts. As always, speak to your plan provider to avoid penalties and to ensure the process goes smoothly.

4. Who’s eligible for a self-directed 401k?

These plans are usually made for people who work for themselves or own a small business with no full-time workers other than the owner(s) and their spouse(s) (s). 

5. What are the tax advantages of a self-directed IRA?

Self-directed plans are a lot like traditional 401(k)s in that they offer tax benefits such as tax-deductible contributions. If you use a Roth account, then contributions are made after taxes meaning you don’t get a tax break right away. But it does let you take money out of the account in the future without having to pay taxes on it.

Ready to get started with a self directed account?

We use and recommend the IRA Club 

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