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Owning and Operating a Self-Directed 401K 101

Ever heard of a self-directed 401K? It might be what you need. It’s not very common for employers to offer a self-directed 401K, more than likely you’ve been contributing to an employer-sponsored 401K. While there are similarities, they’re both retirement savings vehicles, and they follow the same rules, but the fundamental difference is that there’s no middle-man. You’re in control. Let’s go over how that works exactly.

Yearly self-directed 401K contributions

For elective deferrals or the maximum amount that you can have deducted from your taxable income and contributed to your self-directed 401K, the amount is $19,500 for 2020, or $26,000 for 2020 if you’re age 50 or over. This limit is adjusted annually for inflation.

Employer non-elective contributions up to 25% of compensation as defined by the plan, or for self-employed individuals, see below.

Total contributions to a participant’s account, not counting catch-up contributions for those age 50 and over, cannot exceed $57,000 (for 2020; $56,000 for 2019).

Qualified assets

This is where the biggest difference lies between an employer-sponsored 401K, and a self-directed 401K. In an employer-sponsored program, the assets are pre-determined by the 401K custodian that your employer has chosen. You’ll most likely get a mixture of mutual funds composed of stocks, bonds, and money market investments. The most popular option tends to be target-date funds, a combination of stocks and bonds that gradually become more conservative as you reach retirement age.

When your 401K is self-directed, you still have the ability to invest in all of those assets listed above, but you also have the option to invest in real estate like commercial or residential properties, cryptocurrencies, private placements, precious metals, and so much more. You’re given the choice to invest in assets that are outside of the rocky markets, and into assets you want and understand.

Transactions between related parties

Don’t entangle your 401K plan with your family members, either. For this purpose, “family members” are your parents, grandparents, children, grandchildren, or spouse’s children or grandchildren.

That means you can’t lend your self-directed 401K money to any of these relatives, let them live in property owned by your plan, invest in the relatives’ businesses, or otherwise cause your family members to benefit from the plan.

Distributions

The rules for taking distributions from a self-directed 401K plan are the same as those for any other 401K plan. Your 401K plan may allow for hardship withdrawals when you have immediate and serious financial needs. But if you take such a withdrawal, you may have to pay a 10% penalty to the IRS in addition to income tax, unless you meet an exception. It’s possible to qualify for a hardship withdrawal and not meet an exception to the 10% penalty.

You can roll over the amount from a self-directed 401K plan to another qualified retirement plan or IRA, just as you can with any other 401K plan.

It’s your money, and you should be able to buy and sell investments as you choose, taking the risks and reaping the rewards. If your employer offers a self-directed 401K plan, you can do just that.