Solo 401(k) Vs. SDIRA

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If you’re an investor trying to invest in real estate for your retirement, here is a guide to investing in real estate and other alternative assets.

Real Retirement Portfolio Diversification

A retirement portfolio holding mutual funds, stocks, index funds and securities is not diversified. Most of these investments are dependent on equity markets. Any market variation could leave the investor at a loss. Real diversification implies having different asset classes in your portfolio.

Self-directed retirement plans offer the plan holder investment discretion. Their investment options range from traditional stock market products to real estate, mortgage notes, private lending, precious metals and even digital assets. The two most popular self-directed retirement plans for real estate investing include self-directed individual retirement accounts (SDIRAs) and self-directed solo 401(k)s.

Which Property Type Is Best for Investing?

Single-Family Rentals
When compared with multifamily apartments, single-family rentals (SFRs) offer better liquidity as their buyer pool involves first-time homebuyers, seasonal investors, and upsizing or downsizing buyers. Furthermore, the renter is responsible for paying all the utility bills as well as maintenance. As an investor, buying SFRs offer geographical diversification because the investor can purchase properties in different markets.

Multifamily Apartments
Multifamily apartments are an ideal choice for investors with higher investment potential. Unlike SFRs, chances are at least some of the units will always have occupancy, ensuring consistent cash flow. Additionally, multifamily apartments allow investors to benefit from the economies of scale during repair/maintenance as well as property management costs.

Steps to Investing with SDIRAs

1) Open a self-directed retirement account.
Understand that not all plans are structured the same way, so inquire about the self-directed feature of the account.

2) Fund it with qualified rollovers.
You can fund the account through qualified rollovers from traditional IRAs, SIMPLE IRAs, SEP IRA, defined benefits plans, Keogh plans, thrift saving plans, 401(k), 403B and 457 plans. For individuals with a Roth IRA plan, the IRS allows rollover into a self-directed IRA but not solo 401(k) plans.

3) Find a suitable property for your plan.
You must choose an investment property that aligns with your retirement goals and is located in a developing and growing neighborhood.

4) Borrow using nonrecourse finance.
You can leverage to acquire an investment property; however, because IRS rules do not allow personal guarantees, the loan must be nonrecourse. Most banks do not offer such financing; however, there are a handful of lenders who specialize in lending to IRAs and 401(k)s.

5) Purchase property in the name of your plan.
Titling can be tricky in the case of self-directed plans. The property should be titled in the name of the retirement plan itself.

6) Pay maintenance from the plan.
Any financial resources spent on the maintenance and upkeep of the property must come from the retirement plan. Additionally, the IRS prohibits DIY maintenance and repairs, so make sure to hire a third-party contractor for the job. In the case of multifamily apartments, the plan holder must appoint a third-party property manager.

Mortgage Notes

Mortgage notes are built for investors seeking passive income from real estate investments. Using mortgage notes, you are essentially investing in debt and receiving timely repayments with interest. When compared with hard real estate, mortgage notes are easier to manage, and a single investor could purchase as well as maintain a large portfolio. They do not require maintenance, repairs or property management. Additionally, secured mortgage notes are backed by collateral, which means in case of a default, the note holder can foreclose on the property.

Investing in Mortgage Notes with Self-Directed Plans

The initial steps of opening and funding a self-directed retirement plan are common in every asset class. Here’s how to do so when it comes to mortgage funds:

1) Secured Mortgage Notes
You can purchase secured mortgage notes from banks as well as reputable real estate investment firms. It is important to seek an expert opinion before investing in the note.

2) Purchasing Mortgage Notes
For self-directed IRAs, the retirement account holder must have the custodian review the investment prior to completing the transaction. For self-directed Solo 401(k) plans, the account holder can directly purchase mortgage notes using plan assets.

3) Servicing Notes
Any note servicing or accounting must be done by a third-party service provider, with the charges being paid by the retirement plan.

Solo 401(k) vs. SDIRA: Making The Right Choice

A Solo 401(k) is a retirement plan devised for self-employed professionals, solopreneurs and small-business owners operating without employees. A self-directed IRA, on the contrary, is suitable for any professional, salaried employees or business owners with employees. Here is a list of the critical differences between Solo 401(k) and SDIRA retirement plans:

Annual Contributions
Solo 401(k) retirement plans allow annual contributions of up to $56,000 along with additional catch-up contributions of up to $6,000 for plan holders above 50 years of age. Self-directed IRAs allow annual contributions of up to $6,000 along with additional catch-up contributions of up to $1,000.

Alternative Investments
Both SDIRA and Solo 401(k) retirement plans allow alternative investments such as real estate, mortgage notes, private lending, precious metals and digital assets.

Custodian Requirements
A self-directed Solo 401(k) plan does not require having a custodian and can be set up as a trust, giving the plan holder “checkbook control,” whereas an SDIRA must have a custodian who holds the plan assets.

Participant Loan
Each plan holder can borrow up to $50,000 or 50 percent of the Solo 401(k) plan balance, whichever is lower, as a participant loan. Self-directed IRAs do not permit participant loans.

Built-in Roth Component
Solo 401(k) retirement plans have a built-in Roth component, allowing plan holders to contribute after-tax dollars. In the case of SDIRA plans, the plan holder must open a separate self-directed Roth IRA account.

How you invest depends on many factors. Before you make any investment, be sure to have a clear picture of your goals, do your research and consult with qualified professionals.

Dmitriy Fomichenko

Dmitriy Fomichenko is the founder and president of Sense Financial Services LLC, a boutique financial firm specializing in self-directed retirement accounts with checkbook control. He began his career in financial planning and real estate investing in 2000. He owns multiple investment properties in various states and is a licensed California Real Estate Broker. Over the years, he has taught hundreds of investment and financial planning seminars and has mentored thousands of investors.Dmitriy founded Sense Financial Services to help his clients maximize their returns on investments while protecting their hard-earned money. He is very passionate about helping families and individuals achieve financial freedom by following proven Biblical principles of financial planning and investing.