What Is a Self-Directed 401k?

self directed 401k

Will you have enough money to live off of in retirement? The Bureau of Labor Statistics found that only 43% of United States workers participate in a retirement savings plan. This survey specified only retirement plans accessed through an employer.

What do you do if your employer doesn’t offer retirement plans, or you are self-employed? Self directed 401k plans may be the solution for you. Today we’ll explore multiple types of retirement accounts. 

What Are Retirement Accounts?

It’s time to learn about different types of 401k and IRA accounts. This will also allow you to determine if a self-directed 401k plan is right for you and your future.

With a traditional 401k plan, you will not be taxed on earned interest until you withdraw your investment later in life. Even better, you get to invest in a 401k with money pre-tax. This means that you’ll have a greater sum to earn more interest over the years.

This pre-tax ability is yet another incentive to invest in your future.

401k vs. IRA: What’s the Difference?

IRA plans are similar to 401k plans. However, IRA plans are set up on an individual basis and not set-up by an employer. IRA plans also have much smaller yearly limits for your contributions. To set up an IRA plan, you’ll have to work with a 3rd party financial institution.

If you are able to balance both, it is ideal to invest in both 401k and IRA plans. As of 2017, 34.8 percent of American households had at least one IRA account. This is equivalent to 43.9 million households.

What is a Self Directed 401k?

A self-directed 401k is also known as a self-employed 401k. This is because full-time freelancers and self-employed individuals are not able to take advantage of a permanent employer retirement plan. Instead, a self-directed 401k may be the best and only option for those self-employed.

Do you have to be self-employed to have a self-directed 401k? Yes and no. To open a self-directed 401k, you must have earned self-employment income. This can be attained without being a full-time freelancer, however.

You will only be able to contribute to a self-directed 401k in years where you do have some level of self-employment income. Additionally, 401ks always have higher contribution limits when compared to IRAs.

Self-Directed 401k vs. Traditional 401k

The self-directed 401k offers more customization than a typical 401k. Most employer-enabled 401k plans only have select options for workers to choose from. This means that an employer has a large say in which stocks or bonds you can even invest in.

Newer stocks and mutual funds may not be offered in an employer plan. With a self-directed 401k plan, however, your investment options widen. Unlike many traditional employer plans, self-directed plans can allow you to invest in real estate and cryptocurrency. You can even invest in precious metals.

In general, it’s a good idea to invest at least partially in stocks. Historically, other avenues of investments have not proved to be as lucrative over time. For a more in-depth look at choosing your investment areas, read more on our big picture investing guide.

If you are confident in your stock choices, having a self-directed 401k is for you. Charles Schwab saw an 8.7% increase in balances in self-directed brokerage accounts. This increase was seen in early 2019 compared to late 2018.

Increases like this are never promised. However, a self-directed 401k can give you the freedom to learn more about markets you are already fond of and want to grow with.

Can You Save More? Traditional, Roth and Self-Directed IRAs

There is one key difference between traditional and Roth IRAs. With traditional IRA plans, you invest funds into the plan pre-tax. This means you do not pay income or other taxes on funds the year you invest them into a traditional IRA.

Sound familiar? This is exactly how 401k plan investments work as well. However, upon retirement age, you’ll want to start using the money you’ve saved. When you start withdrawing funds then, you will have to pay taxes on the traditional IRA money.

Roth IRAs are the opposite in this sense. When contributing to a Roth IRA, you pay taxes on the funds before depositing. However, you will benefit when you are older and need to withdraw funds. Doing so later in life with then be tax-free.

Finally, both Roth or traditional IRAs can be self-directed. Self-directed IRAs are directly managed by the account holder. They also allow for alternative investments not available on accounts that are not self-directed. Consider these if you want to control exactly which investments you have to the T.

Can You Have Multiple IRAs?

Which IRA plan should you choose? Can you have multiple IRAs?

Hypothetically, using a traditional IRA would be most efficient. This is ideal if you expect to be in a much lower tax bracket later in life. When you finally start withdrawing funds from your IRA, you will thus pay fewer taxes hypothetically even with the growth from interest.

However, if you will actually be in a higher tax bracket during older age, you may want to rely on a ROTH IRA instead. This will allow you to bite the bullet when it comes to taxes now, and benefit by avoiding heavy fees later in life.

You can also have both a traditional and Roth IRA. However, your yearly contribution limit would then apply to the combined sum in both accounts.

Protecting Your Financial Future

No matter the types of investment plans you choose, it’s important to invest early. The more time your investments have to grow, the more likely they will. The magnitude of your investments will also layer.

As your investment amount grows, it’s yearly interest amount will also grow. This is the biggest benefit of investment accounts. Unlike stuffing money in a mattress, your money made now has the chance to grow into something larger and larger over time.

Want to protect your future with a self directed 401k and more? Ready to achieve greater peace of mind with advice from an expert? Consider our “Map My Retirement” service package today. Together, we’ll review your investment accounts and more to secure your financial future.

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