This author receives many emails and telephone calls from individuals who have no idea what an IRA is or a 401K, let alone what they can use this type of chassis for when it comes to investing. Most have no clue they can invest in Real Estate with either chassis, as well. Of course, we always have to disclaim and defer to IRS regulations pertaining to both plans and the ability to make such investments, but can you do it, yes.

No one expects individuals to be experts on the finer points of commonality and distinction between IRAs and 401Ks (or other qualified retirement accounts)…..let’s face it, sometimes the subject matter is not the most exciting. But what is important and should be to most is that IRS rules do not prohibit you from investing retirement assets into Real Estate as long as you follow the rules…
Since, we receive many calls asking the differences between IRAs and 401Ks, let’s go into a little more detail on the basics of a 401K. Both IRAs and 401Ks can invest in Real Estate, but most would agree that the 401K provides some greater benefits….some of these benefits we will address.

First of all, what the heck is a 401K. Most individuals assume (not necessarily incorrectly) that a 401K is for big companies with lots of employees. Well, that can be true, of course. Then others believe that a 401K can be for a smaller company with employees, as well. And, again, that can be true as well. Most, if not all, have no clue that a 401K can be established for either a sole proprietor or a self-employed individual who has a sponsoring corporate entity.

So, what is a SD (Self-Directed) 401K? – The SD 401K is a plan that is created for a small, owner-only (which can include a spouse as well) business. Unlike what most people consider “corporate” 401K plans, a SD 401K is a very cost effective plan that permits significantly higher (potential) amount of contributions over an IRA and allows for profit-sharing contributions as well. Quite simply, the 401K allows for a greater amount of tax-sheltered contributions than other types of retirement vehicles available to small businesses….including self-employed individuals.

Sounds Good…Are There Other Benefits to the 401K? – Well, yes. For those who qualify (get to that in a second), here is but a sampling of some benefits associated with the 401K:

1) Low or No Cost Administration of the Plan;

2) Higher Contribution Limits;

3) Loan Provisions –- Loans for any reason as long as you follow IRS rules for repayment;

4) Employee Contributions being able to be made either Traditional or Roth;

5) Tax Deferred or Tax Free (Roth) growth on investments;

6) Flexible Distribution Options;

7) Ability to consolidate most of one’s existing retirement plans into ONE chassis.

I am Still Interested, BUT How Does One Qualify for the 401K? –- As noted, the SD 401K is for small business owners with no full-time employees (spouse permitted). You can qualify to have the plan and make contributions whether you receive salary, wage, compensation from either an incorporated business OR a sole proprietorship or partnership. In general, the following types or categories of individuals may be excluded from coverage in a 401K plan:

1) Employees under the age of 21;

2) Employees that work less than 1,000 hours per year;

3) Union Employees; and,

4) Non-Resident Alien Employees

I’m Still Reading….So, What Can I Contribute Potentially? –- In most of my phone calls with individuals, they call me assuming that they have to have an IRA AND they assume that the most they can contribute to the plan is $5,000 if they are under the age of 50 and $6,000 if they are over the age of 50. But, not so fast.

Let’s look at the 401K.

1) First off, as a participant in the plan that you serve as Trustee for, you are entitled to contribute a discretionary, tax-deferred (and tax deductible) “profit share” contribution of up to 25% of your income. Further, this contribution does not need to be made every year….it is elective. This is based on 2011 guidelines.

2) In addition, you are eligible to make either a pre-tax salary deferral contribution OR after-tax Roth salary deferral contributions (if your plan allows) of up to $16,500 if you are under the age of 50 or $22,000 if you are over the age of 50. This is based on 2011 guidelines.

3) Maximum Amounts? –- The maximum contribution you can make to the plan through either Profit Share or Employee contributions is the lesser of $49,000 (or $54,500 if you are over the age of 50) or 100% of compensation.

You Mentioned Loans Earlier….What About Them?

Yes, with the 401K you can take out a loan for any reason. The loans are limited to no more than 50% of the account balance of the 401K OR $50,000, whichever is less. Repayment terms are that the loan duration cannot exceed 5 years and quarterly, amortized payments must be made with legitimate interest rates on the loan.

You Said it was Cost-Effective…How Much So? -– With an individual SD 401K, one will not experience high administrative costs of typical 401K plans (with employees) because, generally, these plans are not subject to costly non-discrimination tests for 401K plans. They can be established with no brokerage fees, total flexibility and on and on. Of course, at all times, the administration of these plans must follow all IRS regulations.

Further, with an individual SD 401K under current requirements, you do not need to file any retirement plan tax information until and unless plan assets reach $250,000. Many individuals have account balances below this and, as a result, do not have to report annual values. Even when asset size reaches and surpasses $250,000, plan reporting is limited to completion of the 5500-EZ….a far different and easier tool to use than its ugly cousin, the 5500. Further, as long as you do not add employees AND based on current regulations, you will not need to file the complicated 5500 for your SD 401K.

I Hear With IRAs I Need a Custodian…True with the 401K? -– Not true. Yes, IRAs do need to be “held” by a custodian/trust/bank that serves as the custodian or trustee. With a 401K, this is not a requirement. You, yes YOU, can serve as your own trustee. This is getting more exciting!!

Remember, being the Trustee of your own plan is not to be construed with you being a kid in the candy store; as Trustee, you must follow all IRS rules as Trustee of the plan. However, think of the potential that you have to invest in a plethora of investments activities versus just what your broker gives you as options.

Next post — let’s get into the specifics of how you can establish your plan so you can invest in Real Estate and YOU control the account….no one else.