Is a Solo 401(k) My Best Self-Directed Plan Option?
If you’ve been studying self-directed retirement plans, you’ve likely stumbled on the fact that a Solo 401(k) plan is widely considered to be the best available program.
With a self-directed Solo 401(k), you have the best of both worlds in a high-contribution retirement plan capable of investing in anything the IRS rules allow for with direct checkbook control. The Solo 401(k) provides the maximum amount of both flexibility and control in managing your investment portfolio.
The Solo 401(k) is a powerful retirement plan option, but that doesn’t mean it’s always the right plan for every retirement investor. The Solo 401(k) can be over-marketed and promoted to people for whom it isn’t the right choice.
Plan fit — both today and for the long term — is a critical piece of ensuring your investing success. A Checkbook IRA LLC is another great self-directed program, and maybe a better option than the Solo 401(k) for many investors.
Let’s take a look at some of the key questions to ask when evaluating a Solo 401(k) as your self-directed investing platform.
Do I Qualify for a Solo 401(k)?
As an employer-sponsored retirement plan, there needs to be a business that establishes the Solo 401(k) as an employee benefit. With the Solo 401(k), we’re talking about a version of 401(k) that is simple to administer — and that simplicity comes from the fact that it’s tied to an owner-only business.
That means you need to be self-employed and have no qualifying non-owner employees (other than a spouse). A qualifying employee includes full-time employees working more than 1,000 hours per year, or (starting in 2021), long-term part-time employees working at least 500 hours per year in 3 straight years. Because your business isn’t offering benefits to non-owner employees, the administrative requirements of the plan are greatly reduced.
Many types of businesses are Solo 401(k) eligible, including sole proprietorships, LLCs, and corporations. The business does need to be producing earned income such as commissions, 1099 income as an independent contractor, or W-2 wages from your own corporation. Passive investment earnings such as rental income don’t qualify to sponsor a Solo 401(k).
What Other Qualifications Are There?
The bar to be self-employed is pretty low. As long as you have a compatible business format with an intent to generate earned income, your business can sponsor a Solo 401(k).
As a result of this low bar, some plan promoters will forward the idea of “anyone can qualify” for a Solo 401(k). This assertion implies you can sell a few things on eBay or do some rideshare driving and claim self-employment.
While not entirely untrue, there are a few catches, which is why we urge caution on this front.
Your business needs to be legitimate and ongoing. You can’t create a wee bit of self-employment income in year one and call it good. To qualify as a business, your activity needs to continue year after year, and needs to generate legitimate income to the scale of filing a tax return.
If your business is configured to operate at a loss year over year, eventually the IRS will deem it a hobby and not a business.
Your business doesn’t need to be hugely profitable to be viable as a plan sponsor. In fact, it doesn’t even need to show a profit each and every year. But profits in two out of every 3 years should be a realistic expectation.
If you get tired of dealing with bar-crawl patrons in the back seat of your car every Saturday evening and decide to shut down your “business”, then the 401(k) plan also needs to be shut down.
With what we might call “marginal” self-employment, one also needs to weigh the cost/benefit of operating and reporting on a business relative to the ability to have the Solo 401(k) plan format.
Will I Qualify Next Year?
While no one has a crystal ball vision of their future employment status, it’s meaningful to take a longer-term view of your business plan and ensure ongoing compliance with the Solo 401(k) eligibility requirements.
If your current self-employment is temporary or somewhat tenuous, then a Solo 401(k) may not be the best fit. The other consideration comes with a growing business.
If your long-term plan is to add employees, there will come a time when your business no longer qualifies to sponsor a Solo 401(k). Any full-time employee, which means anyone over the age of 21 working more than 1,000 hours per year, will push your business out of Solo 401(k) eligibility. Likewise, plans for long-term use of part time employees who might work more than 500 hours in 3 consecutive years would jeopardize plan qualification.
If you add qualifying employees, you can “upgrade” to a full-blown 401(k) and provide benefits to those employees, but that is not generally a good solution in a self-directed format. The complexities and liabilities that come with allowing your company employees to self-direct within their 401(k) are beyond what most small business owners want to take on.
The more common path at that juncture is to terminate the Solo 401(k) and rollover your holdings to a Checkbook IRA that is not tied to your business. The paperwork and expense associated with such a transition are manageable, but not something to set yourself up for in a near-term cycle if you can avoid it.
Will I Benefit?
There are several aspects of a Solo 401(k) that can be viewed as benefits when compared to an IRA based self-directed plan. Some of the more notable differentiators include:
- A streamlined structure with no custodian involved
- Higher contribution limits than most IRA plans, topping out at $63,500 per year
- The ability to hold both tax-deferred and Roth funds in the same plan
- The ability for a husband and wife to both participate in the same plan if they are both active in the sponsoring business
- The option to borrow up to $50,000 from the plan on a participant loan
- Exemption from UDFI taxation on debt-financed real estate investments
- Less risk in the event of a prohibited transaction
These are all great features. The real question, however, is what does that mean for you?
- Does your self-employment generate significant income to the point where you can actually make higher contributions?
- Will your spouse also have funds to hold within the plan?
- Do you intend to invest in leveraged rental properties?
If none of those factors apply to your situation, the permanency and simplicity of an IRA-based program may be better suited to your needs.
Does the Benefit Outweigh the Costs?
If you have a legitimate form of self-employment, great. Adding a Solo 401(k) to that is going to be a good solution for you.
If you are essentially making up a side business to have a Solo 401(k), the number one benefit of such plans — higher contribution limits — is likely off the table. You can’t put $63,500 in your 401(k) if the business sponsoring the plan is only netting $3,000.
We often have the opportunity to speak with an investor who has learned something neat about the Solo 401(k), such as the exemption from UDFI taxation on mortgaged real estate investments. As a result, they really want a Solo 401(k) — even if they may not currently have legitimate self-employment today.
Avoiding taxation is always a good thing…except for when it costs more to avoid the taxes than the cost of those taxes. Is it worth setting up a side business, taking time away from family or other interests, keeping records, and filing taxes for that business to avoid the $200 a year in UDFI taxes an IRA might pay on a typical leveraged single-family rental?
Probably not.
Now, if you have a million dollars of 401(k) to put to work in leveraged real estate, the additional overhead of becoming self-employed might be worth the effort to offset the slightly higher UDFI taxation that may occur on that scale.
The difference between theory and reality hinges on the details of a specific scenario, so be sure to ask all the right questions and not get caught up with shiny object syndrome.
Thinking Long-Term Equals Success
Evaluating a self-directed retirement plan requires taking a long-term view. A big part of what we focus on at Safeguard Advisors is helping each of our clients to maximize their chances of investing success by choosing the right plan for their situation and goals.
Finding out two years down the road that you are in the wrong plan for your needs is not a good spot to be in. Taking the time to do a real analysis of your specific needs for today and the long term is the best approach to the transition into a self-directed investment strategy.
We support the Solo 401(k) plan structure, and find it to be a great fit for about 30% of the investors we work with. We also enjoy getting to see the successes of those investors who find the IRA LLC to be better suited to their needs.
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Quick answers to common questions
We’ll take you through a simple, step by step process designed to put your investment future into your own hands…immediately. Everything is handled on a turn-key basis. You take 100% control of your Retirement funds legally and without a taxable distribution.
YES! In 1974, Congress passed the Employee Retirement Income Security Act (ERISA) making IRA, 401(k) and other retirement plans possible. Only two types of investments are excluded under ERISA and IRS Codes: Life Insurance Contracts and Collectibles (art, jewelry, etc.). Everything else is fair game. IRS CodeSec. 401 IRC 408(a) (3)
It’s actually pretty simple. Early on, regulators let the securities industry take the lead in educating the public about retirement accounts. Naturally, brokers and banks promoted stocks, bonds, and mutual funds—giving the impression that those were the only allowed investments. That was never true... and still isn’t. You can probably guess why they kept the rest under wraps.
It is possible to use funds from most types of retirement accounts:
- Traditional IRA
- Roth IRA
- SEP IRA
- SIMPLE IRA
- Keogh
- 401(k)
- 403(b)
- Profit Sharing Plans
- Qualified Annuities
- Money Purchase Plans
- and many more.
It must be noted that most employer sponsored plans such as a 401(k) will not allow you to roll youraccount into a new Self-Directed IRA plan while you are still employed. However, some employers will allow you to roll a portion of your funds. The only way to be completely sure whether your funds are eligible for a rollover is by contacting your current 401(k) provider.
A Solo 401(k) requires a sponsoring employer in the format of an owner-only business. If you have a for-profit business activity – whether as your main income or as a side venture – and have no full-time employees other than potentially your spouse, your business may qualify. The business may be a sole-proprietorship, LLC, corporation or other entity type.
A self-directed retirement plan is a type of IRA or 401(k) that gives you greater control over how your retirement funds are invested. Unlike traditional accounts held at banks or brokerage firms that limit you to stocks, bonds, and mutual funds, self-directed plans allow you to invest in a wide range of alternative assets including real estate, private businesses, precious metals, cryptocurrency, and more.
These plans still follow the same IRS rules and maintain the same tax-deferred or tax-free benefits as conventional retirement accounts. The difference is simply in how and where you choose to invest.
No. Moving to a self-directed IRA or Solo 401(k) does not trigger any taxes, as long as your funds are eligible for rollover.
Self-directed retirement plans maintain the same tax-advantaged status as traditional plans offered by banks or brokerage firms. The key difference is flexibility—our plans are designed to give you greater control and allow for a wider range of alternative investments beyond stocks, bonds, and mutual funds.
A prohibited transaction is any action between your retirement plan and a disqualified person that violates IRS rules and can lead to serious tax consequences. Under IRS Code 4975(c)(1), prohibited transactions include:
- Selling or leasing property between your plan and a disqualified person Example: Your IRA cannot purchase a property you already own.
- Lending money or extending credit between the plan and a disqualified person Example: You cannot personally guarantee a loan your IRA uses to buy real estate.
- Providing goods or services between your plan and a disqualified person Example: You can’t use your personal furniture to furnish a rental property owned by your IRA.
- Using plan income or assets for the benefit of a disqualified person Example: Your IRA cannot buy a vacation home that you or your family use.
- Self-dealing by a fiduciary (using plan assets for their own benefit) Example: Your CPA shouldn't loan your IRA money if they’re advising the plan.
- Receiving personal benefit from a deal involving your IRA's assets Example: You can’t pay yourself from profits your IRA earns on a rental.
If a transaction doesn’t clearly fall within the allowed guidelines, the IRS or Department of Labor may review the situation to determine if it qualifies as a prohibited transaction.
Disqualified persons are individuals or entities that are prohibited from engaging in certain transactions with your IRA or 401(k). Doing so could trigger a prohibited transaction, which may result in taxes and penalties.
Here’s who is considered a disqualified person:
- You (the account holder)
- Your spouse
- Your parents, grandparents, and other ancestors
- Your children, grandchildren, and their spouses
- Any advisor or fiduciary to the plan
- Any business or entity owned 50% or more by you or another disqualified person, or where you have decision-making authority
These rules exist to prevent self-dealing and ensure your retirement plan remains in compliance with IRS regulations.
(Reference: IRC 4975)
Understanding and following these rules can be tricky, but it’s very doable. The best way to stay compliant is to work with professionals who specialize in self-directed retirement plans. They can help you navigate IRS guidelines and avoid prohibited transactions.
If an IRA holder is found to have engaged in a prohibited transaction with IRA funds, it will result in a distribution of the IRA. The taxes and penalties are severe and are applicable to all of the IRA’s assets on the first day of the year in which the prohibited transaction occurred.
Yes. While self-directed retirement plans allow for a wide range of investments, there are a few important restrictions.
You cannot invest in collectibles or life insurance contracts, and you must avoid prohibited transactions—activities that benefit you personally rather than the retirement plan. These include things like buying or selling property to yourself or family members, using plan assets for personal gain, or self-dealing in any way.
Violating these rules could cause your entire IRA to lose its tax-advantaged status. To protect your account, it’s essential to work with professionals who understand IRS regulations and can help you stay compliant.
This is a common misconception. In many cases, professionals may simply be unfamiliar with self-directed retirement plans, as they fall outside their usual scope of work. CPAs and tax preparers are trained to file taxes, not necessarily to advise on alternative retirement strategies. Financial advisors and brokers often work for firms that focus on traditional investments like stocks and mutual funds—and may not benefit from or support alternative options like real estate or private lending.
Self-directed retirement investing is legal under IRS rules—but like any specialized area, it requires working with professionals who understand how it works.
The IRS has rules in place to make sure your IRA is used only for the exclusive benefit of the retirement account—not for personal gain or to help family members. These rules can get complicated because there are many ways a conflict of interest can occur, even unintentionally.
For example, if your IRA buys a house and rents it to your mother, you might be reluctant to evict her if she stops paying rent. That emotional connection creates a conflict between what’s best for your IRA and your personal relationships, something the IRS aims to prevent.
These rules help ensure your retirement account stays compliant and protected. (See IRC 408)
Yes. Most tax-deferred retirement accounts—such as Traditional IRAs, old 401(k)s, 403(b)s, and TSPs—can be rolled over into a self-directed IRA or Solo 401(k), depending on your eligibility. Roth IRAs cannot be rolled into these accounts.
You can contribute directly from earned income, subject to annual IRS contribution limits. The method and amount depend on the type of plan you have (e.g., Solo 401(k) vs. IRA).
To take a distribution, you'll request funds through your custodian or plan administrator. Distributions may be taxable depending on your account type and age. Early withdrawals may be subject to penalties.
For 2025, the Solo 401(k) max contribution limit is $81,250 if age 60-63, $77,500 if age 50-59 or 69+, and $70,000 if under 50. Traditional and Roth IRAs have a limit of $7,000 ($8,000 if age 50+). Limits are subject to IRS adjustments.
Yes. IRA contributions are typically due by your personal tax filing deadline (e.g., April 15). Solo 401(k) contributions follow your business tax filing deadline, including extensions.
IRS reporting requirements vary depending on the type of self-directed retirement plan you have. Here’s a quick breakdown of what you need to know
Please note: Our team can help you understand what’s required for your specific account, but we don’t provide tax or legal advice. We always recommend working with a qualified tax professional to ensure full IRS compliance.
Self-Directed IRA (Traditional or Roth)
- Form 5498 – Filed by your custodian each year to report contributions, rollovers, and the fair market value (FMV) of your account.
- Form 1099-R – Issued if you take a distribution or move funds out of your IRA.
- Annual Valuation – You'll need to provide updated FMV for any alternative assets held in the account, such as real estate or private placements.
Solo 401(k)
- Form 5500-EZ – Required if your plan assets exceed $250,000 as of year-end. Must be filed annually by the plan participant.
- Form 1099-R – Required if you take a distribution or roll funds out of the plan.
- Contribution Tracking – Keep records of employee and employer contributions. These are not filed with the IRS but may be needed for tax reporting or audits.
SEP IRA
- Form 5498 – Filed by your custodian to report contributions and FMV.
- Form 1099-R – Filed by your custodian. Issued for any distributions.
- Employer Contributions – Must be reported on your business tax return (and on employee W-2s, if applicable).
Health Savings Account (HSA)
- Form 5498-SA – Filed by your HSA custodian to report contributions.
- Form 1099-SA – Filed by your HAS custodian. Issued for any distributions.
- Form 8889 – Must be included with your personal tax return to report contributions, distributions, and how funds were used.
