Most self-directed investors are well aware of the vast potential that lies in using the right retirement account, but few really understand the differences between self-directed IRAs and self-directed 401(k)s. There are three major differences between them.
1. IRAs are accessible to anyone of "working age," while 401(k)s are only offered through employers or if you are self-employed.
Do not assume you cannot have a self-directed 401(k) if you do not own your own business and your employer does not offer them. There are ways to get around this, particularly in real estate. Since setting up a solo 401(k) is one of the best decisions you can make as an investor, look into all of your options.
2. IRA accounts usually permit only relatively small annual contributions, while 401(k)s may be eligible for up to $56,000 in annual contributions for account holders younger than 50 and $62,000 for those older than 50.
401(k) plans permit a variety of high volume contributions and catch-up contributions depending on your age. Some versions also have matching contribution options.
3. Prohibited transactions in a self-directed IRA can cost you the value of the entire account, while the same transaction in a 401(k) may often be remedied with relatively little expense and far greater simplicity.
Furthermore, in 401(k) accounts, penalties associated with a prohibited transaction are almost always limited to the asset where the violation occurred. In IRAs, the entire account is affected and fined accordingly.
And the winner is...
For most investors, the "winner" in this showdown is the solo 401(k). However, you do not necessarily have to choose. Many self-directed investors opt to own both types of accounts so they can leverage the unique advantages of each when the situation requires it.