The Checkbook IRA vs. the Solo 401k… Which Is Better?

David Moore: Hi, David Moore with IRA Advantage, and I’ve got Tina Colson in my office meeting up with us today, doing some questioning. It’s Tina’s Testing Wednesday.

Tina Colson: This becomes a theme as we move forward.

David Moore: That’s right. I hope she’s nice to me today.

Tina Colson: Yeah. Today we’re going to talk about the checkbook IRA versus a solo 401k. What are the advantages and the disadvantages to each? Also, who’s eligible? How do we choose what product to put a person in?

David Moore: Great questions. I think that the first thing I would say is that if you can use a solo 401k, you’re going to want to use a solo 401k, for a variety of reasons. As far as eligibility for any of these things, understand self-directed retirement accounts, any IRA can become self-directed. We’re looking at 401k plans, you’ve got to be real careful with what’s going to fit. If you’re happily employed, a current retirement account, current company plan, under 59 1/2, you’re not going to be able to get access to the money. I’ve had people quit their jobs to get access to money. We’ve had people step away, even business owners, step away from their positions to get access to money when they’re not old enough to do it.

Tina Colson: Even divorces, unfortunately.

David Moore: Yes, yes, yes.

Tina Colson: We have seen it all.

David Moore: We’ve got other situations where people come in and we’ll do accounts for two different people, and they end up getting married. You’ve got to really be careful with what’s going on because when you’re looking at those retirement accounts, what they want to do with it, obviously things change a lot if you go from two individual people to a married couple.

When we’re looking at IRAs and 401k plans, most of the time when people come to us, as you know, you’ve been here with us for a year now, why do they come to us? They come to us because they want to buy something Wall Street doesn’t sell, typically.

Tina Colson: Correct.

David Moore: Do either a business startup, they want to further diversify into real estate, make loans, buy notes, something along those lines. Maybe at this point in time, they’re interested in crypto, something like that. That’s why they’re coming to us.

Then understand that, I should know this, but I don’t know what percentage of investment real estate is leveraged. That’s one of the big, big differences.

When we’re looking at self-directed retirement accounts, IRAs, you have tax exposure on income that’s income and gain attributable leverage, where the 401k plan you do not. That’s a big differentiation between those two things. Once again, if you could have a solo 401k, which is a single participant, or you could have a spouse participate in it too, but we’re talking about you work for yourself, self-employed, no employees even part-time, then that solo 401k is going to be an attractive deal. Obviously, real estate brokers, a lot of them, that’s a great vehicle for them. If you don’t have a business or you’ve got employees, then you’re going to want a checkbook IRA, probably.

David Moore: Either way, as I mentioned with the 401k plan, we can have an individual and his or her spouse as a participant in that thing, too. If we’re combining multiple accounts in the IRA space, it’s going to require, if we’re doing a checkbook IRA, you’re going to have an account for each spouse. Then those accounts are going to be common members of that limited liability company.

What I’ve got to say about that is when we’re structuring these things, if it’s a multi-member checkbook IRA LLC, for example, we need to look at that membership. If it’s disqualified parties as members, we need to make sure that we over-fund the initial investment. What I mean by that is, if we don’t get all the money in when we put the deal together, you can’t have additional money coming in from a disqualified source in the future. That would constitute a prohibited transaction. It’s really important that we’re planning ahead and taking care of that stuff with multi-member LLCs, checkbook IRA LLCs. The big differences to me are that tax on leverage that the 401k plan doesn’t have. The other big, big deal is that the cost of a prohibited transaction.

Tina Colson: Yeah. I just want to clarify one thing too, when we’re talking about leverage, for those of you who may not be familiar with that term, it’s basically getting a mortgage with the property that you’re purchasing. That leverage is that debt component of it. It is treated differently when it comes to the tax portion.

David Moore: Thank you, Tina. We had a discussion earlier today, or the last few days, talking about industry terminology and what goes on. Even things like relinquished and replacement property, so on and so forth. Thank you. For those of you out there, I do get really excited, so I start talking very quickly. Anyway, I’m married to an Italian, so this starts going, too. Anyway… right Sheila? When you’re looking at those two things, that tax exposure and leverage is huge and the cost of prohibited transaction is even bigger.

If you commit a prohibited transaction with an IRA, you blow up the entire account as of the first day in the year in which the indiscretion occurred, where the 401k plans, just the money involved with the indiscretion. That’s a big, big difference. 401k plan, you’re not going to have that trust company, too. That makes a difference. You’re, typically, with one of our accounts, you’re going to have a bank account in the plan’s name and tax ID number and you’re the trustee of that plan, signer on the account. It works just like a checkbook IRA, but it’s more forgiving.

David Moore: I guess when I look at, if you’ve got the choice, if we’re looking at, and as I said, most of the time people are coming to us, they want to further diversify their accounts. They’re not going to pull everything out of Wall Street, they just want to add real estate to it.

If we’re doing that with an IRA, I’m going to encourage them to keep all the Wall Street stuff with their current financial advisor and just move what they want to use in the new self-directed IRA, because if they commit a prohibited transaction… You can make a poor investment decision with your Wall Street stuff, but you can’t really blow it up, where with one of our checkbook IRAs, if you want to do something dumb, there’s really not much safety net.

David Moore: If we’re looking at that diversification, let’s move what you want to use in the self-directed world into the checkbook IRA LLC, and keep the Wall Street stuff where it is. As money piles up in the self-directed account, let’s say cashflow off the property, you’re going to have to shovel it back through, through the LLC, back to the trust company, back to your existing financial advisor, so it’s more cumbersome. I mean, think about life. When is the easy way always the best? When is the easy way ever the best way to do something? It’s just, that’s the world.

The right way to do it is move back from the LLC through the trust, coming back to your current financial advisor. By doing that, if you commit a prohibited transaction over here with that checkbook IRA, it doesn’t impact this over here. What’s easiest way to do that? Just open a trading account in the LLC’s name and tax ID number. Those are two different ways to do it, but that’s necessary. Really, if you want to protect it, you have to do it with the IRA, where the 401k plan, you’re not going to do that. You’re just going to have a trading account in the plan’s name and EIN.

David Moore: Those are the big issues that I see really… the cost of a prohibited transaction and the tax on leverage. Those are the big, big deals there. They’re not, as far as the operation of those two things, they both work the same way. You’re writing a check to go make the investment you want.

If you’ve got questions on this stuff further, just please give us a call. Once again, I want to stress for the 401k, you’ve got to be self-employed without employees.

Tina Colson: Yes.

David Moore: The IRA does not have that situation. Those are the biggies.

Tina Colson: Perfect. Thank you so much for answering that, and thank you for joining us today. We appreciate it. IRA Advantage, David Moore and Tina Colson. We also would love it if you hit that like button on the YouTube channel and subscribe. Also, if you have any questions, you can reach us at 503-635-1031, or IRAAdvantage.net. Thank you so much. Have a great day.

David Moore: Thank you. Take care. Bye-bye.