September 7, 2021

The Investing Power Combo - Pairing a Company 401(k) With a Self-Directed IRA

Balancing a 401(k) and a Self Directed IRA 

The basic tenet of successful investing has never changed: thoughtful diversification. It’s impossible to accurately predict which assets or investments will be profitable. However, with thoughtful diversification you don’t need a crystal ball. Financial history has shown that investment spread out over a wide variety of assets will usually deliver a decent return. If you or your advisor can make educated guesses about which assets to choose, that’s even better. This is the idea behind most company sponsored 401(k) plans. The company signs up with one of the big brokerages who provides a mutual fund as the investment vehicle. The mutual fund is diversified within the stock market and its returns reflect that diversification. 

The only downside with the 401(k) plan is that it does not diversify beyond market products. The mutual fund may usually do well, but it too is heavily tracked with the stock market. If stocks take a tumble, then your retirement account can similarly fall. When the market crashed in 2008, a lot of account holders saw a massive decline in their retirement savings. A Self Directed IRA allows retirement investors to diversify beyond the stock market. By investing in alternative assets like local real estate, you can provide alternative routes for your funds to grow that are not tied to the market.  

True diversification would incorporate both kinds of investing: a stock-based 401(k) and a sensible asset Self Directed IRA. This combination allows you to profit from both asset classes in a strong economy and to serve as a hedge when the economy takes a turn. The question is can you invest in both at once? 

Investing in a 401(k) and Self-Directed IRA Together 

Legally there are no impediments to investing in a Self-Directed IRA and Solo 401(k) at the same time. In fact, many investors have more than one retirement account as a result of switching jobs or other life events. However, possessing multiple accounts doesn’t mean you have unlimited freedom to contribute. IRS regulations cap your overall annual contribution, as well as place income limits on certain plans. It’s always best to speak to your accountant to determine the rules for your specific situation. In this article, we’ll help you understand the general principles and explain some of the guidelines. 

Contribution Limits For 401(k) Plans and IRA Accounts 

In 2023 the contribution limit for a 401(k) plan is $22,500. If an investor is 50 or older, the contribution limit jumps to $30,000. The Self-Directed IRA contribution limit is $6,500 and for those 50 or older $7,500. That means that for investors under 50, the combined contribution limit is $29,000 and for those 50 or older $37,500.  

The ability to max out on this contribution limit is determined by a worker’s income. As long as their earned income is beneath a certain threshold, then they can make contributions to both a 401(k) and a Self-Directed IRA. However, once their income exceeds that threshold, then if the worker has a 401(k), they are not entitled to any tax deductions for an IRA contribution. Let’s look at the current limits and see how that would play out practically. 

If a worker is single and their employer offers a 40(k) plan, then their income limit caps out between $73,000 and $83,000. That means that if this worker has an income of $83,000 or more, they are not eligible to make a deductible contribution to an IRA. (However, they can still make a non-deductible contribution.) For a married couple, the limit is higher and will also depend on whether both spouses have access to a 401(k). If only one spouse has access to a 401(k), then the combined income limit is between $218,000-$228,000. If both spouses have a 401(k), then the combined income limit is between $116,000 - $136,000. 

401(k) Plans and a Self-Directed Roth IRA 

A Self-Directed Roth IRA differs from its Traditional counterpart in the fact that it is not affected by a 401(k) plan. Simply put, there are no limits placed on a Roth IRA contribution because of participation in a 401(k) plan. However, there are limits placed on a Roth IRA based on the account holder’s income. The income cap for a single filer is between $138,000 - $153,000. The combined income cap for a married couple is between $218,000 - $228,000. 

The IRA Rollover Option 

A common scenario is when an investor wants to diversify with non-market assets (like real estate), but are limited by their current financial situation. This may not be due to a lack of funds, but rather because they are running into contribution limits. In such a case, is there any way for an investor to achieve true diversification? The answer is yes. An investor can rollover some (or all) of a pre-existing retirement account and start a Self-Directed IRA with it.  

In this scenario, the investor can keep their 401(k) with their current employer, and open in addition to it a new Self-Directed IRA. The funding for the Self-Directed IRA can come either by rolling over exiting IRA accounts, or (if the employer lets it) rolling over part of their existing 401(k). That way they can keep making contributions to the employer plan, while at the same time opening a sizeable enough account to purchase alternative assets.  

Moving Forward With a Self-Directed IRA 

The process for opening a Self-Directed IRA is fairly simple. The actual application should only take about ten minutes and can be done either online or on the phone. The next step is to fund the account by filling out the requisite paperwork for a rollover. Once the Self-Directed IRA account is funded, you are free to start investing.  

Do you already have an asset in mind? There are different kinds of Self-Directed IRA accounts and a Madison specialist can help you decide which one is optimal. Schedule a call here to tell us what you’re trying to accomplish. 

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