Can An IRA or Self Directed 401k Plan Help You Build Wealth?

M. Chad Holland, CFA, CFP® |

Are you harnessing the full potential of your retirement plan? Your retirement account might not be working as hard for you as it could be, especially if you're a high income person, self-employed, or a small business owner. In this article, we'll explore the concept of self-directed 401k and individual retirement accounts (IRAs), and discover how taking more control might help improve your financial future.

Please note: this article is intended to provide general information only. Always consult your tax and financial planning professional for advice and specific recommendations.

The Limitations of Traditional Retirement Plans

According to the Investment Company Institute, Americans have over $9 trillion invested in IRAs and workplace defined contribution plans. This, of course, is good news. If you're someone with large retirement account balances, are those assets in your IRA and 401(k) working as hard as they should be for you?

Many traditional retirement plans offer a limited selection of investment options, typically consisting of mutual funds. These limited options can sometimes come with higher fees too. Together, these factors are capable of placing a drag on performance. As a result, you may notice that these accounts often don't keep pace with your other taxable investments.

But that's not necessarily the only issue. While these retirement plans provide valuable tax advantages, they often come with other significant drawbacks:

  • Anonymous Investing: When you invest in mutual funds, you become just another faceless shareholder to the fund manager. They do not invest for you but for millions of people at once. So, their actions may or may not align with your goals. As a result, they may or may not benefit your overall financial strategy.

  • Loss of Autonomy: By investing in mutual funds, you relinquish control over your investments. Then, fund managers may be constrained by mandates that don't always work in your favor. For example, many mutual funds are required to stay 100% invested, which may mean that you end up taking far more risk than you may prefer in riskier markets. Also, many mutual fund managers now prioritize ESG (environmental, social and governance) goals. That may force them to put certain parameters ahead of generating the best possible return for you and other shareholders.

  • Layers of Fees. Of course, these fund managers don't work for free. While it may not be very transparent, you are paying a percentage of your invested amount to them each year. And as your asset grows, their fee grows along with it, which can eat into your returns.

  • Limited Investment Choices: While some plans offer more choices than others, you usually are limited to a fixed menu of funds. The types of investments offered may not allow you the flexibility to protect your account when markets are volatile. And as your wealth grows, you have less opportunity to diversify, since usually ways to invest in real estate or other alternative asset classes don't always exist.

  • No Lifeguard on Duty: Employers have significant liability for retirement plans, so they wisely will frequently utilize a third party to oversee the creation of the investment menu. However, over time, oversight may drop, which might leave you with fund options that aren't optimal. On top of that, many people don't get professional help with their retirement accounts. With busy lives, managing these accounts may take a back seat to other priorities, meaning these accounts may or may not be helping you achieve your goals.

Clearly, significant tax benefits do exist in these accounts in terms of tax advantages. However, these drawbacks can be a real concern...especially as your retirement plan nest egg grows bigger.

What is a Self-Directed 401(k) or IRA?

Fortunately, there's a solution: self-directed retirement accounts, in the form of IRAs and 401(k)s.

So what exactly is a self directed retirement account? Basically, it's just a special type of account that is offered by specific financial institutions (commonly a brokerage). Those who are eligible will gain access to a broader range of investment options. These can enable you to tailor your retirement portfolio to your unique needs. 

Other than the expanded investing options, most of the same retirement account rules apply to these accounts, such as contribution rates, catch-up contributions, distribution rules, rollovers, penalty regulations, etc.

The only catch: certain IRS rules for self-directed accounts apply, so these are not necessarily available to everyone. For example, if you're an employee, you'll be limited on the 401(k) side unless your employer offers a specific option. Fortunately, self-directed IRAs are available to almost everyone with taxable income, and 401(k) options are becoming increasingly popular among employers.

What are the Benefits of a Self-Directed 401(k)?

These plans are similar to regular retirement accounts, with a few differences. The biggest one, as noted, is that these plans allow a much wider range of investments. This includes the ability to purchase individual stocks and bonds. But it doesn't stop there. Some custodians allow direct real estate investment through these accounts as well as the purchase of private equity, precious metals, and other assets. However, these choices will vary depending on the provider and plan administrator. 

Regardless, these accounts do provide you with much more flexibility. Here's how that can potentially benefit you:

  • Increased Control: Investors have greater control over their investment decisions with self-directed plans. You can choose specific assets based on your individual preferences, risk tolerance, and investment goals, rather than being limited to a pre-selected menu of options.

  • More Diversification Options: Self-directed plans offer a wide range of investment options when compared to traditional retirement plans. This increased diversification can help you spread risk and strive to enhance returns.

  • Potential for Higher Investment Returns: By investing in a wider array of assets, investors can strive to achieve higher returns compared to those limited to traditional investment options.

These accounts retain all their original tax advantages:

  • You can take a tax deduction upfront when you make a traditional IRA or 401(k) contribution each year (up to the maximum contribution allowed). 

  • With a Roth IRA or 401(k) option, you can contribute after tax but then enjoy tax-free withdrawals in retirement.

Of course, one drawback is you need to follow withdrawal rules, which may limit access to the money until you reach retirement age. However, many 401(k) plans allow you to take a personal loan and also allow a hardship withdrawal, so these often have some limited amount of flexibility aside from their retirement purpose.

What are the Key Differences Between a Self Directed IRA and 401(k)?

One of the primary differences is that anyone with taxable income can start a self-directed IRA, while access to a self-directed 401(k) will depend upon whether your employer provides the option. 

With regard to IRAs, it's not usually hard to find a self-directed plan, as these are available from many providers. While there are certain rules, it is generally relatively simple to convert a traditional IRA or similar account to a self-directed IRA.

With the 401(k) version, it can be a bit more involved simply because you must work within the limitations of your company's plan. If you're one of the nation's millions of self-employed people and business owners, you have much more flexibility to set up one of these plans from the start. 

Disadvantages of Self-Directed Retirement Plans

Of course, there are both pros and cons to this strategy. Here are the potential disadvantages to be aware of with self directed accounts.

  • Complexity: Managing a self-directed account requires a higher level of investment knowledge and expertise compared to traditional plans. Investors must thoroughly research and understand their chosen investments, including associated risks and regulations. 

  • Potential for Mistakes: With greater control comes the potential for errors or missteps. Investing in unfamiliar or complex assets, especially alternative assets, without appropriate due diligence can result in losses or legal and tax consequences. Additionally, failing to adhere to IRS regulations governing self-directed accounts could even lead to penalties and disqualification of the plan.

  • Lack of Guidance: Self-directed accounts may lack professional assistance or guidance, leaving investors responsible for making investment decisions independently. This can be daunting for those without adequate experience or resources, potentially leading to suboptimal investment choices.

  • Liquidity Risk: Certain alternative investments available in self-directed 401(k) plans, such as private equity, real estate, or physical precious metals, may have limited liquidity compared to publicly traded assets. This illiquidity can make it difficult to access funds in the event of an emergency or unexpected financial need.

  • Higher Fees: Self-directed plans may incur higher fees compared to traditional plans, particularly if investors utilize specialized services or investment platforms. These fees can erode returns over time, potentially offsetting the benefits of increased investment flexibility.

How the Right Financial Advisor Can Help

As financial advisors to many successful individuals, we believe the true power of these self-directed plans lies in unlocking a major asset for many: your retirement account. Many people have significant balances but don't give this asset as much attention as it deserves. By moving these resources to a self-directed plan, there is an opportunity to make that money a more active part of your overall financial strategy. 

At Holland Capital Management, we often can help clients manage these retirement accounts so they can become a more integral part of their wealth accumulation and preservation strategy. With the additional number of investment choices available, we often find it can help us collectively better manage risk. Or it can provide capital for advanced strategies to help clients strive to achieve goals faster. (This arrangement may involve getting financial advice on the account either directly or indirectly.)

Unlocking Additional Benefits

In some cases, you may be able to gain other benefits from these self-directed accounts. One example is if you're a high-net-worth individual. As you worth grows, you may want to diversify further into alternative assets. That is impossible in most employer retirement plans but very possible in these self-directed accounts.

If you're a business owner, you may have even more options. At Holland Capital Management, we work with our outside specialist partners to help you explore options such as deferred compensation plans, allowing you to potentially save even more on a pre-tax basis for retirement.


Can I move my IRA or 401k into a self-directed account? 

With an existing traditional or Roth IRA, it is usually possible. In that case, you normally just do a transfer, which is a relatively simple process that is coordinated through your account custodians.

With a 401(k), your ability to go the self-directed route will depend upon a few factors. You can normally check in with your HR department to see if this option is available. After you leave employment, you can often do a 401k to IRA rollover, which entails moving your 401(k) funds into a self-directed IRA. Be sure to coordinate with your tax professional and financial advisors to ensure you do it correctly. Otherwise, you may incur penalties. 

Can you transfer an employer 401k to a solo 401k?

Please note that a Solo 401(k) is a different type of retirement account altogether, so the answer is usually no. The Solo 401(k) is an account available to self-employed individuals and has different rules and requirements. 

What requirements apply to self-directed 401(k)s and IRAs?

Most of the same rules that apply to regular retirement accounts apply here. For example, standard 401(k) and IRA contribution, withdrawal and rollover rules apply. For contributions, once you reach age 50 or older, you can also utilize "catch-up" contributions. Regarding withdrawal rules, traditional accounts will impose normal income taxes on amounts withdrawn in retirement. Roth accounts are not deductible upfront, so withdrawals are tax-free in retirement. Then, for most account types, an early withdrawal penalty will normally apply if you withdraw funds prior to reaching age 59 1/2.

Are any investments prohibited in a self-directed 401(k) or IRA?

In some self-directed 401(k)s or IRAs, there is the ability to hold investments like real estate. However, you must do so with care since certain investments are prohibited to maintain their tax-advantaged status and prevent prohibited transactions. These include collectibles, life insurance, and S corporation stock. 

Additionally, engaging in prohibited transactions with disqualified persons, such as yourself, family members, or certain business entities, is not allowed since those people may have a financial interest in the plan or be able to benefit from the transaction. It's crucial for account holders to understand these restrictions to avoid penalties or disqualification of their retirement accounts. Be sure to seek guidance from financial advisors or tax professionals when needed. 

Can I borrow from a self-directed 401k or IRA?

IRAs generally do not allow loans from plan accounts. However, a self-directed 401(k) may allow a loan with your account as collateral; talk to your account custodian to see if that is allowed.

What are the current contribution limits for 2024?

The 2024 contribution limits for 401(k)s were increased from the 2023 tax year amounts. So, in 2024, you may contribute the lesser of 100% of your annual earnings or $23,000. If you are 50 or older, you can contribute an additional $7,500 per year.

Contribution rates for IRAs for 2024 are $7,000, or if you're 50 or older, $8,000.

What else is important to know about a self-directed account?

As financial advisors, one thing we frequently see is people forgetting to keep their account beneficiary up to date. One common error is to still have an ex-spouse as the designated benifeciary. Once you pass away, this is not generally reversible. So, if they are the beneficiary when you die, they will receive your 401(k) or IRA funds, regardless of what your will or other estate planning documents may direct. That's why it's wise to periodically revisit your beneficiary designation on all accounts to make sure it represents your current wishes.

Conclusion: Take Control of Your Financial Future

A qualified retirement plan is a foundational part of preparing for retirement. However, many people tolerate generic plans and limited investment options. As your wealth grows, you may be able to put that money to work more productively with a self-directed plan. Especially for self-employed individuals and business owners, this can be a fantastic way to better diversify and pursue your financial goals with more precision.