Unleash the Power of Your 401(k) Plan

In 1980, Ted Benna, a Philadelphia benefits consultant, noticed that a law passed in 1975 could help employers unburden themselves from the responsibility of providing a lifetime of income to their retirees through qualified defined benefit pension plans. He noticed that paragraph “k” of Section 401 on the Internal Revenue Code could be used by employers to allow their employees to take a salary reduction as a tax-deferred contribution to their retirement plans. That was the beginning of the qualified defined contribution 401(k) retirement plans which shifted the burden of providing for retirement from the employer to the employee.

Today, trillions of dollars of employees’ retirement savings are tied up in employer-sponsored 401(k) plans. Insurance companies and stock brokerages have benefited financially by providing products to satisfy the needs of employees, particularly annuity and mutual fund investments. Unfortunately, many of these investment vehicles have underperformed leaving retirees with less money than they had counted on at retirement. Some employees have become so skittish about investing their retirement savings in the volatile stock market that they have chosen to put their money into bonds and money market accounts (MMAs) rather than risk the possibility of losing their nest egg. The problem is, these investment options don’t keep pace with inflation.

Fortunately, there is a better option available. Form your own limited liability company or Sub-S corporation and set up your own qualified self-directed one participant (often called solo or individual) 401(k) plan to supplement your current company-sponsored retirement program. Although you can’t contribute more to your retirement plans than the law allows, you can have more than one 401(k) retirement plan. This allows you to invest directly in income-producing real estate. I have worked with several individuals, in conjunction with an experienced third party administrator, who have successfully used this method to invest in alternative investments like income-producing real estate to achieve a higher return on their retirement funds.

Here’s a couple of examples of how it works. A nurse in her mid-40s has worked for a major corporation for years. Her plan is fully vested. She had her money invested in mutual funds which were earning her an anemic return. She approached her plan administrator who told her she could not invest directly in a real estate investment. So she and her husband, after establishing an LLC, set up a self-directed solo 401(k) plan to which they could each contribute. They are now investing in an income-producing real estate investment that will likely yield them a return that is more than double the return they were getting on their existing plan. Another person who works for a small corporation had his retirement savings invested in a money market account because he had seen others lose a lot of money in the stock market. His money market account was earning him less than $2,000 a year on $280,000. He chose to form an LLC and set up a self-directed solo 401(k) plan and invest in an income-producing real estate project. His projected return on a $200,000 investment is slated to be $1,000 a month. That’s $12,000 a year compared to the meager $2,000 a year he was earning.

Here’s an illustration of how an investment in an income-producing real estate project works. Collectively, a group of like-minded investors, assisted by an experienced real estate syndicator, pool their resources to develop, construct, own and manage an income-producing real estate investment. In a few short years, the project is worth considerably more than their original investment. With income-producing real estate, the tenants who rent in your project provide the income to help you achieve a significant cash-on-cash return.

Like any investment, income-producing real estate may not be the right investment for you. However, many have experienced better returns by forming an LLC and creating a self-directed solo 401(k) plan. There are some eligibility requirements you must meet, but for many this has been an approach that has enhanced the returns they have achieved on the retirement investments. And the beauty of it is, at retirement, the real estate asset doesn’t have to be liquidated to provide the income to meet your retirement needs. It can be passed on as a legacy to your wise investing prowess. The Internal Revenue Service (IRS) permits this type of self-directed retirement accounts. Many of the standard stock brokerage firms and financial planning organizations do not. They want to take your money, charge relatively high fees, and invest only in products that pay them a commission. It’s become a very self-serving approach to retirement investing.

From my perspective, you can achieve significantly higher returns by taking the initiative to set up your own self-directed solo 401(k) plan and investing in income-producing real estate to augment your current employer-provided 401(k) plan. In many cases, it’s also possible to transfer some of your existing retirement funds into your new solo 401(k) even though most company-sponsored administrators will tell you that you can’t touch your 401(k) plan until you retire or your employment with the company has ended. There are several experienced, IRS-sanctioned third-party administrators who will help you navigate the process. I have personally assisted several of my clients with setting up their own solo 401(k) retirement plans. It takes a few weeks to accomplish, but it is well worth it. If you need some assistance, give me a call.