A self-directed Solo 401(k) provides a great amount of flexibility when it comes to investing your retirement savings. As part of designing your plan to best suit your investing goals, it pays to give consideration to the structuring of financial accounts within your plan.
How you configure you plan financial account structure will depend on several factors such as how many participant accounts you have and whether you wish to have brokerage assets in your plan.
We wanted to take some time to discuss some options in this regard and provide some helpful tips for creating an optimal design.
Plan Participant Accounts
As an employee/saver in your plan, you are a participant in the plan. If your spouse is also employed and compensated by the business that sponsors the plan, they can also be a participant.
A participant account is a segregated value tracked at the level of participant and tax treatment. As a participant, you may have both tax-deferred and Roth participant accounts, for example. Similarly, your plan could hold a tax-deferred account for you and a separate tax-deferred account for your spouse.
As plan administrator, it is your responsibility to know the distinct value of each participant account within the plan at any given point in time.
Any banking structure you need to create must address this record keeping need.
Establishing Separate Financial Accounts per Participant Account
We recommend that you have separate bank or brokerage accounts for each plan participant account. This structure best facilitates your reporting needs.
As you make plan contributions, take participant loans, or take distributions from your plan, these must be recorded at the individual participant account level.
You can take a participant loan or issue taxable distributions from multiple participant accounts in your own name but must clearly illustrate the source of funds for such transactions to ensure accurate reporting of value.
Investing with Multiple Accounts
When you invest with the Solo 401(k) the outside world only sees “the plan” as a single unit. When the plan purchases real estate, for example, the title transaction reflects the plan on title, not the underlying participant account or accounts that are being used.
On the back end, however, you need to know which participant account(s) are funding the transaction and accurately track over time the respective ownership interest each account has.
Once you designate the equity split of a particular investment, all future income and expenses associated with that investment need to retain that split. You cannot change participation over time or move value from one account to another.
Designating Allocation when Making an Investment
When making an investment, you can assume pro-rata ownership based on what each account holds at the time or you can make a specific designation of which funds are being used. Either way, it is important that you keep a record of how you choose to allocate funds towards the investment.
An example with a plan where John & Marie each have funds within their plan is shown below. They plan to make a new investment totaling $100,000 in value.
Account Holdings at Time of Investment
|Account||Account value||% of plan Total|
Example of Pro-Rata Allocation
Example of Specific Allocation
The Advantage of “Project Accounts”
Using a dedicated bank account for a specific investment transaction can be beneficial when there are multiple participant accounts in a plan. The reason is that you do not need to track the allocation of expenses and income with every single transaction.
Let’s see how this works with the above example and the specific allocation case. If you setup a separate bank account for that deal and initially capitalized it with $50K each from the two accounts used, you have baked-in the 50/50 split. You then use that bank account for all expense and income transactions over the life of that investment. If over time the investment produces some income you wish to invest elsewhere you send it back to the individual participant accounts in the same 50/50 ratio. The project account is always 50/50 in this example, and therefor easy to administer and track.
With one investment, that strategy does not add a lot of value. You could just as easily use a spreadsheet to track the project. You could pay expenses and receive income via one of the two participant accounts and then periodically reconcile by moving money between accounts on the back end.
But what if you make another investment, using $100K from the Marie’s account and $25K from John’s traditional account? Or what if after making the first investment on the pro-rata basis, you then make new contributions or rollover funds into the plan that skew the percentage of the plan total represented by each account?
In these cases, the next investment will not be at the same ratio as the first, regardless of how you allocated funds for that first investment
A separate “project account” for the next deal then makes your life as plan administrator simple. Project 1 is always 50/50 and managed through its account. Project 2 might be 80/20 between two different accounts and would be managed through its separate bank account.
Incorporating Brokerage Trading Accounts
In situations where you may use several project accounts, it might be most effective to house the primary participant accounts with a brokerage and the project accounts with a bank.
That way, you get the advantage of putting non-invested capital and/or the earnings spun off by your primary plan investments to work in the stock market, but get the more sophisticated cash handling features of a true bank for the “project” investments.
When working with a brokerage in this fashion, you will establish separate accounts for each participant account, but all under the name of the plan itself.
It usually makes sense for these accounts to be “trustee directed”, as most Solo 401(k) plans house funds belonging to spouses. Either partner can then administer the accounts.
If you had a scenario where unrelated business partners hold a plan for their business, having “participant directed” accounts might make more sense. That way, each individual could only manage their own account.
Working with the Right Bank or Brokerage
While most any bank or brokerage can hold an account for your Solo 401(k), most will not really be at all knowledgeable about the plan. As a result, you can get a lot of questions or push-back when you start designing a plan banking structure that involves multiple accounts.
Working with a Solo 401(k) friendly bank that is specifically familiar with the Solo 401(k) format and has staff trained on this topic can be a big advantage. They can help you navigate account setup more easily and you will receive better support over the long term.
Most brokerages are easy to work with. They have been servicing custom 401(k) plans for decades. As such, they usually have special account types and dedicated support teams that are familiar with the 401(k) structure.
Adjust as Needed
One of the great things about the Solo 401(k) is that you can tune your plan configuration to your current needs. As you grow your plan and make a wider range of investments, you can alter your banking configuration as needed. You can easily add, remove, or re-purpose project accounts over time. So long as your banking structure facilitates your need to accurately track the value of each participant account in your plan, you are A-OK.