What Is a Self-Directed 401(k)?

Self-directed 401(k) plans let savers decide how to invest their pre-tax retirement contributions. Rather than being limited to the pre-approved funds typically offered by traditional 401(k) plans, self-directed 401(k) plans allow you to choose exactly where you’ll invest your money. Here’s a full rundown on self-directed 401(k)s so you can decide if it’s the right option for your retirement savings.

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Self Directed 401(k) Plans Explained

A self-directed 401(k) lets you invest as you see fit. You can choose your own mutual funds, stocks and bonds rather than sticking to the pre-made funds typically associated with a 401(k). You can even invest in more unconventional assets like real estate and commodities if your employer allows it. The types of investments you can choose include:

Real estate (residential or commercial)
Tax liens
Private placements
Precious metals
Energy investments
Equipment leasing
Foreign currency

While self-directed 401(k) plans offer a much wider range of choices and greater flexibility, there are some limits on what you can invest in. For instance, you can’t hold collectibles, like artwork or antiques, or insurance in one. There are also certain prohibited transactions, which we describe in greater detail below.

Pros of Self-Directed 401(k) Plans

Self-directed 401(k) plans have many of the same perks as traditional 401(k) plans. They offer the same benefit of pre-tax savings through automated payroll deductions. Both types of 401(k) plans are subject to the same contribution limits, withdrawal rules and rollover rules, so they’re also equal in those ways.

Additionally, there are some upsides to choosing a self-directed 401(k) over a traditional 401(k). First and foremost is the level of control that a self-directed 401(k) offers. Rather than being limited to the investments that your plan administrator chooses, you have the power to decide where you’ll invest.

This brings us to another pro of self-directed 401(k) plans: the number of investment choices you can pick from. Traditional 401(k) plans typically limit you to premade funds. Self-directed 401(k)s, on the other hand, allow you to invest in everything from stocks and bonds to real estate and tax liens.

Cons of Self-Directed 401(k) Plans

On the flip side, you may pay more in fees with a self-directed 401(k) because of the investment types you can choose. While the exact cost of the plan depends on your plan administrator and which investment choices you make, it’s likely you’ll make more frequent trades if you invest in stocks rather than in the mutual funds and index funds favored by traditional 401(k) plans. Frequent trading fees can eat into your overall rate of return.

It takes a lot of expertise to make a self-directed 401(k) perform well. Even professional fund managers consistently underperform index funds, which simply aim to mimic the performance of the overall market. And even if you have considerable investing expertise, do you have the time to manage your investments and give your retirement plan the attention it deserves? Many busy people would be better off with some low-cost index funds that they can set and forget.

Self-Directed 401(k) Prohibited Transaction Rules

If you decide that a self-directed 401(k) is right for you, you’ll need to know the rules. The IRS prohibits certain transactions in self-directed 401(k) plans. Should the IRS determine that you’ve made a prohibited transaction, your account will no longer be tax-advantaged and all of your investments would become taxable. This could result in a hefty tax bill, so you want to be sure to abide by the rules.

Any transaction (a sale, lease, exchange, transfer or payment) between the self-directed 401(k) owner and a disqualified person is against IRS rules. A disqualified person is any person who either provides services to the plan or has a financial interest in the plan.

Spouses, parents, grandparents, children, grandchildren and their spouses and daughters and sons-in-law are all considered disqualified persons, as are your account beneficiary, your account custodian or administrator and any company in which you directly or indirectly own at least 50% of the voting stock. You’re also a disqualified person. You can’t use property or other investments in your account to benefit yourself nor can you use real estate in your account as collateral for a personal loan.

There are also rules specific to self-directed 401(k) investments in real estate. You can’t use your contributions to buy a rental property and then enlist your parents to be your tenants. That would be what the IRS calls a prohibited transaction because you’re using your 401(k) funds to benefit family members, who are disqualified persons.

How to Set Up a Self-Directed 401(k)

To be eligible to open a self-directed 401(k) you must have earned taxable compensation during the current financial year. Employers may offer self-directed 401(k) plans as an alternative to a traditional 401(k). In this instance, the plan administrator would also manage a self-directed 401(k).

There are three main ways that you can fund your self-directed 401(k):

Transfers: Transferring funds from previous 401(k)s, SEP-IRAs, SIMPLE IRAs and traditional IRAs; the only funds that can’t be transferred are Roth IRAs
Profit sharing: Receiving a direct share of profits; can be up to 25% of the sponsoring entity’s profit
Contributions: Deferring income into the account

Notably, the contribution limits for self-directed 401(k) are the same as the contribution limits for traditional 401(k) plans. For 2023, that limit is $22,500, which increases to $23,000 in 2024. For catch-up contributions, which are available to anyone over the age of 50, the limit is an additional $7,500, bringing the total contribution limit to $30,000 in 2023 (and $30,500 in 2024).

Self-Directed 401(k) Rollovers and Withdrawals

The withdrawal and rollover rules are the same for self-directed 401(k) plans as traditional 401(k) plans or IRAs. If you withdraw from a self-directed 401(k) before the age of 59 1/2, you’ll face a 10% penalty for early withdrawal unless you qualify for an exemption.

If you want to roll over a self-directed 401(k) to an IRA, you have 60 days to roll over, after which the money you’ve removed from your 401(k) becomes a taxable withdrawal. Ask the brokerage that hosts your IRA to help you make a direct, tax-free and penalty-free rollover. You may want to roll over to a self-directed IRA if you like having a high degree of control over your investments.

Bottom Line

A self-directed retirement plan allows you to make all of the investment decisions. Instead of investing in a managed plan, you get to decide where your money goes, when to buy or sell additional assets and what those assets are. If you’re experienced in investing then this might be an interesting option for you. If you’re not sure what assets to invest in then you might want to consider a different plan that is more managed for you.

Tips for Getting Retirement Ready

Self-directed 401(k) plans are one of a number of retirement savings accounts you can choose from. If you can’t decide which option is right for you, talk to a financial advisor. Finding a financail advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Start saving for retirement early. No matter which retirement savings account you settle on, it’s always better to start saving sooner than later. The sooner you invest your money, the more time you have to reap the benefits of compound interest. This can have a big impact on your retirement savings.