Planning for retirement is difficult at the best of times. Besides, the plethora of investment options available today makes choosing among different retirement savings options a nightmare for all but the savviest investors. If you’re wondering whether you can have concurrent 401k and self-directed IRA plans, you’ve come to the right place.
Even if you are currently invested in a 401k plan, you can open one or more self-directed IRAs. Annual contribution and tax-deduction limits will still apply. Unlike your 401k, a Self Directed IRA permits you to invest in things outside the stock market, in things like real estate and private businesses.
This article will explain the pros and cons of going down this route.
Why Consider Multiple Retirement Savings Plans
401ks and self-directed IRAs are different types of retirement savings plans. Each offers a different set of benefits.
401ks are employer-sponsored retirement savings plans which offer employees tax benefits on their savings. However, a significant drawback of 401k plans is the limited number of assets you can invest in under the plan.
Self-directed IRAs resolve this problem by allowing individuals to invest in a wider variety of assets. They also enable investors to exercise greater control over decisions that will affect their eventual retirement funds, such as when and what to invest in or divest from.
Of course, there is a catch: the greater control and flexibility self-directed IRAs offer also means that these plans demand greater expertise, vigilance, and investment of time to administer. In addition, the IRS places tighter restrictions on annual contributions you can make to a self-directed IRA.
But why not operate both types of accounts at the same time and enjoy the best of both worlds?
Benefits of Having a Current 401k and a Self-Directed IRA
By investing in both 401k and self-directed IRA plans, employees can:
- Diversify their investments.
- Maximize their savings.
- Exercise greater control and discipline when investing.
The hybrid approach can be a win-win for those who know what they are doing or are willing to do some extra work. It offers an opportunity to grow your retirement funds more than a 401k while mitigating the risks associated with a self-directed IRA.
Diversifying Investments
401k plans can only invest their funds in mutual funds and publicly listed stocks. These restrictions shield the investing public from exposure to more volatile asset classes.
Funds you place in a 401k plan are managed by experienced money managers. While even seasoned professionals can get things wrong, your money is generally safer in their hands unless you are an accomplished investor.
In addition, the finance industry receives greater oversight, although its credibility has been seriously damaged over the past decade.
Still, most often–and for the average investor–401ks have historically worked well. However, there are notable exceptions. Those retiring in the wake of historically catastrophic economic downturns can see their precious funds dwindle.
Moreover, savvy investors may prefer to take greater risks based on their superior reading of market conditions.
Unlike 401ks, Self-directed IRAs can also invest in:
- Private companies
- Precious metals
- Foreign currencies
- Real estate
- Digital assets such as cryptocurrencies
If you wish to diversify your investments beyond the restrictions laid by 401k plans, you will need to invest in self-directed IRAs. However, it is not an either-or scenario; you can set up a self-directing IRA without closing your 401k.
In this scenario, investing in a self-directed IRA will allow you to diversify your existing portfolio while maintaining your current 401k as a hedge. You can also open multiple self-directed IRAs, although this will involve more fees and more effort to monitor.
Maximising Savings
I’ve already mentioned that one of the significant drawbacks of self-directed IRAs is the more substantial limits the IRS places on annual contributions you can make to these funds. So, only investing in self-directed IRAs means you limit your overall contribution ability.
In addition, self-directed IRAs will not receive contributions from employers, further limiting the size of funds invested.
Since the size of your eventual retirement fund will depend on the amount of money you put in, ensuring maximum contributions during your peak earning years is essential to growing a sizable retirement fund.
Maintaining both types of retirement savings plans will allow you to seek additional capital gains by diversifying into more risky assets while still ensuring you are maximizing your current savings.
Restrictions on total annual contributions and withdrawals will still apply; you will just be utilizing these to the fullest.
Control and Discipline in Investing
Finally, while not everyone should attempt to time markets, returns from investing in riskier assets can be maximized by timing buy and sell decisions.
For instance, real estate is a historically cyclical industry. Choosing when and how much to invest in real estate can offer outsized returns.
On the other hand, maintaining a 401k along with your self-directed IRA will ensure greater discipline in savings and investment.
In a 401k, regular tax-deducted contributions from your monthly salary will go towards investing for your retirement. While inside Self Directed IRA, you are limited to a maximum of $6,000 in annual contributions, depending on age.
Drawbacks of Having a Current 401k and a Self-Directed IRA
There are also significant drawbacks to holding different types of retirement savings plans. Doing so will require a substantial investment of time. Monitoring and managing a real estate asset for example, requires more time than that of a passively invested 401k account full of stocks and bonds.
Requires More Time and Effort Monitoring Investments
The most significant drawback of having both a 401k and a self-directed IRA is the more substantial investment of time and energy it will require on your part. The less experience you have with financial instruments, the harder this will be.
But even experienced financial professionals need to spend significant time monitoring their investments. You will have to keep track of the number and types of assets you own to ensure they add up to a risk profile you are comfortable with.
You may also have to read the annual reports of companies you have invested in, follow market cycles, and keep track of geopolitical events and macroeconomic factors.
Additionally, you will have to maintain constant vigilance to ensure you comply with all IRS regulations regarding self-directed IRAs. For instance, self-directed IRAs are not allowed to invest in gems, art, collectibles, or life insurance.
Similarly, there are restrictions on investing in assets owned by you, your family members or beneficiaries, and any associated parties. Thus, keeping track of all the rules and regulations can also be taxing, besides monitoring investments.
To summarize, self directed IRA’s are meant for people who want to take their IRA or old 401k funds and invest in things they know and understand, as opposed to leaving your money with an investment advisor, who may or may be competent to navigate ever-changing markets.
Risk of Poor Decision-Making
With the chance to make greater returns comes greater risk. If you have never made any direct investment before, into real estate or any other sector, it may wise to consult your investment advisor to see their thoughts on a specific investment you wish to engage in.
Keep in mind investment advisors get paid by AUM, or ‘assets under management.’ It is often the case that when you speak with investment advisors, they’ll have canned responses, like ‘stay the course’ and ‘markets are cyclical’ to encourage you to keep your funds with them instead of moving your funds to a self-directed IRA, and invest them yourself. It will require fortitude to tell your advisors that in your mind, you think you can do better with the retirement account money than they are. That being said, if you’re the type of person who asks your financial advisor what to do, you may not be the best fit for a Self Directed IRA. LIkewise, if you’re the type of person who instructs your investment advisor how you want your funds allocated, a self-directed IRA could be the perfect fit.
If you are unsure what to do, staying with an investment advisor may be your best option.
Final Thoughts
401ks and self-directed IRAs are both useful financial instruments that offer distinct sets of pros and cons. Combining both account types makes sense for those who know what they are doing and are willing to put in a little more effort.