The Two Main Dangers Of A Self Directed 401k Plan

The 401k rules technically allow employers to offer self-directed 401k plans. What is a self-directed 401k plan?  Simply put, it’s a 401k with a brokerage window, essentially allowing you to by any publicly-traded security out there (along with private investment trusts, too).

There are two main dangers of a self-directed 401k plan. The rules governing these are complex and complicated; if they are not followed completely, the IRS will disallow the 401k or certain portions of it. Individuals managing their own retirement accounts may lose the funds. People with a self-directed 401k are targeted by crooks who want the money; one of the most popular schemes is Ponzi schemes.

A 401k self directed plan allows people to direct their investments personally without being limited to the few pre-selected mutual funds most employers choose to offer.  Many people, dissatisfied with the returns they’ve been getting the past few years, are turning to non-traditional methods of investment. For example, real estate can be held in a self directed 401k plan though either Real Estate Investment Trusts or private partnerships and many investors are pursuing this in pursuit of higher returns.

If the rules are not followed, the IRS can disqualify the 401k or a portion of it with the associated penalties and interest. Life insurance and collectibles are not allowed under this program. Everything else can be used to generate retirement money;  tax liens, deeds of trust, equipment leasing, precious metals, business franchise, stocks, bonds and currencies.  Basically, if you can buy it on an exchange somewhere, you can own it in a self-directed 401k.  However, if the self directed 401k rules are not followed and the IRS determines a nonqualified transaction has taken place, they can disallow the 401k and assess penalties and interest on part or all of the 401k’s assets.

The other major danger is the con artists looking for ways to separate people and their money. Ponzi schemes work well; the people starting in the new investment plan get a great return on their money and brag to their friends and relatives. After a few months or year or two, the amount of new money flowing into the Ponzi scheme slows and the payments are reduced or stopped; the 401k holder has nothing left but a few pieces of worthless paper. Investors directing where the money goes need to be extremely cautious in the investments made. As Will Rogers said, “I am more concerned about the return of investment than I am about the return on investment.”

Many people choose a self-directed 401k as a way to increase retirement income and are successful in the endeavor. There are two major dangers of this plan every investor should be aware of and take steps to avoid. The rules for a self-directed 401k are complicated and need to be followed carefully. Any investment contemplated should be researched carefully to protect this valuable retirement account.