Earn $10 when you view your rate on a personal loan *
Bonus deposited into a SoFi Money® account. See terms.

Benefits, Drawbacks, and Options of a Self-Directed 401(k) Plan

By Brian O'Connell · March 15, 2021 · 5 minute read

We’re here to help! First and foremost, SoFi Learn strives to be a beneficial resource to you as you navigate your financial journey. Read more We develop content that covers a variety of financial topics. Sometimes, that content may include information about products, features, or services that SoFi does not provide. We aim to break down complicated concepts, loop you in on the latest trends, and keep you up-to-date on the stuff you can use to help get your money right. Read less

Benefits, Drawbacks, and Options of a Self-Directed 401(k) Plan

Self-directed 401(k) accounts aren’t as common as managed or target-date 401(k) plans, but they can be of real value for DIY-minded investors.

These 401(k) plans—which may be employer-sponsored or available as a solo 401(k) for self-employed individuals—expand account holders’ investment choices, giving them more control over their own retirement plans. Instead of being limited to a packaged fund, an investor can choose specific stocks, bonds, mutual funds and sometimes even alternative investments, in which to invest their retirement money.

What is a Self-Directed 401(k) Account?

The key promise of self-directed 401(k) plans is control. They allow retirement plan savers to basically act as a trustee for their own retirement funds.

A self-directed 401(k) plan offers expanded investment choices, from stocks, bonds, funds, and cash, to alternative investments like real estate, commodities, and even cryptocurrencies.

For a plan holder who believes they have the investment know-how to leverage better returns than a managed fund or target-date fund, a self-directed 401(k) can be an appealing choice.

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

Setting up a self-directed 401(k) plan can be fairly straightforward. As long as your employer offers one, and you have earned taxable income for the current calendar year, you can enroll. Alternatively, if you are self-employed, you can search for a financial institution that offers such a plan.

Once a 401(k) account is established, employees can fund it in the following ways:

•  Plan transfer. An employee can shift funds from previous or existing 401(k) plans and individual retirement accounts (IRAs).
•  Profit sharing. An employee receiving funds from a company through profit sharing can use that money to open a self-directed 401(k) plan—up to 25% of the profit share amount.
•  Direct plan contributions. Any income related to employment can be contributed to a self-directed 401(k) plan.

Pros and Cons of Self-Directed 401(k)s

Like most investment vehicles, self-directed 401(k) plans have their upsides and downsides.

Pros of Self-Directed 401(k) Plans

These attributes are at the top of the self-directed 401(k) plan “pro” list:

•  More options. Self-directed 401(k) plans allow retirement savers to gain more control, flexibility, and expanded investment choices compared to traditional 40k plans, putting their money exactly where they want—without relying on established funds.
•  Tax deferral. Like regular 401(k) plans, all self-directed 401(k) plan contributions and asset gains are tax-deferred.
•  Employee matching. Self-directed 401(k) plans make room for employer matching plan contributions, thus potentially paving the way for more robust retirement plan growth.
•  Plan diversity. Account holders can invest in assets not typically offered to 401(k) plan investors. Alternative investments like real estate, cryptocurrencies, gold, silver and other commodities, and private companies are allowed, thus lending additional potential for diversity to self-directed 401(k) plans.

Cons of Self-Directed 401(k) Plans

These caveats and concerns are most often associated with self-directed 401(k) plans:

•  Higher-risk investments. Historically, alternative investments like precious metals and real estate come with more volatility—and hence more risk—than stocks and bonds.
•  Early withdrawal penalties. As with traditional 401(k) plans, self-directed 401(k)’s come with a 10% tax penalty for early withdrawals (before age 59 1/2.)
•  Diversification is on you. You’ll need to choose among stocks, bonds and funds to augment your self-directed 401(k) plan asset allocation.
•  Higher fees. Typically, self-directed employer retirement plans cost employees more to manage, especially if an investor makes frequent trades.
•  Larger time investment. Since self-directed 401(k) plans offer access to more investment platforms, savers will likely need to spend more time doing their due diligence to research, select, and manage (especially in the area of risk assessment) their plan options.

Common Self-Directed 401(k) Investments

The ability to choose from an expanded list of investment categories is an intriguing benefit for a 401(k) plan holder who believes they have the investment know-how to leverage better returns from investments like real estate, precious metals, or shares of private companies, among other eligible alternative investments.

For any retirement saver looking to leverage those options, the key is understanding what potential opportunities and what risks those extra self-directed investment vehicles bring to the table. Here’s a closer look at two of the more common alternative investments linked to self-directed 401(k) plans.

Real estate

Investing in real estate simply means investing in residential or commercial properties, or real estate funds, with the goal of income generation. A self-directed 401(k) plan allows for real estate investing outside of the plan holder’s personal residence.

Examples of residential properties include:
•  Single-family homes
•  Condos
•  Townhouses

Examples of commercial real estate include:
•  Multi family homes
•  Office or retail buildings
•  Storage facilities and warehouses

To invest in real estate with a self-directed 401(k) plan, an investor would use their 401(k) funds to purchase the property, as well as to pay for maintenance, taxes, and other property-related expenses.

Real estate can be cyclical in nature, and can require large amounts of cash when investing in direct real estate properties. Thus, risk of investment loss is real and must be treated prudently by self-directed 401(k) investors.

Precious metals

Investing in “hard commodities” like gold, silver, titanium, copper, zinc, and bronze, among other metals, are allowable with self-directed 401(k) plans. Self-directed 401(k) plan participants can either invest in precious metals directly, like buying gold bullion or coins, or invest in precious metals via stocks or precious metal funds.

Precious metal investing can be high risk, as gold, silver, and other metals can be highly volatile in value. As with real estate, investors have to be able to ride out chaotic market periods for commodities—but for some, the potential payoff is worth it.

Investments That Aren’t Allowed Under Self-Directed 401(k) Plan Rules

While the list of investment vehicles that are included in a self-directed 401(k) plan are substantial, regulatory rules do prohibit specific investment activities tied to several of those asset classes. These investment strategies and associated transactions, for example, would not pass muster in self-directed 401(k) plans.

Real Estate with Family Ties

While investing in real estate is allowed in a self-directed 401(k) plan, using that real estate for extended personal gain is not allowed. For example, that could include buying an apartment and allowing a family member to live there, or purchasing a slice of a family business and holding it as a 401(k) plan asset. Neither of these scenarios is allowed under 401(k) plan regulatory rules.

Loans

Self-directed 401(k) plan consumers may not loan any plan money to family members or sign any loan guarantees on funds used in a self-directed 401(k) plan.

No investment benefit beyond asset returns

Self-directed 401(k) plan holders cannot earn “extra” funds through transactions linked to plan assets. For example, a plan holder can buy a real estate property under 401(k) plan rules but he or she cannot charge any management fees nor receive any commissions from the sale of that property.

Basically, a self-directed 401(k) plan participant cannot invest in any asset category that leads to that plan participant garnering a financial benefit that goes beyond the investment appreciation of that asset. That means not using 401(k) funds to purchase a personal residence or investing in assets like investments of collectibles (i.e. vehicles, paintings or jewelry or real estate properties that the plan participant personally uses.

The Takeaway

While self-directed 401(k) plans can add value to a retirement fund, self-directed retirement planning is not for everyone.

This type of account requires more hands-on involvement from the plan holder than a typical target-date or managed fund might. Additionally, investing in alternative investments like precious metals, real estate, and other risk-laden investment vehicles, require a realistic outlook on downside risk and a healthy knowledge of how investments work beyond stocks, bonds, and funds.

If you’re looking to open a retirement account such as an IRA or Roth IRA, you can do so at a brokerage, bank, mutual fund house, or other financial services company, like SoFi Invest®. SoFi Invest will help you invest your money in accordance with your personal goals and risk tolerance.

See how SoFi Invest can help you invest in your future.


SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal. Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Lending Corp and/or its affiliates.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
SOIN20181

All your finances.
All in one app.

SoFi QR code, Download now, scan this with your phone’s camera

All your finances.
All in one app.

App Store rating

SoFi iOS App, Download on the App Store
SoFi Android App, Get it on Google Play

TLS 1.2 Encrypted
Equal Housing Lender