Mark Kohler compares IRAs and 401(k)s, covering contribution limits, income limits, and borrowing options. 401(k)s let you borrow against your balance and handle leverage without tax complications, while IRAs allow 60-day rollovers and self-directed investing but trigger UDFI taxes when you use leverage.
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Hi, Mark Kohler here with another tax and legal tip. Let's talk about the IRA and 401k. I'm consistently asked, what's the difference which one's best for me? Well, there's pros and cons to both and it depends on your situation. Let's hit the whiteboard. Now. There's a lot here, so it's going to take us probably a couple whiteboards to work through this. But I'm going to work quickly and I'm going to suggest you get a consultation with either an attorney or CPA at our office with a professional that understands the difference and isn't trying to sell you something. So let's hit IRA and 401k. And again, like I said, there's pros and cons to both. The first one is contribution limits. If you want to put away a lot of money, the IRA may not be for you. If you're just trying to get some investment investments going and can afford to save four or five hundred bucks a month max. Well, this could be a perfect fit because with the IRA you can only do 5500 or if you're age 15 above, you can do 6500. So you're limited. You know, there's some limits there. With a 401k, you can do 18 grand or up to 24,000 if you're over age 50. And you can also do up to a 25% match of the contributions. So we can sock away a lot of money with 401k. Also with the IRA there's income limitations, meaning you don't get a tax deduction if you make too much money. So this is not a good fit. But then with 401k, there's no income limitations. So again, that shows kind of one of the first major differences when it comes to the IRA and 401k. Next comes the 60 day and borrowing provisions. But let's make sense of that. With an ira you can actually take the money out for up to 60 days. And as long as you put it back, there's no penalty, there's no tax, nothing. Take it out, go make some money, go use it wisely, put it back, you keep the profit of what you may be made. That's called a 60 day rollover. That's okay with an IRA, but you cannot do a 60 day rollover with a 401k. So no 60 day rollover. Well, that's a pain. But with a 401k, you can borrow. That's awesome. You can borrow up to 50 grand or 50% of the balance in your 401k, that's a big deal. IRA, you cannot borrow from an IRA. So no borrowing provision. Now let me say this now as some of you might be getting confused as to. I'm already confused Mark, which one's for me? Just watch, listen and look at the differences, make some notes and then when we have a consultation or conversation we can look at what your goals are, your fact pattern and help tailor it to your situation. Now let's talk about ease and affordability, cost of setup, all that sort of stuff. The IRA is going to be cheaper and easier. It's just because you can walk into any bank and get one going and I recommend it. If you can even save $100 a month, go in and start an IRA and get the process started, you start to look at the trajectory of saving now versus later. It's huge, right? It snowballs that time value of money. So get started and it's cheap and easy. With a 401k it could cost you a little bit to set up. Now if you have a day job and they provide a 400, 401k and there's some matching. Whole other world, right? Pretty cool. But if you're an entrepreneur and have an S corporation or small business, oh I love the 401k. I'll explain a couple other those benefits here in a second. But the cost is going to be around 1200 bucks to set up. If anybody's trying to charge you a lot more than that, get a second opinion. But we charge 1200 bucks and you get to be your own trustee and you get to self direct your 401k. Something I'll come to in a minute. But there's a cost to set up. But again there's more flexibility and benefits down the road. Now regarding that flexibility, with an IRA you have to have a custodian or a bank or a third party that's going to give you statements and kind of control the money or at least invest it where you say. Now you can still self direct which I'm coming to here. But the nice thing about a 401k is you can self trustee. Now some may say that's like giving you a loaded gun. You're gonna have to know the rules so you don't get into trouble. But the 401k can be so affordable and simple. Once you set it up. We charge 300 bucks a year to help you maintain it. Kind of like your third party administrator to give you the rules. But you can self trustee. There's no custodian, no stockbroker, or a bank telling you what you can do. That's the Beauty of the 401k. Again, this solo you and your small business is you can be in control. Which brings us to self directing. Self directing you can do in both models self directing. If you haven't learned about this before, watch some of my other videos. But you can invest in what you know best Real estate. Small businesses do hard money loans, buy super bowl tickets and resell them. Selena Gomez tickets. You can buy anything you can except collectibles like wine or coins. But you can buy these items and then resell them and the profit goes back into your retirement account, whether it's an IRA or 401k. Now when you're self directing, probably the last big difference between the two is this thing called Unrelated Debt Financed Income or udfi. Now for those that are experts out there, you've been self directing your retirement account for a while. You if you take your IRA and borrow money to buy a rental property, put 50,000 down and borrow 50,000. You now have leverage in your IRA. You're going to pay what's called UDFI or Unrelated Debt financed Income when you go sell the property. But the beauty of a 401k is there's no UDFI. So when I have clients that want to borrow, they're going to lean towards the 401k because they avoid that tax altogether. Bottom line, let me make this basic recommendation. If you want to put away a lot of money or you want to self direct and borrow or leverage in the investments you're doing, a 401k is going to make the most sense. If you're not going to self direct with leverage and you just want to get a few dollars put away, or you already have a big IRA with a nest egg and you just want to self direct it, an IRA may be a simpler way to go. So again, depending on your situation, both of them could work for you. It's not one being better or worse than the other. So get your consultation, do your research and apply it to your situation. Thanks so much for watching and if you found that helpful, please look in the description below. 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