Self-managed 401(k) Regulations by the Internal Revenue Service
Regular 401(k) plans often provide a limited range of investment options. If you're an enthusiastic investor, you might prefer having more control over your investments.
A self-directed 401(k) plan could be what you need. This type of plan includes a "brokerage window" that your employer might allow, enabling you to invest part or all of your 401(k) as per your preference. Whether your employer provides this benefit and the investments it allows, depends on their decision.
Self-directed 401(k) plans adhere to the same rules and requirements as conventional 401(k) plans. If your employer supports self-directed plans, familiarize yourself with the Internal Revenue Service (IRS) rules prior to making contributions to your account.
Self-directed 401(k) regulations and conditions
1. Annual contribution limitations
The maximum annual deductible contribution from your taxable income, which can be deposited in your 401(k) account, is $23,500 for 2025 (up from $23,000 in 2024). This limit is adjusted annually for inflation.
If you're 50 years or older at year's end, you can contribute an additional $7,500 as catch-up contributions for both 2024 and 2025. Employees aged 60 to 63 can make a higher catch-up contribution of $11,250 in 2025, as a result of the SECURE 2.0 Act changes.
Your employer can also contribute to your account, but the overall combined contribution limit for both employers and employees, excluding catch-up contributions, is $70,000 for 2025 ($69,000 for 2024).
If you work for a single employer during the year, you shouldn't have to worry about exceeding the 401(k) plan contribution limit as your employer calculates this limit for you. However, if you work for multiple companies, it's easy to surpass the limit since one employer might be unaware of the other's contributions.
If you exceed the 401(k) contribution limit, you must notify your plan administrator and return the excess amount prior to the following year's tax deadline, to avoid double taxation. Failing to do so could result in the IRS disqualifying your plan.
2. Prohibited investments
While having a self-directed 401(k) plan through your employer, remember that the "self-directed" term has limitations. Your employer may impose restrictions on the types of investments you can make. For instance, they might limit investments to mutual funds.
You're also prohibited from investing in any asset from which you can derive immediate benefit, such as your personal home or collectible vehicles. Investing in businesses owned by family members is also forbidden.
If your employer allows it, you can invest in securities, real estate, precious metals, currencies, and other assets.
3. Transactions with related parties
Avoid involving your 401(k) plan with your family members. Family members for this purpose include your parents, grandparents, children, grandchildren, or spouse's children or grandchildren.
This means you cannot lend your 401(k) money to your relatives, allow them to live on property owned by your 401(k) plan, invest your 401(k) money in their businesses, or otherwise benefit your family members from your 401(k) investments.
Related Retirement Topics
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4. Distributions
The distribution rules for a self-directed 401(k) plan mirror those of a traditional 401(k) plan. If you withdraw before the age of 59 1/2, you might be subject to a 10% penalty to the IRS, in addition to ordinary income tax, unless you meet specific exceptions.
Your employer's 401(k) plan may permit hardship withdrawals when you have immediate and serious financial needs.
If you leave your job, you can roll over a self-directed 401(k) plan to another qualified retirement plan or IRA, just as you can with any other 401(k) plan. As long as you transfer your funds to another tax-advantaged account, this process should not result in a taxable event.
Your money, and you should have the freedom to buy and sell investments as you choose, bearing the risks and gaining the rewards. If your employer offers a self-directed 401(k) plan, you can certainly do that.
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After transitioning into retirement, it's crucial to have a solid financial plan. Utilizing the control over investments offered by a self-directed 401(k) plan can be beneficial in this regard, providing opportunities to allocate funds towards desired investments.
In managing your self-directed 401(k) plan, be mindful of the investment options and limitations set by your employer. While you have more investment freedom, you may still be subject to restrictions on prohibited investments, such as personal properties or businesses owned by family members.
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