Individual retirement plans: which one is right for you?

If you do not have a company-sponsored retirement plan, then which option is best for you: a self-directed IRA or a Solo 401(k)? A Solo 401(k) and a self-directed IRA are both designed for individuals, but they each have its own features and rules.

Enjoying a company-sponsored retirement plan is not an option for many American workers.

In private industry, 26 percent of full-time workers do not have access to a retirement plan, according to a 2014 report from the U.S. Department of Labor. Among part-time workers, 63 percent cannot participate in an employer-sponsored retirement plan. And half of all small-business employees lack such a plan.

As a result, many U.S. workers must look to other ways to build retirement savings on their own. Two popular options are a self-directed IRA and a Solo 401(k). Each has its own features and rules for participation.

Eligibility requirements

A Solo 401(k) and a self-directed IRA are both designed for individuals. To contribute to an IRA, a person needs only to have earned income, whether from a part-time or full-time job.

A Solo 401(k), on the other hand, is designed for certain self-employed individuals. This includes independent contractors, freelancers and small-business owners. To be eligible for a Solo 401(k), also called a One-Participant 401(k), you need to show proof that you are self-employed and that you don’t have any full-time employees.

With both an IRA and a Solo 401(k), it is possible to have a traditional 401(k) at the same time if all other requirements are met. These two options can be an alternative — or a complement — to a traditional plan.

Contribution limits

You can sock away as much as $5,500 into an IRA account each year. People over 50 can contribute an additional “catch-up” amount of $1,000, for a total of $6,500.

A Solo 401(k) offers its owner the unique ability to make both salary-deferral and profit-sharing contributions. Each plan participant is allowed to contribute up to $53,000 in 2015. The catch-up allowance for participants over 50 is $6,000.

If you have an employer-sponsored 401(k), your IRA contribution limit is independent of your 401(k) contributions. However, if you have both a traditional 401(k) and a Solo 401(k), the salary deferral contribution of $18,000 a year is the maximum for both plans combined. Therefore, many choose to make a salary-deferral contribution to their traditional 401(k) and maximize the profit-sharing contribution from their business to the Solo 401(k).

The Solo 401(k) includes a loan option, but plan owners should proceed with caution.

Custodian requirements

A Solo 401(k) is not required by the IRS to have a third-party administrator or custodian. Therefore, the plan owner can assume the role of the plan trustee and administrator. All decisions and responsibilities will then lie with the plan owner. Alternatively, some companies provide management and custodian service for Solo 401(k) plans.

An IRA must have a qualified custodian. However, self-directed IRA options are available, in which the custodian remains passive and allows the plan participant to make investment decisions. This option is often called a “Checkbook IRA” or “self-directed IRA LLC.”

With the self-directed option, both a Solo 401(k) and an IRA can invest in a wide array of assets, including stocks, bonds, mutual funds, real estate, precious metals and more.

Roth option

While traditional retirement plans offer tax-deferral benefits, a Roth IRA or Roth Solo 401(k) takes after-tax contributions but allows tax-free gains.

With the Solo 401(k), the Roth account is already built in with the plan. The plan owner will only need to keep a good record of Roth contributions without having to create a new account. The contribution is limited to the salary deferral portion of $18,000 a year. There is no income limit for the plan participant.

With an IRA, the plan owner will need to set up a separate Roth IRA plan. The contribution limit is $5,500 a year. There are certain income restrictions to contribute to a Roth IRA plan.

Having an individual retirement plan can be a great way to save more for the future. Study your options and decide on the best plan that fits your needs.