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What is a Self-Directed 401k?

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  • Written By: John Lister
  • Edited By: Kristen Osborne
  • Last Modified Date: 13 August 2019
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A self-directed 401k is the most common type of retirement savings plan in the United States. It is also known as a participant-directed plan. The option means that the saver makes his own decision about how the money he saves is invested, though in many cases, this will be on the basis of professional advice.

A 401k plan takes its name from the relevant section of the Internal Revenue code, the combined body of United States tax law. The plan allows workers to save for retirement and deduct the money they save, known as contributions, from their taxable income. They then pay income tax on this money as and when they receive it after retiring. Though the worker still pays tax on the money in the end, the delay means the money put into the 401k can grow over time rather than go straight to the IRS.

Many 401k plans are set up by companies and offered to their employees. In many cases, the company will put some money into the plan, as well as that put in by the employee from their wages. This is considered a benefit of employment at the company.

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A self-directed 401k is a type of plan set up by a company that allows the employee to decide how the funds in their plan are invested. How this works varies from case to case. It is relatively rare that the employee will have complete control over all of his funds. Some plans will limit the options available have for investing, for example, to particular types of mutual funds. Other plans may limit the percentage of the funds that are under the employee's control.

The contrast to the self-directed 401k is the trustee-directed 401k. This is where the employer appoints trustees to oversee the scheme. The trustees then make the decisions as to how the money should be invested.

The main benefit of a self-directed 401k is that the employee has more control over how his money is invested. This means the plan can better reflect his personal attitude to risk and security. The main drawback is that the employee may be less skilled at making sound investments. One common problem is that the employee is tempted to make more frequent changes to his investment choices, particularly in responding to market fluctuations. This contrasts with most professional advice that takes a more long-term approach to retirement fund investments.

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