Still Don’t Understand Your Retirment Plan Options?

I am always surprised that more people are not aware of the opportunity to buy investment real estate with their retirement plans. As a Certified Financial Planner ™, I am charged with the fiduciary obligation to advise clients on the best use of their investment dollars to meet their goals, needs and resources.

Owning a fully paid for rental property in your IRA or 401(k), professionally managed by a quality property management company, can offer an excellent monthly income stream that you cannot outlive. Depending on rents, purchase price, and management and maintenance costs, a rental property can produce 5% to 10% income streams, even higher in some locations.

A recent article by some of my colleges talks about living off a 201(k). To compensate for the poor returns and higher rates of withdrawal, David Frisch, a fee-only CFP® says, the client may have no choice but to return to work.

What they are referring to is the traditional withdrawals and sales from securities to produce income. To compensate for lower returns, inflation and longer life span, clients will have to lower their withdrawal rates to 2.8% from 4%. That is a far cry from the 5% + income rates rental real estate can provide. Rents are historically a great hedge against inflation and should provide for increasing income over time.

While investing in hard assets like real estate is a critical addition to any retirement plan, it does not answer every aspect of a retirement plan. Items such as liquidity, diversification, and the ever present rules of real estate (location, location, location) must be addressed.

Using loans to buy real estate in your retirement plan is also a useful tool, but also adds risk and planning needs to ensure the property is fully paid for by your retirement date.

Ask your Realtor® about using your retirement plan to buy investment real estate. They should be able to direct you to a qualified investment specialist or firm that can help you establish a self directed IRA or 401(k) that you can use to buy real estate.

Posted in 401(k) loans, Financial, Investment, IRA Loans, Real Estate, Retirement, Self-directed 401(k), Self-directed IRA, Taxes | Tagged , , , , , , , , , , , , | Leave a comment

Fiscall Cliff AND End of World Averted!

It seems we are still here - at least to me. With the end of the world averted on December 21st, 2012, the next big fear was the “fiscal cliff”. It seems a temporary stay has been issued and we can move on to the next soul crushing fear facing us. Stay tuned to your favorite news channel to find out more about what next you should be very very afraid of.

I am making lite of some truly important challenges facing us both as a nation and individually. But I do so to try and bring perspective – in spite of the constant state of fear the world seems to put on our shoulders every single minute of every single day, somehow we persevere.

I would say to you the same things I say to my clients; focus on what you can control and don’t lose sight of the important things in your life. If  living in fear is important to you then you have my sympathy but not my attention. Now on to the tax issue.

Because of the expiration of the temporary Social Security payroll tax cut many of us were enjoying the past two years, the new tax deal will, at this point anyway, result in additional federal taxes on all wage earners.

Social Security is financed by a 12.4 percent tax on wages up to $113,700. Employers pay half and workers pay the other half in the form of withholding from your paycheck. This reduced the share paid by workers from 6.2 percent to 4.2 percent for 2011 and 2012, saving a typical family about $1,000 a year.

This is not a change in any tax rate for almost everyone – the new tax package would increase the income tax rate from 35 percent to 39.6 percent on income above $400,000 for individuals and $450,000 for married couples only.

While this will result in some drag on the economy, I believe that bringing the full funding of Social Security back to previous levels will be a plus in the long run.

According to CNBC*  here are the amount of increases each household should see in 2013:

Annual income: $20,000 to $30,000

Average tax increase: $297

Annual income: $30,000 to $40,000

Average tax increase: $445

Annual income: $40,000 to $50,000

Average tax increase: $579

Annual income: $50,000 to $75,000

Average tax increase: $822

Annual income: $75,000 to $100,000

Average tax increase: $1,206

Annual income: $100,000 to $200,000

Average tax increase: $1,784

Annual income: $200,000 to $500,000

Average tax increase: $2,711

Annual income: $500,000 to $1 million

Average tax increase: $14,812

Annual income: More than $1 million

Average tax increase: $170,341

 *http://www.cnbc.com/id/100348254

 

Posted in Uncategorized | Leave a comment

December 21, 2012


Since this might be the last day on earth I thought I would take a minute to post a short poem. It doesn’t really have anything to do with finance or taxes or IRAs or 401(k)s; I just thought that in the middle of a day when many people have had one more thing to be afraid of that they, like me, might want to take a minute and contemplate truly important things in their lives. Enjoy!

I finally found my love for God
On this
The Last Day of the World

Making many mistakes
I know it’s true
I had fallen so far
And then I met you
I finally know my love is true
On this
The Last Day of the World

I traveled the world
Experienced adventurous things
And then I raised children
Truly Wonderful Beings
I finally know God’s ultimate challenge
On this
The Last Day of the World

Seeing the beauty
Of this magnificent Earth
Watching the trees and flowers grow
The setting Sun – a rising Moon
I finally feel true Grace
On this
The Last Day of The World

I imagine Space
So vast and empty
So cold and void
Yet so full of Light and Wonder
I finally sense infinite serenity
On this
The Last Day of the World

I’ve loved so much
And lost so many
This bittersweet life
Is filled with mystery
And then you filled this empty hole
I finally know my place in life
On this
The Last Day of the World

I finally found God’s love for me
On this
The Last Day of the World

Posted in Uncategorized | Leave a comment

Obamacare is going to tax my 401(k)! (not really)

Recently I have been hearing a lot about how 401(k)s are going to be taxed under Obamacare. Now that the election is over the Patient Protection and Affordable Care Act (PPACA) that became law back in March 2010 is here to stay.

It has created quite a bit of confusion and misunderstanding on the new taxes that will come into effect.

Outside of the mandated penalty for not getting health insurance, which the Supreme Court clarified in the case last summer as a tax, there is an increased Medicare tax placed on high income earners.

According to Michael Maye, the founder and president of MJM Financial Advisors in a recent article in The Street, “the first new tax is an incremental 0.9% Medicare tax on wages above $250,000 (married filing joint) and $200,000 (single).”

The tax applies to wages and is before deductions for items like 401(k) contributions and healthcare premiums The tax also applies to self employment income earned by sole proprietors and partnerships as well.

The second part of the tax applies to unearned income (not wages) and encompasses several different forms of income with some specific exclusions.

It works like this – pay the lower of 3.8% of:

1) excess Modified Adjusted Gross Income above $250k if married (or $200,000 if single) or

2) unearned income.

For example, a married couple with a Modified Adjusted Gross Income of $270,000 and unearned income of $10,000 would owe $380. The calculation works as follows:

The lower of:

  • Excess Modified Adjusted Gross Income is $20,000 x 3.8% = $760
  • Unearned income is $10,000 x 3.8% = $380

Unearned income includes: taxable interest, dividends, net capital gains, annuities, rents (non-trade/business), and royalties. Luckily, tax planning does exist for this second tax.

Exemptions include:

  • Municipal Bonds
  • Roth conversions
  • Income from distributions from tax-favored retirement plans and accounts such as 401(k) plans, pension plans, traditional IRAs, and Roth IRAs

Of course if you read between the lines, your  investment real estate net rents will be taxed – if you are a high income earner but – rents received by real estate held inside your retirement plan is not subject to this tax!

Of course each person’s tax situation is different, so careful planning is in order for most anyone moving forward. But stop worrying about your 401(k) getting taxed by Obamacare.

It is just not true.

Posted in Uncategorized | Leave a comment

How To Enjoy Tax Free Retirement Income (part2)!

Our last post discussed some of the tax planning advantages of owning real estate in your IRA or 401(k) plan. To summarize:

  • The IRS taxes your retirement account based on its Fair Market Value (FMV)
  • Non-marketable holdings can have a discounted value for taxpaying purposes
  • Case law has shown that the IRS will allow up to a 40% discount when valuing a non-marketable asset held by retirement plans
  • It may make sense to convert a holding and pay taxes now rather than waiting for that elusive “lower tax bracket” promised during your retirement years

Now let’s look at another type of asset that can be held by IRAs and 401(k)s. These are commonly called a private placement, Reg. D offering, or even a hedge fund. These are a type of exempt security (exempt from registration) and have no secondary market.

To differentiate between an exempt and non-exempt security, think of a Mutual Fund as a non-exempt security. You can buy and sell your shares on the open market, it is priced at its Net Asset Value (NAV) at the end of each business day, thousands of shares and investors are involved in it, and all of this is a matter of public record.

An exempt security is much the opposite. While it is still a security, the exempt status removes it from public record (generally speaking – hence the term private placement), and essentially forbids any share holder to sell their stake in the holding to another third party.

This very limited liquidity is the key to accessing a discounted valuation when converting, distributing or calculating a 701/2+ year olds’ Required Minimum Distribution (RMD).

Let’s Look at an example:

ABC Financial Services has a placement that has purchased a $4MM commercial property. It is holding, improving, and managing this property for the benefit of its investors, and plans to collect and distribute rents while waiting for the property improvements and increasing rents to allow the placement fund to sell the property at a profit.

Mr. Investor has used his self-directed 401(k) plan to purchase $100,000 worth of the units in the placement. He wishes to convert his holding to the Roth portion of his 401(k) to pay taxes now and enjoy tax free income when he retires. If he owned stocks, bonds, or mutual funds with his account, the conversion would be taxed at the full $100,000 because the NAV equals the FMV of the holdings (no liquidity restrictions).

If Mr. Investor has a tax rate of 30% his tax bill would be $30,000. However, since he owns units in a non-marketable type of security, the IRS could allow a 25% to 40% discount in the FMV of his holding. If a third party qualified appraiser provided a 40% discount in its valuation of this private placement for fair market valuation reasons Mr. Investor’s tax bill would be significantly reduced.

$100,000 Net Asset Value – 40% Discount ($40,000) = $ 60,000 Fair Market Value

Mr. Investor would pay taxes on $60,000. At his 30% tax rate his tax bill would now be $18,000! This gives him an effective tax rate of 18% today, and tax free income, distributions, and he can leave the 401(k) Roth account to his kids or grandkids income tax free.

Now let’s assume for a moment that Mr. Investors holding is the same as before, but the fund management has a loan against this property for $2MM. His holdings net value would be reduced by the outstanding loan since this would have to be paid off upon sale of the property.

$100,000 Asset Value – 40% Discount ($40,000)= $60,000 Net Asset Value

$60,000 Net Asset Value – outstanding loan of $50,000= $10,000 Fair Market Value

Mr. Investor would pay taxes on $10,000. At his 30% tax rate his tax bill would now be $3,000! This gives him an effective tax rate of 3% today, a rate he would likely never see during retirement. Oh and he still gets the tax free income, distributions, and he can still leave the 401(k) Roth account to his kids or grandkids income tax free.

As we discussed in our last post it is not so simple as to just assign a value to the transfer. You must use a qualified third party appraisal firm to establish the appropriate FMV and discount factor. Please keep in mind this is an illustration and is not specific tax or legal advice. Your circumstances will differ from these and your taxes might be higher or lower than those shown. Also, there will be  appraisal costs to consider, although many private placement managers will provide their investors with these valuations upon request.

It is so critical to know the powerful planning strategies owning real estate (or better yet – real estate held in a private placement) inside your retirement account can offer. All you have to do is start now and tax free income is yours to have – with a little planning.

 

Posted in 401(k) loans, Financial, Investment, IRA Loans, Real Estate, Regulation, Retirement, Self-directed 401(k), Self-directed IRA, tax free, Taxes | Tagged , , , , , , , , , , , , , , , , , , , , | Leave a comment

How To Enjoy Tax Free Retirement Income!

Most everyone is aware of the opportunities the Roth IRA provides in the way of accumulating tax deferred dollars and then enjoying tax free distributions. Of course this extends to owning real estate in your Roth IRA (or post-tax 401(k) account) too.

What many investors are unaware of is the tax saving strategies available to them when converting existing real estate holdings inside their IRA (or preferably their individual 401k).

Let’s take a minute to discuss how your IRA distributions and conversions are taxed. When you are 70 ½ you must begin to withdraw funds from your IRA or 401(k). The amount you are required to take – the Required Minimum Distribution or RMD – is calculated using your age and the Fair Market Value (FMV) as of December 31st of the previous tax year.

For example, if the FMV of your retirement account is $100,000 as of December 31st 2011 and you turn 70 ½ during 2012, your RMD would be $3,649.641.The same tax treatment is applied when converting to a Roth or post-tax account.

Now let’s suppose for a minute that you own a rental home and you have 10 years until you retire or are going to need income. In Arizona a $100,000 rental home provides approximately 6% to 8% net income. We will assume for argument sake that we are getting just north of 7% income and this amount will remain the same over this illustration.

Upon retirement the income produced of $7,200 annually will be fully taxable. At a combined tax rate of 25% your tax bill will be $1,800.

However, if you were to convert the home to a Roth today you would pay taxes on 100% of the FMV, or $100,000. This would likely move you to a net tax rate of 30% or more. So it wouldn’t make sense to pay $30,000 today just to save $1,800 per year in taxes later. It would take more than 15 years of distributions to break even.

However, the IRS allows for a discounted valuations on low or non-marketable and minority assets of up to 40%2.

If you were to convert 20% of the rental home plus all income to your Roth or post-tax account each year for 5 years your tax bill could be significantly reduced. Take a look at the following chart for a comparative study. We will assume that rents remain the same and the property increases in value by 3% annually. The effective tax rates will be 25%. There is no loan on the subject property.

You can see that the breakeven point is established basically on day one of the distribution period. From then on, any income or capital gain distributions will be a tax-free. You could quite literally distribute the home from your Roth or post-tax account and then live in it.

Of course it is not so simple as to just assign a value to the transfer. You must use a qualified third party appraisal firm to establish the appropriate FMV and discount factor. Please keep in mind this is an illustration and is not specific tax or legal advice. Your circumstances will differ from these and your taxes and appraisal costs might be higher or lower than those shown.

However, it is important to know the powerful planning strategies owning real estate in your retirement account can offer. All you have to do is start now and  tax free income is yours to have – with a little planning.

1http://apps.finra.org/Calcs/1/RMD 2http://www.mercercapital.com/index.cfm?action=page.item&id=193

Posted in 401(k) loans, Financial, Investment, IRA Loans, Real Estate, Retirement, Self-directed 401(k), Self-directed IRA, tax free, Taxes | Tagged , , , , , , , , , , , , , , , | Leave a comment

Buying Rental Real Estate With Your IRA or 401K

Yes you can direct your custodian or trustee to purchase investment real estate with your IRA or 401(k). If you have the right type of plan. A truly self directed IRA or 401(k) allows you the control over what you can invest in – as long as it is not prohibited by the IRS.

Buying real estate with your retirement dollars has been written about many, many times by many different authors, so I am not going to beat you up with more of the same. Buy a rental property with your retirement plan - rents are treated the same as a dividend and specifically excluded as an active trade or business that could trigger certain tax consequences.

Instead, I would like to share some of the questions I get from people trying to find a unique solution to a problem or issue they are currently facing.

Joe from California called and has two rental homes he owns – both with loans and both upside down (more debt than equity). He has a pretty large sum in his 401(k) at work and wants to use these funds to help refinance his debt to something more affordable.

Unfortunately he only has two options – take a loan from his 401(k) of which the maximum allowed is $50,000 and must be paid back over a 5 year period, or take a distribution and pay taxes and penalties. Lending money to yourself, or using your retirement plan to buy real estate you or your LLC already own, are strictly prohibited.

A prohibited transaction will cause your entire retirement plan to be distributed, with hefty penalties (up to 100%!!!) plus taxes on the entire distribution. If you have your funds invested in less-than-liquid investments like real estate you may be forced into a fire sale to pay the tax and that could compound your loss.

Hal from the Phoenix area has a retirement home he wants to buy and move into when he retires in 5 years. Unfortunately the community where he wants to buy the home does not allow rentals to anyone other than immediate family members. His daughter wants to rent the home, but as a disqualified person (son,daughter, dad, mom - in other words a linear relation) she is prohibited from occupying the property – so no can do.

Bill from Las Vegas  has a lot he wants to build his retirement home on and has about 15 years until he retires. Land is (dare I say it?) dirt cheap these days and he would like to acquire this premium spot while it is affordable. This transaction is OK until you get to the meaty part – he wants to camp on the land between now and retirement.

While it seems counter-intuitive his accountant recommended he go ahead and distribute enough funds to buy now and pay the penalties and taxes today. Ouch you say? Well who knows where tax rates are going to be in the future – with so much government debt do you think they are going lower?

At the end of the day you are going to pay taxes on your retirement funds someday. If there is another way to help you build value for your retirement, in this case a very low cost lot at a very good location, purchased to hold the home he and his family will enjoy throughout his retirement years, paying the piper today just might be your best alternative.

Posted in 401(k) loans, Financial, Investment, IRA Loans, Real Estate, Retirement, Self-directed 401(k), Self-directed IRA, Taxes | Tagged , , , , , , , , , , , , , | 1 Comment

What type of Self Directed Retirement Plans are there?

First, we should discuss what we mean by a self directed retirement plan. These plans generally allow an individual  access to alternative investments not normally available through the usual channels.

For example, you might see that Fidelity will have a “self-directed” IRA or 401(k) plan available, but this usually means that the individual can select from the known universe of stocks , bonds, mutual funds, ETFs, and options or futures contracts.

It does not mean this individual can buy a rental home or a private placement or precious metals with his or her IRA or 401(k).

In the “true” self-directed world, there are two types of plans available for the investor; an individual retirement account, or IRA, or an individual 401k. These plans fall under different sections of the IRS code, and each have distinct treatment by the IRS. In the case of the 401k, (sometimes referred to as solo 401k, solo k, i401k, self employed 401k etc.) the Department of Labor has additional regulations that must be followed, as this is an employer sponsored plan (see Why 401k? for more specific details).

A third party custodian is necessary to hold your funds with the IRA. They usually have to sign documents and pay funds in relation to a real estate or other investment transaction, and they have much higher annual fees than your traditional IRA would have at a wire house like Fidelity or Schwab. You can expect to pay from$200 up to $500 annually.

The 401k plan has many excellent features and benefits, and is by far the better plan. First of all it is not necessary to have a third party involved with your plan. This gives you much more direct control -  not to mention the elimination of annual fees. As any good planner will tell you, fees eat into your investment returns. 95% of you can qualify for your own 401(k) so don’t be intimidated.

This is a huge topic, and to keep your reading time a s short as possible, I will be breaking this up into several posts. Stay tuned for lots more and happy planning!

Posted in 401(k) loans, Financial, Investment, IRA Loans, Real Estate, Regulation, Retirement, Self-directed 401(k), Self-directed IRA, Taxes, Uncategorized | Tagged , , , , , , , , , , , , , , , | Leave a comment

Giving up on Retirement?

A past article in USA Today (Market hurting returns on US retirement plans – May 16 2008) states that more than 25% of workers age 45 – 64 have postponed plans due to the sputtering economy. That was back in May of 2008. One can assume that statistic has not improved much. With the market appearing to be disconnected with everyday American lives, it becomes critical for all of us to look for ways to take control of our 401(k)’s and retirment dollars. Mutual funds and company investment choices are not making it. Your plan may be worth more today than 5 or 10 years ago, but probably not by much more than your contributions.

Stay tuned for our series on self-directed retirement plans with a focus on owning investment real estate. We will cover the differences between owning and funding IRA’s vs. 401(k)’s, why you should consider your own 401(k) plan, how real estate can add security to your retirment income, rules and regulations, and much more.

Posted in 401(k) loans, Financial, Investment, IRA Loans, Real Estate, Retirement, Self-directed IRA, Slef-directed 401k, Taxes, Uncategorized | Tagged , , , , , , , , , , | Leave a comment

Will The President Provide Economic Security?

Today an industry magazine, Investment News Daily, published an article representing a survey of advisors. They were asked which candidate they believe is most qualified to lead the U.S. toward recovery and growth. Their answers were interesting and revolved around removing President Obama, with a call for less regulation and lower taxes.

Regardless of political leanings, laws, regulations, taxes, and other economic influences, all economic movement comes from supply and demand. If our economy is based on consumption (most economists would argue this point to the tune of 66% to 75% causation), then demand will be created when there is a sense of real security in housing values and job safety.

Companies will produce goods and services once they see a clear demand for them, not based on which parties president is in office or what regulation or tax law is or isn’t in effect.  When this happens, jobs will be created in the U.S. It is no more complicated than that.

A wise teacher once told me that to get the right answer you must ask the correct question. The question is not one of public policy or who should  be president, but how do we as a nation (and advisors) help create a sense of security for each and every one of us.

While I don’t have the answer to that question, I believe it is one that should be a major topic of discussion. My opinion is that lowering taxes on the wealthiest, and to not require a fiduciary standard to broker dealers and their Registered Reps, will do little to add to anyone’s sense of  security (except to those that would profit from this public policy).

Posted in Financial, Investment, Real Estate, Regulation, Retirement, Taxes | Tagged , , , , , , , , , , , , , , | Leave a comment