IRA Rollovers, Explained

An IRA rollover is a transfer of funds from one retirement account a traditional IRA or Roth IRA.

IRA Rollovers are defined as tax-free transfers of retirement from one type of investment account to another. Rollovers were originally introduced to increase the mobility of qualified plan funds for employees moving from one job to another.

You can find the basic provisions governing rollover transfers here. These provisions cover transfers from one IRA to another, transfers from qualified pension, profit-sharing, stock bonus, and annuity plans to IRAs, and transfers from IRAs to qualified plans.

There are a few rare exceptions to the rollover rules. For example, in certain situations, an IRA can make a rollover distribution to a health savings account (HSA).

In other words, if you receive a distribution from a qualified plan (such as a 401(k)), you might decide to put some or all of the distribution amount into an IRA. The IRA that receives the qualified plan distribution is called a rollover IRA.

You can do this either through a direct transfer or via check. If you do a rollover via check, your custodian will write you a check, which you will then deposit into the other account.

How Often Can I Do a Rollover?

The privilege of rolling over from IRA to IRA may be exercised only once in a 12-month period.

Can You Rollover Funds From a Traditional IRA to Another Traditional IRA?

Yes, as long as the money being moved is withdrawn from your old account and deposited in another account within 60 days. Failing to follow this rule can cause your rollover to lose tax-deferred status and cost you big time.

This rule operates on an all or nothing basis. The entire amount received from your old IRA must be transferred to the designated IRA. If you pocket anything, the rollover rule does not apply, and everything received from the old IRA, including any amount transferred to another IRA, is treated as a taxable distribution.

What If I'm Transferring Property That Isn't Money?

If property other than money is received from your old IRA, that property, (not substitute property of equal value or the cash proceeds of the property's sale), must be included in the transfer to the new IRA.

Note: According to our friends at the Tax Court, the rollover contribution must be of cash if the distribution is in cash.

Can I Rollover Funds From a Qualified Plan to a Traditional IRA?

Yes. A qualified plan (or annuity participant) can roll over any distribution other than a distribution that:

 Note: An employee's surviving spouse may also roll over a similar distribution received on account of the employee's death.

Can a Traditional IRA be Rolled Into a Qualified Plan?

Yes. Within 60 days after the distribution, an IRA can be rolled into an eligible retirement plan for the distributee's benefit.

The term “eligible retirement plan” includes:

A rollover contribution must include the entire amount received in the distribution, but it may not exceed the portion of the distribution that, in the absence of the rollover, would be included in the distributee's gross income.

Can I Rollover a Traditional IRA I inherited?

No, usually. A taxpayer whose interest in an IRA is as a beneficiary of the person who created the IRA is usually denied the privilege of rolling over tax free from the IRA to another type IRA or a qualified plan or tax deferred annuity.

Rare exception: a surviving spouse may roll over to another IRA but not a qualified plan.

So why isn't this usually allowed? Because the tax allowances for IRAs (including an IRA’s tax exemption) are intended to encourage saving for the retirement of the contributor and surviving spouse.

Blame Congress. They're the ones who decided it was inappropriate to allow the tax exemption to be prolonged by rollovers after the contributor has died and the account has passed into the hands of a person other than a surviving spouse.

Are There Reporting Requirements For Traditional IRA Holders?

Yes. But don't worry, it's not that bad! (Hopefully you have someone else doing the paperwork for you.) Individuals maintaining IRAs and surviving beneficiaries under IRAs must usually file an annual information return on Form 5329.

Also, an individual maintaining an IRA must make an information filing for each year in which a nondeductible IRA contribution is made or a distribution is received from an IRA.

The filing, which must be included with the individual's return for the year, must disclose the following:

What Will The IRS do if You Fail To File Properly?

A $50 penalty is assessed for not filing, unless you can justify why you didn't. Also, because non-deductible contributions are recoverable tax free upon distribution, the IRS will want $100 if these contributions are overstated in the return and you, the taxpayer, cannot justify the overstatement.

I hope this article answered any questions you may have had. If you have any questions about IRA rollovers feel free to ask me, I'd love to help you.

 

Rollover IRAs Explained

An IRA rollover is a transfer of funds from one retirement account into another, such as a traditional IRA or Roth. You can do this either through a direct transfer or via check. If you do a rollover via check, your custodian will write you a check account which you will then deposit into the other account.

Rollovers are defined as tax free transfers of retirement from one type of investment account to another. Rollovers were originally introduced to increase the mobility of qualified plan funds for employees moving from one job to another.
You can find the basic provisions governing roll over transfers here. These provisions cover transfers from one IRA to another, transfers from qualified pension, profit-sharing, stock bonus, and annuity plans to IRAs, and transfers from IRAs to qualified plans.

There are a few rare exceptions to the rollover rules. For example, in certain situations, an IRA can make a rollover distribution to a health savings account (HSA).

In other words, if you receive a distribution from a qualified plan (such as a 401k), you might decide to put some or all of the distribution amount into an IRA. The IRA that receives the qualified plan distribution is called a rollover IRA.

How Often Can I do a Rollover?

The privilege of rolling over from IRA to IRA may be exercised only once in a 12-month period.

Can You Rollover Funds From a Traditional IRA to Another Traditional IRA?

Yes, as long as the money being moved is withdrawn from your old account and deposited in another account within 60 days. Failing to follow this rule can cause your rollover to lose tax-deferred status and cost you big time.

This rule operates on an all or nothing basis. The entire amount received from your old IRA must be transferred to the designated IRA. If you pocket anything, the rollover rule does not apply, and everything received from the old IRA, including any amount transferred to another IRA, is treated as a taxable distribution.

What If I'm Transferring Property That Isn't Money?

If property other than money is received from your old IRA, that property, (not substitute property of equal value or the cash proceeds of the property's sale), must be included in the transfer to the new IRA.

Note: According to our friends at the Tax Court, the rollover contribution must be of cash if the distribution is in cash.
Can I Rollover Funds From a Qualified Plan to a Traditional IRA?

Yes. A qualified plan (or annuity participant) can roll over any distribution other than a distribution that:

 Note: An employee's surviving spouse may also roll over a similar distribution received on account of the employee's death.

Can a Traditional IRA be Rolled Into a Qualified Plan?

Yes. Within 60 days after the distribution, an IRA can be rolled into an eligible retirement plan for the distributee's benefit.

The term “eligible retirement plan” includes:

A rollover contribution must include the entire amount received in the distribution, but it may not exceed the portion of the distribution that, in the absence of the rollover, would be included in the distributee's gross income.

Can I Rollover a Traditional IRA I inherited?

No, usually. A taxpayer whose interest in an IRA is as a beneficiary of the person who created the IRA is usually denied the privilege of rolling over tax free from the IRA to another type IRA or a qualified plan or tax deferred annuity.

Rare exception: a surviving spouse may roll over to another IRA but not a qualified plan.

Why Not?

Because the tax allowances for IRAs (including an IRA’s tax exemption) are intended to encourage saving for the retirement of the contributor and surviving spouse.

Blame Congress. They're the ones who decided it was inappropriate to allow the tax exemption to be prolonged by rollovers after the contributor has died and the account has passed into the hands of a person other than a surviving spouse.

Are There Reporting Requirements For Traditional IRA Holders?

Yes. But don't worry, it's not that bad! (Hopefully you have someone else doing the paperwork for you.) Individuals maintaining IRAs and surviving beneficiaries under IRAs must usually file an annual information return on Form 5329.

Also, an individual maintaining an IRA must make an information filing for each year in which a nondeductible IRA contribution is made or a distribution is received from an IRA.

The filing, which must be included with the individual's return for the year, must disclose the following:

What Will The IRS do if You Fail To File Properly?

A $50 penalty is assessed for not filing, unless you can justify why you didn't. Also, because non-deductible contributions are recoverable tax free upon distribution, the IRS will want $100 if these contributions are overstated in the return and you, the taxpayer, cannot justify the overstatement.

I hope this article answered any questions you may have had. If you have any questions about IRA rollovers feel free to ask me, I'd love to help you.

 

Should You Convert Your IRA or 401k to Roth?

Are you thinking about converting your IRA or 401k to a Roth? Doing so may or may not be a good idea. If you have a traditional IRA or 401k, your money is currently growing tax deferred and you'll pay tax on the money as it is drawn out at retirement. So why might you want to convert? Read on to learn the benefits, and who is a good candidate for this kind of switch.

Reasons to Convert Your Traditional IRA/401 to a Roth

A Roth is the opposite of a traditional IRA or 401k. Roth IRAs and 401ks grow and the money invested in them is distributed tax free when you decide to retire. So if you had a Roth, you'd pay taxes now and pay no taxes on distributions when you decide to retire.

The benefit of paying now is it's less money in the long run. If you can afford to pay taxes today, they'll be cheaper than their equivalent in 20 or even 5 years. $20 today can inflate dramatically in the time until you retire.

There are several differences between traditional and Roth accounts. To put it simply, a Roth is best for you if you plan on being in a higher tax bracket then the one you're in now when you retire. If you plan on being in a lower tax bracket, a traditional account is better for you.

Note: You may also want to check out our related articles:

Roth IRA Conversion Doesn't Have to Be Forever

Yes that's right! If you have second thoughts, you can convert at any time. The good news is you can convert your traditional IRA to a Roth IRA, or your traditional 401k to a Roth 401k. The price to make that conversion is including the amount you convert to Roth as taxable income for the year in which you make the conversion.
For example, if you convert $100,000 from your traditional IRA to a Roth IRA in 2017, you will list $100,00 as income on your 2017 tax return. You will then pay any federal and state taxes on that income depending on your 2017 tax bracket.

You probably don’t like the idea of paying additional taxes to convert. Honestly, who would? Nobody likes paying their friends at the IRS more taxes now. However, you can easily end up saving more money as your account grows and the entire growth comes out tax free.

Three Situations Where Converting Your IRA or 401k Funds to Roth Is Your Most Profitable Option:

  1. Expecting Higher Than Average Returns From An Investment Opportunity.

If you're about to make an investment you expect will produce huge returns, then it'll be in your best interest to convert to a Roth.
Wouldn't you rather pay tax on the smaller investment amounts now? Those larger returns will go back into your Roth IRA or 401k, where they will grow to an unlimited amount and come out tax free.
I realize this is hard to predict. After all, if it was easy we'd all be rich. However, a situation like this is bound to happen when you're investing in real estate, startups, pre-IPOs, and other investments.

  1. Low Income Year.

The biggest pain of a conversion is that you have to pay tax on the money you convert. The best time to convert is when you're in a lower tax bracket because you'll end up paying less in taxes.
For example, if you are married and have $50K of taxable income for the year and you decide to convert $100K to Roth, you will pay federal tax on that converted amount at a rate of 15% which would result in $15,000 in federal taxes.
And don't forget about state income tax (if you live in a state that actually has one) because they tax conversions the same way the fed does!

If you choose to convert when you're in a high tax bracket at around $250,000 of income, then you’d pay federal tax on a $50K conversion at a rate of 33%. This would result in federal taxes of $16,500. In other words, that's one third of your money down the drain. Ouch!

Unfortunately, many of us have careers where we can't just expect to be in a lower tax bracket. This option is probably more likely for those who are self employed as small business owners, consultants and freelancers.

  1. You'd Rather Have The Money Sooner Instead Of Later

Roth accounts are kind of like the gift that never stops giving.  With a Roth you can take out the funds you've contributed or converted (NOT the earnings) after five years without paying tax or the early withdrawal penalty. Even if you aren’t 59 1/2.

For Roth conversions, the amount you convert can be distributed from the Roth account five years after the tax year in which you converted. The five-year clock starts to tick on January 1st of the tax year in which you convert, regardless of when you convert within the year.

Let's say you converted your traditional IRA to a Roth IRA in May 2017. You'd be able to take a distribution of the amounts converted without paying tax or penalty on January 2nd, 2022.

Whereas if you try to access funds in your traditional IRA or 401k before you are 59 1/2, you will pay tax AND a 10% early withdrawal penalty even if the amounts you distribute are only the contributions you put in, not the investment gains.

Roth accounts offer you flexibility, plain and simple. So if you're looking to always have access to your retirement money, a Roth is what you need!

Final Thoughts on Who Should Convert to a Roth

Whether or not you should convert to a Roth largely depends on your future. Will you be richer or poorer when you retire? Also, many employers are willing to match your contributions to a traditional 401k to a certain degree, whereas for a Roth they aren't.

For most people, a Roth conversion simply isn't worth the money. But for some circumstances, it's a no-brainer. If you need help determining if a Roth conversion is in your best interest call Royal Legal Solutions now at (512) 757–3994 to schedule your retirement consultation.

A Series Of Landmark Prohibited Transaction Cases: Peek & Fleck Vs The IRS

This article is part 2 of a series with the goal of educating you, the Self-Directed IRA LLC investor, on how to successfully invest & avoid triggering prohibited transactions.

At this point in your life you know two things in life are certain, those things being death & taxes. It almost feels like a no-win situation, doesn't it? Funny enough, according to Greek mythology, you even have to pay to book passage on the boat that takes you to the afterlife.

Why You Should Understand Prohibited Transactions

Try to think of prohibited transactions as the sharks circling you and your state of the art Self-Directed IRA LLC investment boat.
The prohibited transaction rules are extensive, and the penalties even more so. Penalties for triggering a prohibited transaction range from excise taxes to instant dismantlement of your IRA plus fines.  (Can you say "ouch" ?)

As you can see, anyone investing with a Self-Directed IRA LLC should be careful to avoid engaging in prohibited transactions, for to do so is doom. Not to mention, the IRS will always have an eye on you from then on out. (But then again, they already did, didn't they?)

Peek & Fleck Vs The IRS

In 2001, two taxpayers, Mr. Lawrence Peek and Darrel Fleck decided to use Self-Directed IRA's to acquire a business. They established Self-Directed IRAs using 401k rollovers, created a new company named FP Company, and then directed the IRAs to purchase the stock of FP Company with the cash in their IRA's.

To finalize their purchase, in addition to the cash and other credit lines, FP Company provided a promissory note to the sellers. This promissory note was backed by the personal guarantee of Peek & Fleck, and the guarantees were then backed by the deeds to the Peek & Fleck's homes.

In 2003 and 2004, Peek & Fleck converted their traditional IRAs to Roth IRAs. In 2006 and 2007, the IRAs sold FP Companies stock, which had increased in value, for a gain. Peek & Fleck used their Roth IRAs to ensure there would be no tax on the gain from the sale of the stock.

The IRS, believing a prohibited transaction had occurred, audited the income tax return for both Peek & Fleck for the tax years of 2006 and 2007.
After reviewing the individuals’ tax returns, the IRS adjusted their tax returns to include the capital gains income from the sale of the stock as well as imposed excise tax for excess IRA contributions.

Both Peek and Fleck contested the IRS’s adjustment and went to the Tax Court with a petition.

Why Was This A Prohibited Transaction Case?

The IRS argued that Mr. Fleck’s and Mr. Peek’s personal guarantee of a promissory note from FP Company to the sellers of the business in 2001 as part of FP Company’s purchase of the business assets were prohibited transactions.
Unfortunately for Peek & Fleck, The Tax Court agreed with the IRS. The Tax Court found that Peek & Fleck had committed prohibited transactions, that their IRA's had ceased to be IRA's as of the beginning of 2001, and that their capital gain from the sale of FP Company by the IRA's should've been taxed.

The Tax Court pointed to Internal Revenue Code Section 4975, which prohibits direct and indirect lending of money or extensions of credit between an IRA and its owner.

The Tax Court found that it did not matter if the loan guaranteed by Peek & Fleck was to FP Company and not the IRAs directly. Why? Because IRC Code 4975 clearly prohibits the lending of money or extension of credit between a retirement plan and a disqualified person.
Then Peek & Fleck countered this, claiming that the IRS’s notices issued in 2006 and 2007 were too late because the loan was made in 2001. The IRS disagreed and so did the Tax Court.

The court cited that since the non-recourse loan was ongoing, the prohibited transaction continued and on January 1, 2006 it remained true that both Mr. Peek and Mr. Fleck personally guaranteed the company loan.

Case Outcomes & Summary

The Tax Court found that Mr. Peek, his attorney, and his business colleague's  (Mr. Fleck) personal guarantees of a loan/note from their newly-formed corporation stock of which was owned by Peek & Fleck's Self-Directed IRA's, to third party incident to asset purchase transaction, was an IRC Section 4975 prohibited transaction.

The Court set a precedent, finding that whether or not their IRA's were involved directly was irrelevant since IRC Section 4975 was broadly worded to include both direct and indirect loans and guaranties to IRAs.

What Happened to Peek & Fleck?

The Tax Court found Peek and Fleck liable for a 20% tax penalty because their underpayments of tax were a “substantial understatement of income tax”. But unfortunately for them, that wasn't the worst part.

Most prohibited transactions are resolved with the owner paying a tax, such as UBTI or UBIT. But in this case, because a prohibited transaction occurred between an IRA and its owner, which results in the tax disqualification of the IRA, Peek & Flecks IRAs were disqualified and totally distributed.

What You Can Learn From This Prohibited Transaction Case

The Peek case affirmed that, in the eyes of the Tax Court and the IRS, an IRA holder can legally use retirement funds to invest in a wholly owned entity that is controlled by him or her without triggering the IRA prohibited transaction rules. That entity could be an LLC, to give a clear example.

What was not mentioned above is that Peek & Fleck relied on the advice of a certain CPA, who was also advocating for the transaction, no doubt for personal gain. (Conflict of interest, anyone?)

When it comes to investing with a Self-Directed IRA, you should always seek the help of a professional who knows the ins and outs of the IRS rules so you don't find yourself in a situation like Peek & Fleck.

If you want to learn more about investing with a Self-Directed IRA LLC and how to avoid triggering prohibited transactions, take our Tax Discovery Quiz.

Keep more of your money with a Royal Tax Review

Find out about the tax savings strategies that you can implement as a real estate investor or entrepreneur by taking our Tax Discovery quiz. We'll use this information to prepare to have a productive conversation. At the end of the quiz, you'll have an opportunity to schedule your consultation.    TAKE THE TAX DISCOVERY QUIZ

Are You Eligible For a Solo 401k? What About Your Employees?

Chances are if you're reading this you've probably heard of a solo 401k, which our friends at the IRS call a "one participant 401k." But what about solo 401k eligibility? Before you waste 5 minutes of your life reading my masterpiece, I'd like to let you know: if you're not self employed you aren't eligible for a solo 401k.

I know, some people just got their hearts broken. It'll be okay, trust me. You've got options. And you can read about the Roth IRA and conventional IRAs/401ks from our previous posts on the subjects. Anyway, for those of you who are self employed and interested in learning more about solo 401ks, read on.

Solo 401k Basics

The solo 401k was born out of the Economic Growth and Tax Relief Reconciliation Act of 2001, or EGTRRA. The idea is to give kick-ass entrepreneurs who'd rather work for themselves than "the man" an opportunity for tax-deferred retirement savings.

With that introduction out of the way, you should know there are some limitations to solo 401k eligibility.

What Are The Limitations Of a Solo 401k?

A solo 401k is limited to companies with one employee (you as the owner) although if you have a spouse then he or she can also contribute to the plan. Partners or shareholders can be included in the plan as well.

Your company can have part-time employees who are excluded from the plan, as long as they work less than 1,000 hours a year, or belong to a union or are non resident aliens.

But if your company takes on full time employees who aren't married to you (the boss), then your solo 401k will unfortunately have to be converted to an old-school 401k plan.

The solo 401k plan is available to anyone who is already a business owner or who will be establishing a sole proprietorship and does not have, or plan to have, full time employees.

The solo 401k is great for consultants, freelancers, home businesses, and independent contractors. So now I bet you want to know about the contribution rules huh. As a good host, I must oblige my audience.

Solo 401k Contribution Rules

If you're under the age of 50, you can make a max contribution in the amount of $18,000. This amount can be made before or after tax.

On the profit sharing side, your business can also make a 25% (20% in the case of a sole proprietorship or single member LLC) profit sharing contribution up to $36,000. That comes out to a combined max of $54,000.

Note: If you're over the age of 50, the contributions are the same, except you can contribute $6,000 extra.

The 2 Kinds Of Solo 401k Contributions

The solo 401k plan accepts two types of contributions: salary deferrals and a profit sharing contribution. Both are tax deductible and grow tax-deferred until withdrawals.

You can withdraw money from your solo 401k penalty free after you turn 59 1/2. Withdrawals after age 59 1/2 are taxed as ordinary income. Withdrawals must begin at the age of 70 1/2--but this rule doesn't apply if you go Roth style.

To fund a solo 401k, you can rollover funds from your previous retirement plans, IRAs etc,  by setting up a Trust account for the solo 401k and directly transferring your funds from the old custodian to the trust bank account.

A Trustee needs to be designated to hold the assets of your solo 401k, preferably you. However, if you do serve as Trustee, you cannot legally benefit directly from the trust, enter into a transaction with the trust, or use the trust as your personal fund.

Since a solo 401k is an IRS qualified retirement plan, it has to have a written 401k plan document that establishes the provisions of the plan. It's a lengthy document which will explain how the plan works and operates.

For example, the plan document will explain how you are able to borrow up to 50% or $50,000 (whichever is greater) from your solo 401k tax free, and literally for free. You pay interest, but the interest is paid into your account, so you're really paying yourself.

What Are The Technical Requirements For a Solo 401k Plan?

Great question! To be eligible for a solo 401k plan you must meet two eligibility requirements:

Allow me to explain these two lines in detail.

The Presence of Self Employment Activity

This basically means you should be the owner/operator of one of the following: sole proprietorship, LLC, C Corporation, S Corporation, or Limited Partnership where the business intends to generate revenue for profit and make contributions to the solo 401k plan.

There's no set amount of revenue for profit you should be generating. In most cases the IRS will consider you eligible if your business is legitimate and run with the intention of generating profits. You can be self employed either part time or full time, and even have another job somewhere else.

You can also participate in an employer’s 401k plan alongside your solo 401k. But if you choose to do this, your contribution limits will not be raised. (So a few thousand dollars contributed to your employer 401k will mean a few thousand dollars less you can contribute to your solo 401k.)

The Absence of Full-Time Employees

As you already know, a solo 401k is available to self employed individuals or small business owners who have no other full time employees.

The following types of employees are excluded from solo 401k coverage:

If you have full-time employees age 21 or older (other than your spouse) or part-time employees who work more than 1,000 hours a year, you will have to include them in any plan you set up. You can get around this by employing independent contractors.

Once you have a solo 401k, you'll be able to invest in anything from real estate to cryptocurrency and more!

Everything You Need To Know About IRA & 401k Distributions

Are you ready for the next phase of life? One that leaves the daily grind behind? If you're nearing retirement age, you've been saving for a long time, and now you're getting close to the point where you can start taking distributions (finally).

Let's review everything you need to know about taking a distribution from an IRA or 401(k).

Options For IRA or 401(k) Distributions

When you receive a distribution from a 401k or IRA you should weigh the following tax options:

What Happens When You Take Money Out of Your IRA or 401(k)?

You'd think this would be a no brainer, wouldn't you? You saved up for retirement, now it's time to start receiving it. But it's never simple when the IRS is involved. When you take money out of your IRA or 401K, the following income tax rules apply.

How Are Distributions From a Traditional IRA Taxed?

Distributions from a traditional IRA are taxed as ordinary income, but if you made non-deductible contributions, not all of the distributions will be taxable.

Internal Revenue Code Section 72(t) imposes a tax equal to 10 percent of certain early distributions from IRAs (exclusive of portions considered a return of non-deductible contributions).

The 10% tax, which must be paid in addition to the regular income tax on the distribution, applies to all IRA distributions except the following:

 

Options For Receiving Distributions Before Retiring

The current retirement plan rules discourage taking distributions before retirement. The following are the options you have when receiving a distribution prior to retirement:

As I mentioned above, you can also choose to do forward averaging. But your best bet is to just wait until you reach retirement age.

Clash Of The Titans: IRA Vs 401K

You've probably heard a lot about 401ks and IRAs. But do you know how they compare to each other? More importantly, how do you know which is better for you?

401ks are usually employer-sponsored retirement accounts. Unfortunately, not everyone has access to those. Meanwhile, anyone can open a Roth IRA or Traditional IRA. To get the most benefits possible, you should max out contributions to both accounts if you're able to.

But maxing out both may not be an option for you. So the real question here is, should you contribute to your IRA or 401k first?

I'll give you two answers, one will be a short "quick version" while the other will be a detailed comparison and contrast analysis via chart below (as in, the actual "Clash of the Titans" you came here for.)

Let's start with the quick and dirty version.

The Quick Answer: IRA Vs. 401k

The account you should contribute to first depends heavily on whether your employer offers a 401k with a company match. Scroll to the option that applies to you.

Contribute to your 401k only to the point where your employer will no longer continue matching your contributions. This way, you can get as much free money as possible. Then consider an IRA.

Start with an IRA first. Opening one is free. After contributing up to the limit, contribute to your 401k for the pre tax benefit it offers.

 

A Detailed Comparison of The 401k, Traditional IRA, and Roth IRA: Clash Of The Titans

 

  401k

 

Traditional IRA Roth IRA
contribution limit $18,500 for those under age 50.

$24,500 for those age 50+.

$5,500 as a combined IRA limit. $6,500 for those age 50+.
Pros Employer contribution match. (If offered.)
Higher annual contribution limit.
Contributions lower taxable income in the year they are made.
Eligibility is not limited by income.
Able to borrow up to $50,00 or 50% of your 401k's value, whichever is greater.
Large investment selection.
If deductible, contributions lower taxable income in the year they are made.
Large investment selection.
Qualified withdrawals in retirement are tax free.
Contributions can be withdrawn at any time.
No required minimum distributions when you retire.
Cons No control over plan and investment costs.
Limited investment selection.
Distributions in retirement are taxed as ordinary income, unless a Roth 401k.
Required minimum distributions start at age 70 1/2.
Contribution limits are lower than a 401k.
Deduction phased out at higher incomes if you or your spouse are covered by a workplace retirement account.
Distributions in retirement are taxed as ordinary income.
Required minimum distributions begin at age 70 1/2.
Contribution limits are lower than a 401k.
No immediate tax benefit for contributing.
Ability to contribute is phased out a higher incomes.
Bottom line Fund a 401k first if your company is willing to match your contributions. Fund an IRA first if your 401k doesn't offer a match or if you can't get a 401k.

If you max out your IRA, start funding your 401k. Are you not sure which IRA is best for you?

If you plan on being in a higher tax bracket when you retire, choose a Roth. (Yea. I know that isn't the easiest thing in the world to predict.)

Keep reading to read more useful information about IRAs and 401ks, along with the conclusion to this article. Spoiler alert: we are going to discuss a nontraditional option that you might consider--especially if you're a real estate investor.

  401k Traditional IRA Roth IRA
Tax treatment of contributions Contributions made with pretax dollars, which reduces your taxable income on a dollar for dollar basis. Some employers offer a Roth 401k option, funded with after tax dollars.
Investments in the account grow tax deferred. If Roth 401k, investments grow tax free.
Contributions are deductible. Higher income and participation in a workplace retirement account (for you or your spouse, if married filing jointly) may reduce or eliminate deduction.
Investments in the account grow tax deferred.
Contributions are not deductible.
Investments in the account grow tax free.
Investment options Limited choice of investments.

Some plans have a brokerage option with access to investments outside of the plan.

Any investment available through your account provider (stocks, bonds, mutual funds, etc.).
Taxes on withdrawals after age 59 ½. Distributions are taxed as ordinary income. If Roth 401k, distributions are tax free. Distributions are taxed as ordinary income. Distributions are tax free as long as the account has been open for at least five years.
Early withdrawal rules before age 59 ½. Unless you meet an exception, early withdrawals of contributions and earnings are taxed and subject to a 10% penalty. Unless you meet an exception, early withdrawals of contributions and earnings are taxed and subject to a 10% penalty. Contributions can be withdrawn at any time without taxes or penalties.

Unless you meet an exception, early withdrawals of earnings may be subject to a 10% penalty and income taxes.

Best Practices For Traditional 401ks and IRAs

If you've got enough money, max out both. Otherwise, fund your 401k to the point where you max out your employer contributions for the year, then max out your IRA. And if you have a lot of money to invest, consider establishing a Self Directed IRA LLC.

Note: You may also want to check out our related articles:

What Is a Self-Directed IRA LLC & Should I Get One?

A Self Directed IRA LLC offers the same benefits as a Traditional or Roth IRA, but with even more investment opportunities available for you to choose from, such as real estate, along with asset and liability protection up to one million dollars.

Fair warning though, a Self Directed IRA LLC requires more involvement on your part and is not intended for passive investors. I'll tell you this though. If you're already investing in real estate with your personal funds, there's no reason for you not to get a Self Directed IRA. If you're considering this option, you may find our previous article on investing in real estate with your Self-Directed IRA LLC helpful.

If you still have questions about IRAs, 401ks, or lesser-known retirement options, feel free to ask them below or contact us.

 

Top 10 Self Directed IRA Questions: A Bona-Fide Checklist

You wouldn't believe how many people ask me these questions. Especially number 1 on our list. I can promise you that by the end of this article, you're guaranteed to walk away (or should I say click away?) with new knowledge regardless of your IRA experience level.
Let's dive right into it shall we!

What is a self-directed IRA?

A self-directed IRA is an IRA where the custodian of the account allows the IRA to invest into any investment allowed by law. These investments include: real estate, stock, gold and cryptocurrency, just to name a few.
If you haven't heard about self-directed IRA's before, that's understandable. The main reason most people haven't is large financial institutions who administer most U.S. retirement accounts don’t think it's a good idea to hold real estate or non publicly traded assets in retirement plans.

Can I rollover or transfer my existing retirement account to a self-directed IRA?

I can't blame you for wanting to know, now can I?
The answer to this question is that depends. The chart below can help you determine the answer.

Your Situation: Transfer/Rollover
I have a 401k or other company plan with a current employer. No, in most instances your current employer’s plan will make it impossible until you reach retirement age.
I inherited an IRA and keep the account with a brokerage or bank as an inherited IRA. Yes, you can transfer to a self-directed inherited IRA.
I have a Traditional IRA with a bank or brokerage. Yes, you can transfer to a self-directed IRA.
I have a Roth IRA with a bank or brokerage. Yes, you can transfer to a self-directed Roth IRA.
I have a 403(b) account with a former employer. Yes, you can roll-over to a self-directed IRA.
 
I have a 401k account with a former employer.
 
Yes, you can rollover to a self-directed IRA. If it is a Traditional 401k, it will be a self-directed IRA. If it is a Roth 401k, it will be a self-directed Roth IRA.

 

What can a self-directed IRA invest in?

The most popular self-directed retirement account investments include:

Under current law, a retirement account is only restricted from investing in the following:

What restrictions are there on using a self-directed IRA?

When self-directing your retirement account, you must be aware of the prohibited transaction rules found in IRC 4975. These rules don’t restrict what your account can invest in, but rather, whom your IRA may transact with.
The prohibited transaction rules restrict your retirement account from engaging in a transaction with someone who is a disqualified person to your account. A disqualified person to a retirement account includes: The account owner, their spouse, children, parents, and certain business partners.
So, for example, your retirement account could not buy a rental property that is owned by your father since a purchase of the property would be a transaction with someone who is disqualified to the retirement account (e.g. father). On the other hand, your retirement account could buy a rental property from your cousin, friend, sister, or a random third-party, as they are not disqualified persons.

Can my self-directed IRA invest in my personal business, company, or deal?

No, it would violate the prohibited transaction rules if your IRA transacted with you personally (or with a company you own).

What is a checkbook-control IRA or IRA/LLC?

Many self-directed retirement account owners, particularly those buying real estate, use an  IRA/LLC (aka “checkbook-control IRA”) as the vehicle to hold their retirement account assets.
An IRA/LLC is a special type of LLC, which consists of an IRA (or other retirement account) investing its cash into a newly created LLC. The IRA/LLC is managed by the IRA owner, and the IRA owner then directs the LLC investments and the LLC to take title to the assets. Which pay the expenses to the investment, and receive the income from the investment.
However, there are many restrictions against the IRA owner being the manager (such as not receiving compensation or personal benefit) and many laws to consider. You definitely want to consult with your attorney before establishing an IRA/LLC.

Can my IRA invest cash and can I get a loan to buy real estate with my IRA?

Your IRA can buy real estate using its own cash and a loan/mortgage to acquire the property. Whenever you leverage your IRA with debt, however, you must be aware of two things. First, the loan your IRA obtains must be a non-recourse loan.
A non-recourse loan is made by the lender against the asset, and in the event of default the sole recourse of the lender is to foreclose and take back the asset. The lender cannot pursue the IRA or the IRA owner for any deficiency. Also, your IRA may be subject to a tax known as unrelated debt financed income tax (UDFI/UBIT).

 Are there any tax traps? (UBIT/UBTI)

The Unrelated Business Income tax (UBIT) applies when your IRA receives “unrelated business income.” However, if your IRA receives investment income, then that income is exempt from UBIT tax. Investment income exempt from UBIT includes the following.

 So, make sure your IRA receives investment income as opposed to “business income”.

What is unrelated debt financed income (UDFI)?

If an IRA uses debt to buy an investment, then the income attributable to the debt is subject to UBIT. This income is referred to as “unrelated debt financed income” (UDFI), and it causes UBIT. The most common situation occurs when an IRA buys real estate with a non-recourse loan.
For example, let’s say an IRA buys a rental property for $100,000, and that $40,000 came from the IRA and $60,000 came from a non-recourse loan. The property is now 60% leveraged, and as a result, 60% of the income is not a result of the IRAs investment, but the result of the debt invested.
Because this debt is not retirement plan money, your friends at the IRS require tax to be paid on 60% of the income. So, if there is $10,000 of net rental income on the property then $6000 would be subject to UBIT taxes.

Should I use an individual 401k instead of a self-directed IRA?

This is where things get interesting!
An individual 401k is a great self-directed account option, and can be used instead of an IRA for persons who are self-employed with no other employees (other than business owners and spouses). If you are not self-employed, then the individual 401k will not work in your situation.
An individual 401k is generally a better option for someone who is self-employed and still trying to maximize contributions, as the individual 401k has much higher contribution amounts ($54,000 annually versus $5,500 annually for an IRA).
On the other hand, a self-directed IRA is a better option for someone who has already saved for retirement and who has enough funds in their retirement accounts which can be rolled over and invested via a self-directed IRA as the self-directed IRA is easier and cheaper to establish.
Another consideration in deciding between an individual 401k and a self-directed IRA is whether there will be debt on real estate investments. If there is debt and the account owner is self-employed, they are much better off choosing a individual 401k over an IRA as individual 401ks are exempt from UDFI tax on leveraged real estate.
Congratulations! You made it to the end of this article!
That sure was a lot of information wasn't it? Hopefully this article helped you, and if you have any questions please don't hesitate to ask them.
 

How to Fund Your Business or Start-Up With Self Directed IRA

Do you have a private company or start-up that could use some funding? Maybe you're planning on starting your own soon. Whatever the case is, you're in for some great news!

There are tens of trillions of dollars in retirement plans across the United States. But did you know that these funds can be invested in your business? Yes, it’s true! IRA's and 401k's can be used to invest in start-ups, private companies, and even real estate.

Most entrepreneurs and retirement account owners have no idea that retirement accounts can invest in private companies. And there's a good reason for that. (More on this later.)

And it's not just anyone who owns these retirement funds, it's EVERYONE! Literally. Have you ever asked anyone to invest in your business with their retirement account?

Probably not.

But why not? How much do you think they have in their IRA or old employer 401k and how attached do you think they are to those investments? Think hard on that one.

(The answer is they usually have lots of money and they probably don't even know anything about what it's invested in.)

Those two questions have paved the way for over a billion dollars to be invested in private companies and start-ups!

This kind of funding isn't as uncommon as you might think.

Recent industry surveys show that there are over one million retirement accounts that are self-directed into private companies, real estate, venture capital, private equity, hedge funds, and start-ups.

How does it work?

So now you want to know how these funds are properly invested into your business. Well, if you ask your CPA or lawyer, the typical response is, “It’s possible, but we wouldn't recommend it.” Which probably means they don't know-how.

So they don't know, how about you ask a financial adviser? If you ask a financial adviser, especially your own, they'll tell you it's a bad idea. Most likely because you won't be paying him or her fees like how you do with mutual funds, annuities, and stocks.

There are "different" risks in a private company or start-up investments, so self-directed IRA investors need to be cautious and they shouldn’t invest everything into one private company or start-up. And yes, you will probably need some help regarding the tax and legal issues.

What is a Self Directed IRA?

A self-directed IRA is a retirement account that can be invested into any investment allowed by law. In order to invest in a private company, start-up, or small business, the retirement account holder must have a self-directed IRA. If you have an account with a "typical" IRA or 401k company, such as Vanguard or Ameritrade, then you can only invest in investments allowed under their platform. Usually, these companies won’t allow your IRA or 401k to invest in private companies or start-ups. To do so, you would first need to roll over or transfer the funds to a self-directed IRA custodian.

For a detailed list of the companies that provide these types of accounts, check out the (RITA) Retirement Industry Trust Association’s website and membership list. RITA is the leading national association for the self-directed retirement plan industry.

How to sell corporation stock or LLC units to Self Directed IRA's

Are you seeking capital for your business in exchange for stock or other equity? You might consider offering shares or units in your company to retirement account owners. And no, you don't have to go public. Companies that have had individuals with self-directed IRA's invest in them before they were publicly traded include Google, Facebook, PayPal, Domino’s, Sealy, and Yelp.

There are many investment options available. Popular ones include:

Note: you must comply with state and federal securities laws when raising money from investors.

What You Need to Know: Prohibited Transactions

One of two important things to be aware of when someone invests their retirement account money into your business relates to what they can and can't invest in (prohibited transactions). The tax code restricts an IRA or 401k from transactions with the account owner personally or with certain family members (parents, spouse, kids).

This is called the prohibited transaction rule. If you own a business personally you can’t have your own IRA or your parent's IRA invest into your company to buy your stock or LLC units. However, family members such as siblings, cousins, aunts, and uncles could move their retirement account funds to a self-directed IRA to invest in your company. Anyone else can invest in your company without worrying about that rule.

Note: If a prohibited transaction occurs, the investors self-directed IRA is entirely distributed. Make sure the rules are followed!

What You Need To Know: UBIT Tax

The second thing you need to be aware of is the tax known as Unrelated Business Income Tax (UBIT).

UBIT is a tax that can apply to an IRA when it receives “business” income. Generally, IRAs and 401k's don’t pay tax on the income or gains that go back to the account because they're considered "investment income". Investment income would include rental income, capital gain income, dividend income from a c-corp, interest income, and royalty income. (e.g. income from a mutual fund).

However, when you go outside of these forms of investment, you may find yourself outside of “investment” income. This means you might be receiving “business” income that is subject to the extremely costly “unrelated business income tax.”

This tax rate is at 39.6% at $12,000 of taxable income annually last time I checked. That’s steep. You want to make sure you avoid it.

When should an investor anticipate paying UBIT?

The most common situation where a self-directed IRA will have to pay UBIT is when the IRA invests in an operational business selling goods or services that do not pay corporate income tax.

Let's say you own a new business that sells goods online, and is organized as an LLC and taxed as a partnership. This is a very common form of private business and taxation, but one that will cause UBIT tax for net profits received by self-directed IRA. On the other hand, if your new business was a c-corporation and paid corporate tax (that’s what c-corps do), then the profits to the self-directed IRA would be dividend income, a form of investment income, and UBIT would not apply.

Self-directed IRAs should expect that UBIT will apply when they invest into an operational business that is an LLC but should expect that UBIT will not apply when they invest into an operational business that is a c-corporation.

Note: IRAs can own c-corporation stock, LLC units, LP interest, but they cannot own s-corporation stock.

Are you an LLC wanting to raise capital from other peoples IRA's or 401k's?

You should have a section in your offering documents that notifies people of potential UBIT tax on their investment. UBIT tax doesn’t your company any additional money or tax. But it will cost the retirement account investor since UBIT is paid by the retirement account.
If the investment from the self-directed IRA was via a note or other debt instrument, then the profits to the IRA are simply interest income and that income is always investment income, which is not subject to UBIT tax.

Interestingly, many companies raise capital from IRAs for real estate or equipment purchases. These loans are often secured by the real estate or equipment being purchased and the IRA ends up earning interest income like a private lender.

Recap (because that was a lot!)

So, here’s a brief recap of everything you just read.

Retirement account funds can be a huge source of funding and investment for your business, so it’s worth some time and effort to learn how these funds can be used. Just make sure you follow the rules.

How to Fund Your Business With Self-Directed IRA and 401(k) Money

Do you have a small business or start-up that could use some funding? If so, you're in for some great news!

There's tens of trillions of dollars in retirement plans across the United States. But did you know that these funds can be invested into your business?

IRAs and 401(k)s can be used to invest in startups, private companies, and even real estate.

Most entrepreneurs and retirement account owners have no idea that retirement accounts can invest in private companies. And there's a good reason for that. (More on this later.)

And it's not just anyone who owns these retirement funds, it's EVERYONE! Literally. Have you ever asked anyone to invest in your business with their retirement account?

Probably not.

But why not? How much do you think they have in their IRA or old employer 401(k) and how attached do you think they are to those investments? Think hard on that one.

(The answer is they usually have lots of money and they probably don't even know anything about what it's invested in.)

Those two questions have paved the way for over a billion dollars to be invested in private companies and startups!

This kind of funding isn't as uncommon as you might think. Recent industry surveys show that there are over one million retirement accounts that are self directed. Those accounts invest heavily in private companies, real estate, venture capital, private equity, hedge funds, and start-ups.

How does it work?

So now you want to know how these funds be properly invested into your business. Well, if you ask your CPA or lawyer, the typical response is, “It’s possible, but we wouldn't recommend it.” Which probably means they don't know how.

What about you ask a financial adviser? If you ask a financial adviser, especially your own, they'll tell you it's a bad idea. Most likely because you won't be paying him or her fees like how you do with mutual funds, annuities and stocks.

There are "different" risk in private company or start-up investments, so self directed IRA investors need to be cautious and they shouldn’t invest everything into one private company or start-up. And yes, you will probably need some help regarding the tax and legal issues.

What is a Self Directed IRA?

A self directed IRA is a retirement account that can be invested into any investment allowed by law. In order to invest into a private company, start-up, or small business, the retirement account holder must have a self directed IRA.

If you have an account with a "typical" IRA or 401(k) company, such as Vanguard or Ameritrade, then you can only invest in investments allowed under their platform.

Usually these companies won’t allow your IRA or 401(k) to invest in private companies or start-ups. To do so, you would first need to rollover or transfer the funds to a self directed IRA.

For a detailed list of the companies that provide these types of accounts, check out the (RITA) Retirement Industry Trust Association’s website and membership list. RITA is the leading nationwide association for the self directed retirement plan industry.

How to sell corporation stock or LLC units to Self Directed IRAs

Are you seeking capital for your business in exchange for stock or other equity? You might consider offering shares or units in your company to retirement account owners. And no, you don't have to go public.

Companies who have had individuals with self directed IRAs invest in them before they were publicly traded include: Google, Facebook, PayPal, Domino’s, Sealy and Yelp.

There are many investment options available. Popular ones include:

Note: you must comply with state and federal securities laws when raising money from investors.

What You Need to Know: Prohibited Transactions

One of two important things to be aware of when someone invest their retirement account money into your business relates to what they can and can't invest in (prohibited transactions).

The tax code restricts an IRA or 401(k) from transactions with the account owner personally or with certain family members (parents, spouse, kids).

This is called the prohibited transaction rule. If you own a business personally you can’t have your own IRA or your parents IRA invest into your company to buy your stock or LLC units.

However, family members such as siblings, cousins, aunts and uncles could move their retirement account funds to a self directed IRA to invest in your company. Anyone else can invest into your company without worrying about that rule.Note: If a prohibited transaction occurs, the investors self directed IRA is entirely distributed. Make sure the rules are followed!

What You Need To Know: UBIT Tax

The second thing you need to be aware of is the tax known as Unrelated Business Income tax (UBIT). UBIT is a tax that can apply to an IRA when it receives “business” income. Generally, IRAs and 401(K)s don’t pay tax on the income or gains that go back to the account because they're considered "investment income".

Investment income would include rental income, capital gain income, dividend income from a c-corp, interest income, and royalty income. (e.g. income from a mutual fund).

However, when you go outside of these forms of investment, you may find yourself outside of “investment” income. Which means you might be receiving “business” income that is subject to the extremely costly “unrelated business income tax.”

This tax rate is at 39.6% at $12,000 of taxable income annually last time I checked. That’s steep. You want to make sure you avoid it.

When should an investor anticipate paying UBIT?

The most common situation where a self directed IRA will have to pay UBIT is when the IRA invests into an operational business selling goods or services who does not pay corporate income tax.

Let's say you own a new business that sells goods online, and is organized as an LLC and taxed as a partnership. This is a very common form of private business and taxation, but one that will cause UBIT tax for net profits received by self directed IRA.

On the other hand, if your new business was a c-corporation and paid corporate tax (that’s what c-corps do), then the profits to the self directed IRA would be dividend income, a form of investment income, and UBIT would not apply.

Self directed IRAs should expect that UBIT will apply when they invest into an operational business that is an LLC, but should expect that UBIT will not apply when they invest into an operational business that is a c-corporation.
Note: IRAs can own c-corporation stock, LLC units, LP interest, but they cannot own s-corporation stock.

Are you an LLC wanting to raise capital?

You should have a section in your offering documents that notifies people of potential UBIT tax on their investment. UBIT tax doesn’t your company any additional money or tax. But it will costs the retirement account investor since UBIT is paid by the retirement account.

If the investment from the self directed IRA was via a note or other debt instrument, then the profits to the IRA are simply interest income and that income is always investment income, which is not subject to UBIT tax.

Interestingly, many companies raise capital from IRAs for real estate or equipment purchases. These loans are often secured by the real estate or equipment being purchased and the IRA ends up earning interest income like a private lender.

Recap (because that was a lot!)

So, here’s a brief recap of everything you just read.

The bottom line

Retirement account funds can be a huge source of funding and investment for your business, so it’s worth some time and effort to learn how these funds can be used. Just make sure you follow the rules.

The Not-So-Well-Known Benefits of Roth IRAs

Many investors and financial professionals are familiar with the primary benefits of a Roth IRA: that after you pay taxes on the money going into the Roth IRA that the plans investments grow tax free and come out tax free.  That being said, there are so many more benefits to the Roth IRA that need to be noted. I’ll note just three.

Benefit #1: Roth IRAs are not subject to RMD.

Traditional retirement plan owners are subject to regulations known as Required Minimum Distribution rules which require the account owner to start taking distributions and paying tax on the distributions (since traditional plan) when the account owner reaches the age of 70 ½. Not being subject to RMD rules allows the Roth IRA to keep accumulating tax free income (free of capital gain or other taxes on its investment returns) and allows the account to continue to accumulate tax free income during the account owner’s life time.

Benefit #1: Your Roth IRA Can Outlive You

A surviving spouse who is the beneficiary of a Roth IRA can continue contributing to that Roth IRA or combine that Roth IRA into their own Roth IRA.  Allowing the spouse beneficiary to take over the account allows additional tax free growth on investments in the Roth IRA account. A traditional IRA on the other had cannot be merged into an IRA of the surviving spouse nor can the surviving beneficiary spouse make additional contributions to this account.
Non spouse beneficiaries (e.g. children of Roth IRA owner) cannot make additional contributions to the inherited Roth IRA and cannot combine it with their own Roth IRA account. The non-spouse beneficiary becomes subject to required minimum distribution rules but can delay out required distributions up to 5 years from the year of the Roth IRA account owner’s death and is able to continue to keep the tax free return treatment of the retirement account for 5 years after the death of the owner. The second option for non-spouse beneficiaries is to take withdrawals of the account over the life time expectancy of the beneficiary (the younger the beneficiary the longer they can delay taking money out of the Roth IRA). The lifetime expectancy option is usually the best option for a non-spouse beneficiary to keep as much money in the Roth IRA for tax free returns and growth.

Benefit #3: Roth IRAs Don't Have Early Withdrawal Penalties

Roth IRA owners are not subject to the 10% early withdrawal penalty for distributions they take before age 59 ½ on amounts that are comprised of contributions or conversions. Growth and earning are subject to the early withdrawal penalty and to taxes too but you can always take out the amounts you contributed to your Roth IRA or the amounts that you converted without paying taxes or penalties (note that conversions have a 5 year wait period before you can take out funds penalty and tax free).
Roth IRAs are a great tool for many investors. Keep in mind that there are qualification rules to being eligible for a Roth IRA that leave out many high income individuals. However, you can convert your traditional retirement plan dollars to a Roth IRA (sometimes known as a backdoor Roth IRA) as the conversion rules do not have an income qualification level requirement on converted amounts to Roth IRAs. This conversion option has in essence made Roth IRAs available to everyone regardless of income.
 

RMD Penalty Waiver: Using The 5329 Form For a Missed IRA Required Minimum Distribution

With all due respect to any financial masochists in the audience, nobody derives pleasure from paying taxes. But it's kind of part of the deal of living and working in the United States.

You have to pay Uncle Sam, and he's not about to start making exceptions for the money from your IRA. One of the requirements of IRA accounts is that you will have to take a Required Minimum Distribution eventually. Failure to do so  is something Uncle Sam frowns upon. In fact, he dislikes it so much that he'll send his minions to hit you with a massive 50% penalty.

The penalty is 50% on the amount you should have distributed from your IRA to yourself. This is tremendously annoying to a person who has otherwise been fiscally responsible, because they are essentially being punished for failure to pay themselves. From their own IRA. You know, the kind of account most of us save into for all of our working lives.

The irony of this situation is lost on nobody, but with that massive of a threat hanging over your head, you should know how to avoid it.

So, if you've been hit with the 50% penalty, don't throw yourself a pity party just yet. There’s some good news about how you can possibly get a RMD penalty waiver.

Steps To Getting the RMD Penalty Waived

In the event that you failed to take RMD for your IRA, you may be able to get a waiver for the penalty if you admit the mistake to the IRS by submitting the forms we'll talk about below (See Steps 2 and 3).  We all know Uncle Sam loves his paperwork, and yes, I'm telling you that you can possibly get back in his good graces with his favorite thing: more paperwork!

Fortunately, it's not an overwhelming amount of paperwork, especially for what you stand to gain (or more accurately, not lose). I'll describe the process in two simple steps, laid out in plain English.

Step #1: Take The RMD

Even if you know fully well that you intended to dodge the RMD, you're going to have to correct the "error" to get any sympathy from Uncle Sam. Better late than never. But you want to get this first step knocked out as expeditiously as you can, so you can move on to the super fun forms in Step #2.

Step #2: Complete Section IX Of Form 5329.

First, you'll need to say what you should have taken as an RMD. Using this number, you will calculate the penalty tax due. It's okay if you're not a math whiz—use a calculator

Now scroll down to Line 52. Here, you will need to put the letters "RC" next to the exact dollar amount you are requesting to have waived.

Step #3:  Attach a Missed RMD Letter of Explanation

Your statement of explanation will need to hit on two key points. The first thing you need to explain is the “reasonable error” that caused you not to take RMD. The IRS does not provide a precise definition or clear-cut circumstances for “reasonable error."  However, one expert I consulted with the IRS told me the IRS does respond well to oversights in a broad variety of situations where they can be persuaded the error was unintentional or otherwise not your fault.

Since these categories are vague, let's look at circumstances or situations that have worked for other taxpayers in this situation.  

Examples include suffering from a mental illness or falling victim to a damaging health situation or equally legitimate reason that may have stopped you from filing accurately.  If you've reached the age of 70 ½ years, or are new to taking RMDs, or fail to understand the requirement, these can also serve you. Other clients have succeeded in receiving waivers based on taking bad recommendations from a professional they had entrusted to help them, such as an advisor, custodian or accountant.

If one or more of these situations apply to you, list any and all of them. The IRS, despite its hawkish reputation, does certainly respond to logic and, if you're lucky, with empathy.

The second thing you need to explain is the reasonable steps you took or intend to take in the immediate future to remedy the mistake you made.

Showing Good Faith Gets You The Waiver

By the time you’re filing the exemption request, you want to have already contacted your IRA custodian. If you haven't by this point, be sure to do so before you file. This way, you can take the late RMD (see: Step 1). This means that as soon as you submit the RMD penalty tax waiver, you would be caught up and would have already remedied the error. Showing good faith is more likely to get you the waiver you need.

You can contact the IRS's Taxpayer Advocate Office as well for assistance following these steps, as well as more specific advice regarding your individual situation.

Keep in mind that RMD failures won’t go away. Uncle Sam is like an elephant: he never forgets. Sooner or later you’ll start getting collection letters from the IRS requesting the 50% penalty tax. The best way out of it is to get as ahead of it as you possibly can. You should correct your RMD failure, request the waiver, and fill out all of the necessary paperwork as soon as you learn of the looming problem.

This is especially if you have an inherited Roth IRA, as those withdrawals would ordinarily be totally tax-free! 

Conclusion

If you’ve been hit with a 50% penalty don’t panic. You may be able to get a waiver for the penalty if you admit the mistake to the IRS by filing a 5329. Come clean. Throw yourself at the mercy of the court.

You’re going to have to write a Statement of Explanation that outlines:

  1. What makes your error “reasonable,” such as mental health issues or bad advice from a bad advisor. The IRS is, at times, capable of compassion.
  2. The process you are planning to take, or have taken, to correct the error. If you’re on top of things, you’ve already taken the missed RMD. This makes everything clean, from your explanation for the error, to the enemy’s acceptance of your reasonable explanation.

Keep in mind that RMD failures don’t disappear. The IRS is a relentless, greedy machine. They WILL get their money. Get your error fixed!

Hopefully your panic level has dropped by now. The above is a simple, clear explanation of what steps you’re going to take. Essentially, your explanation will be that you already corrected the RMD failure as quickly as you could upon learning of the error.

If you are the beneficiary of an inherited IRA, check out our article, Calculating RMD For An Inherited IRA.

 

 

How The IRS Can Take Your IRA Money: Taxes and Distributions

You're probably already aware of some of the countless ways the IRS tries to get your money. Here in the land of the free and the IRS, we all are. Let's talk about how you can give them less and pocket more using your IRA.

How Uncle Sam Gets Your IRA Money: Taxes and Distributions

Consider the main ways the IRS gets its hands on your IRA's dollars.

As a result, any money distributed from your 401k to you will be reduced by 20%. That 20% will be sent to the IRS in expectation of the taxes that will be due from you come time for distribution.

However, any money distributed from an IRA is not subject to the 20% withholding as you can opt-out of withholding. This legit loophole is just one of the advantages of using an IRA in retirement instead of a 401k. What this means is the money distributed from an IRA can be received by you in full.

Remember, the tax owed on a distribution from an IRA or 401k is identical. The difference between the two is when you are required to pay the IRS. Regardless of which you use, you will receive a 1099-R from your custodian/administrator. But in the 401k distribution, you are required to set aside and effectively pre-pay the taxes owed.

Example of Bypassing Withholding Tax on your IRA/401k

Okay so, what is the use of information if you never learn how to apply it. (College anyone?) Let’s walk through a common situation to illustrate the above information you just learned.

John is 65 years old and has successfully grown his 401k to a nice amount. He's decided to retire (finally) and enjoy his life the way it was meant to be, on a beach somewhere. He wants to take $500,000 from his 401k. He contacts his 401k administrator and is told that on a $500,000 distribution they will send him $400,000 and that $100,000 will have to be sent to the IRS for him to cover the 20% withholding requirement.

But wait. John just read this article, he knows that the 20% withholding requirement does not apply to IRAs. John decides to rollover/transfer the $500,000 from his 401k directly to an IRA.

Once the funds arrive at his IRA, John takes the $500,000 distribution from the IRA.  There is no 20% withholding tax so he actually receives $500,000 in total. John will still owe taxes on the $500,000 distribution from the IRA and he will receive a 1099-R to include on his tax return.

All in all, John has given himself the ability to access all of the money distributed for his retirement account without the need for sending money to the IRS at the time of distribution.

There you have it, folks. Don’t take distributions from a 401k and then voluntarily donate money to the IRS when you can roll over/transfer those 401k funds to an IRA and receive all of your money without a 20% withholding.

For more information on making your retirement dollars work harder for you, contact us with any questions. Feel free to look around at our many other articles on 401ks, IRAs, the self-directed IRA LLC, and of course, the mighty Roth IRA. Which choices will be best for you depends on many factors, but you can save a lot of time and money by getting advice from our legal and tax experts. Take our tax discovery quiz and schedule your personal retirement consultation today, and live large in the long run.

How To Buy Your Retirement Home Ahead Of Time Using A Self Directed IRA

Chances are you've been steadily growing your IRA for quite some time. Did you know that you can buy a retirement home with a Self Directed IRA (SDIRA)?

Yep, it's true. But there are a few things you need to know first.

If you have any other IRA besides a SDIRA, you can only hold investments. You can't just go buy a home with your IRA and live there. However, with a SDIRA, you can buy an "investment property", which you can later distribute and use personally.

Let's break this strategy down.

Steps To Using a Self-Directed IRA to Buy a Retirement Home

If you are seriously interested in using your SDIRA to purchase a retirement home, then know that it works in two phases.

First, your IRA purchases the property and owns it as an investment until you decide to retire. (You need an SDIRA for this.) Second, upon your retirement (after age 59 ½), you can distribute the property via a title transfer from your SDIRA a regular IRA. This allows you to personally use the home and benefit from it personally. Before you go out and buy your future retirement home, you should consider a couple of factors.

Avoid Prohibited Transactions

Be careful to avoid those dreadful "prohibited transactions". The rules in place currently do not allow you, the IRA owner, or certain family members to have any use or benefit from the property while it is owned by the IRA.

The IRA must hold the property strictly for investment. The property may be leased to unrelated third parties, but it cannot be leased or used by the IRA owner or prohibited family members (kids, siblings, parents, etc). Only after the property has been distributed from the self-directed IRA to the IRA owner may the IRA owner or family members reside at or benefit from the property.

You Must Distribute The Property Fully Before Personal Use

The property must be distributed from the IRA to the IRA owner before the IRA owner or his/her family may use the property. Distribution of the property from the IRA to the IRA owner is called an “in kind” distribution, and results in taxes due for traditional IRAs.

For traditional IRAs, the custodian of the IRA will require a professional appraisal of the property before allowing the property to be distributed to the IRA owner. The fair market value of the property is then used to set the value of the distribution.

For example, if your IRA owned a future retirement home that was appraised at $250,000, upon distribution of this property from your IRA (after age 59 ½) You would receive a 1099-R for $250,000 issued from your IRA custodian to you.

One of the drawbacks of this strategy is that distribution taxes can be high. You might prefer to take partial distributions of the property over time, holding a portion of the property personally and a portion still in the IRA to spread out the tax consequences of distribution.

However, that would be a tiresome process, as you would have to appraisals each year to set the fair market valuation. While this can lessen the tax burden by keeping you in lower tax brackets, you and your family still cannot personally use or benefit from the property until it is entirely distributed from your IRA.

Bottom Line: Play By The Rules With Your Self-Directed IRA

Remember that you should wait until after you turn 59 ½ before taking the property as a distribution, as there is an early withdrawal penalty of 10% for distributions before age 59 ½.

While this strategy is possible, it is not for everyone and certainly is not easy to accomplish. Few things worth doing in life are. SDIRA investments come with rules, and self-directed IRA investors should make sure they understand those rules. Remember, you can't use your retirement home for personal use until after its been distributed and you may or may not end up paying lots of taxes.

How To Get Out Of The Annuity You Bought With Your IRA

Did your adviser tell you how great annuities are, and how they can guarantee a life time of income for you and your spouse? Yep, they tell everyone that. But the truth is, most people eventually want to learn how to get out of an annuity.

Ways to Get Out of an Annuity

After you've retired and decided your annuity isn't as great as you thought it would be, there is a good chance you will ask these three questions:

  1. What's an annuity? (It's okay, most people don't know.)
  2. Can I cancel it and get my money back to invest in something else?
  3. Are there any penalties if I cancel? If so, how do I get around them?

Most people who own an annuity with an IRA are seeking to use those retirement plan dollars in a new investment opportunity with the goal of increasing returns. However, getting rid of an annuity owned by your IRA isn’t as easy as selling a mutual fund or stock investment.
Let's begin with the big questions here, the ones you already asked by being interested in this article. But first thing's first. Let's define annuities.

What is an Annuity?

The annuity you own is a contract with an insurance company. By signing this contract you agreed to either invest a lump sum or a series of payments with an insurance company.
In doing so, the insurance company agrees to pay a specific amount of money to you over your life. There are many variations of annuities. But the simple explanation is you give up money now to an insurance company and they promise to pay you money later. The longer you wait to get paid the more they will pay you later.

Can I Cancel My Annuity and Get My Money Back?

You can cancel your annuity, but you may be subject to a surrender penalty. Unfortunately there is usually no way around this penalty. Most annuities have a surrender penalty where you, the owner of the annuity, get penalized for requesting a return of the investment within a certain period of years of the initial investment.
This time period is known as the "surrender period". The surrender penalty on a 10 year surrender time period is usually 10% and decreases by 1% each year thereafter until it goes to zero after 10 years.
For example, if you invested a lump sum of $150,000 into an annuity and one year later (in year 2) you wanted to get your entire $150,000 back, you would be subject to a 9% surrender penalty of $13,500.
You would get back $136,500, but would forfeit the rest. Some penalty schedules are worse than others and they all vary. The surrender schedule is in your annuity contract documents and can also be requested at any time from the company holding your annuity.

How Do I Avoid Paying Taxes When Cancelling My Annuity?

Once you cancel an annuity owned by your IRA, the funds need to stay within your IRA in order to avoid taxes and penalties from your friends at the IRS. You can request the annuity company to transfer the IRA annuity cash balance over to a new IRA custodian of your choosing. Most investors find self-directed IRA the best method for this.
Once you’ve taken these steps, you’re retirement plan funds will be in an IRA and available to invest in stock, cryptocurrency, (link to cryptocurrency article here, "internal" links improve SEO) real estate, mutual funds, bonds and all other investments available to IRA holders.
If you have any questions about your annuity, please don't hesitate to ask me personally. You can reach out in the comments or contact me directly. I'd love to help! If you're ready to get out of your annuity, learn more about your retirement planning options, or take your retirement investments to the next level, schedule your consultation today.
 
 
 

Your Quick Fix: Self-Directed IRA Benefits & 2017 Contribution Limits

 For 2017, the IRA contribution limits will remain the same as 2016.  This means the following is true for individuals:

Let's look at some quick tips about the Self-Directed IRA LLC and contributions.

Take Control of Your Retirement Account: The Self-Directed IRA LLC

A Self-Directed IRA LLC will offer you the ability to make tax free investments without custodian consent.
Think of a Self-Directed IRA LLC as a special purpose limited liability company that is created, owned and managed 100% by you. Or someone else, if you choose.
The advantage of using an LLC to make the investment is that an LLC is treated as a pass-through entity for tax purposes, meaning you, the owner of the LLC, would be subject to the tax and not the LLC itself.
In most cases, all income and gains generated by the IRA LLC would flow back to the IRA tax free. Also, the LLC allows you to keep IRA funds in your LLC bank account, instead of with a far away custodian. For you that means greater flexibility and less delays when it comes to investing.

You Can Invest in Anything

With a Self-Directed IRA LLC, you will be able to invest in almost any type of investment opportunity that you discover, including: domestic or foreign real estate (rentals, foreclosures, raw land, tax liens etc.), private businesses, precious metals (i.e. gold or silver), hard money & peer to peer lending, as well as stock and mutual funds.
Your only limit is your imagination. The income and gains from these investments will flow back into your IRA tax free.

Quick List of Self-Directed IRA LLC Benefits

When you get a Self-Directed IRA LLC:

If you have any questions about Self-Directed IRA LLCs, you can always ask in the comments below, or contact us directly. We're here to help you.
 

7 Benefits Of The Self-Directed IRA

The benefits of the self-directed IRA include absolute freedom & control to decide how you invest and what you invest in. When you think about it, this is a privilege the average investor lacks.

IRA stands for Individual Retirement Account, and it's a great way to save for your retirement. A lot of people think an IRA itself is an investment - but it's just the vehicle in which you keep stocks, bonds, mutual funds and other assets. A self-directed individual retirement account (SDIRA) is a special IRA that can hold a variety of investments types normally prohibited from regular IRAs.

While there are many advantages to this powerful investment tool, we've taken the time to list some of our favorites. Below you can read about the top seven exclusive & cost effective benefits of the self-directed IRA LLC.

Benefit #1: Tax Advantages

With a self-directed IRA LLC, you have all the tax advantages of traditional IRAs, as well as tax deferral and tax free gains. All income and gains generated by your IRA investment will flow back to your IRA tax free.
What this means is that you'll experience tax free growth.

Instead of paying tax on the returns from your investments, tax is paid only at a later date when a distribution is taken, leaving your investment to grow tax free.

Benefit #2: Investment & Diversification Benefits

What about self-directed IRA real estate? Your choices include real estate & private business entities. Once again, you can do this tax free.This will also enable you to build a solid portfolio that'll generate beefy returns in both good times and bad times.

Benefit #3: Access

The benefits of the self-directed IRA LLC include having direct access to your IRA funds. This  allows you to make an investment quickly and efficiently. There is no need to obtain approvals or send money to an IRA custodian.

Benefit #4: Speed 

With a self-directed IRA LLC, whenever you find an investment that you want to make with your IRA funds, simply write a check or wire the funds straight from your LLC bank account to make the investment. Other retirement accounts usually have to talk with their custodian first, which can cause a delay.

Benefit #5: Lower Fees

Another advantage to a self-directed IRA LLC account is that you can save a lot of money on custodian fees.
You will not be required to pay custodian transaction fees and account valuation fees. (Which can add up to be thousands of dollars over the years.)

Benefit #6: Limited Liability

By using a self-directed IRA LLC, your IRA will benefit from the limited liability protection afforded by using an LLC. With an LLC, all your IRA assets held outside the LLC will be "shielded" from attack.

This is especially important in the case of IRA real estate investments. This is an area where many state statutes impose an extended statute of limitation for claims arising from defects in the design or construction of improvements to real estate.

Benefit #7: Asset & Creditor Protection

By using this distinct category of retirement account, you will be protected for up to $1 million in the case of personal bankruptcy. Most states will also protect a SDIRA from creditors.

The Bottom Line: The Self-Directed IRA Makes Sense

The self-directed IRA LLC is like an IRA on steroids. If you want to take control of your finances, consider this legal entity for your real estate investments (or other assets).
 

Can Your IRA Invest In & Own Bitcoin and Other Cryptocurrencies?

Yes, your IRA can invest in and own bitcoin and other cryptocurrencies. Bitcoin is a form of virtual currency using blockchain technology. Bitcoin can be exchanged between people for goods, services and of course, dollars.
From 2011 to September 2017, the value of Bitcoin has risen from $0.30 per Bitcoin to a shocking $3,772 per Bitcoin. As a result, investors are beginning to seriously consider whether their retirement account can invest in and own actual Bitcoin or other forms of cryptocurrency. Maybe you are too, now that you just read that. I can't blame you.

Can Your IRA Own Bitcoin?

Yes! Your IRA can own Bitcoin and other forms of cryptocurrencies, such as Ethereum and Litecoin. The only items your IRA cannot invest in is life insurance, S-Corp stock and collectibles.

How Are Bitcoin Gains Taxed?

The IRS has stated that Bitcoin and other forms of virtual currency are property. The sale of property by an IRA is generally treated as capital gain, so the buying and selling of cryptocurrency for investment purposes wouldn’t trigger unrelated business income tax (UBIT) or other adverse tax consequences that can occasionally arise in an IRA.

3 Steps To Owning Cryptocurrency With Your IRA.

  1. First, you will need a self directed IRA with a custodian who allows for alternative assets, such as LLC's.
  2. Second, you will invest funds from the IRA into the LLC. Your IRA will own an LLC 100%, and that LLC will have a business checking account.
  3. And third, the IRA/LLC will use its LLC business checking account to establish a "wallet" to invest and own Bitcoin through the wallet. The most widely used Bitcoin wallet is through a company called Coinbase. You can use a wallet on Coinbase to buy, sell and digitally store your cryptocurrency.

There are already publicly traded funds and other avenues (Bitcoin Trusts) where you can own shares of a fund that in turn owns Bitcoin. But, if you want to own Bitcoin directly with your IRA, you’d need to follow the steps above.
Don't underestimate Bitcoin and other forms of cryptocurrency. You're living in the digital age now. Cryptocurrencies have great potential, as of this writing one Bitcoin is worth $3,772 , almost triple that of an ounce of gold. Times change.
However, as with any new investment, make sure you proceed with caution. Who knows, by the time you read this article, Bitcoin could be worth nothing, or it could be well on its way to being the "currency of the future". Just to give you an idea, the value of Bitcoin is about as volatile as a Dutch Tulip...(pictured below, click the link if you don't know about "tulip mania")
 
 

Solo 401k Plan Roth Contributions: Frequently Asked Questions

The short answer is yes. Your Solo 401k does allow for Roth contributions.

You can choose to treat contributions under your plan which would otherwise be "elective deferrals" as designated Roth contributions. In this context, an “elective deferral” is an employer contribution to your 401k plan which is excluded from your gross income.

An elective deferral is instead a designated Roth contribution if you “designate” it as not being excludable. Your designated Roth contributions for any year may not exceed the maximum amount of elective deferrals that could be excluded from gross income.

All About the Roth IRA: A Hybrid Account

The Roth "sub-account" of the Solo 401K Plan is a hybrid of sorts. Although it is technically a type of 401k plan, it has some of the features of a Roth IRA. Only after-tax salary deferral contributions may be deposited in the Roth 401k sub-account.

No employer contributions and no pretax employee contributions are permitted. The entire account will contain only after-tax contributions from your salary plus pretax earnings on those contributions.

Note: Because the Roth 401k is actually just part of a regular 401k plan, most of the rules that apply to a regular 401k plan also apply to a Roth 401k plan, including the contribution limits.

Can a Roth 401k Plan Exist On Its Own?

We wish! Unfortunately, the answer is no. A Roth 401k plan is only available as an option that can be added to a traditional 401k.

When Are Roth 401k Distributions Taxable?

Distributions from a designated Roth account are excluded from gross income if they are:

However, the exclusion is denied if the distribution takes place within five years after your first designated Roth contribution to the account from which the distribution is received. Or if the account contains a rollover from another designated Roth account, to the other account.

Other distributions from a designated Roth account are excluded from gross income under Internal Revenue Code 72 only to the extent they consist of designated Roth contributions and are taxable to the extent they consist of trust earnings credited to the account.

Can I Convert a Traditional 401k Plan to a Roth 401k Plan?

Yes, you can. The Small Business Jobs Act of 2010, signed by then-President Obama contains a provision, which went to effect on Sept. 27, 2010. This provision allows for the conversion of a traditional 401k or 403b account to a Roth in the same plan if their employer offers one.

However, you must pay income tax on the amount converted. Let's take a look at 3 important criteria below that need to be satisfied in order for you to reap all the benefits of a Roth 401k:

All income and gains from your Roth 401k plan investment would be tax free!

Can I Rollover the Roth 401k Plan to a Roth IRA?

Yes. You are permitted to roll over your Roth 401k plan assets into a Roth IRA. Your assets can be transferred via a direct rollover, which will avoid mandatory income tax withholdings.

Can I Rollover a Roth IRA to a Roth 401k Plan?

No. But you can rollover assets from a Roth 401k to a Roth IRA. (Basically, you can't do the reverse.)

How Are Distributions From Roth 401ks Taxed?

 All distributions from Roth 401k's are either qualified distributions or non-qualified distributions.

Also, because all qualified distributions from Roth 401ks are tax-free, they are also exempt from the early distribution tax as well.

What is a "Qualified Distribution?"

A “qualified distribution” from a Roth IRA is excluded from gross income. To be qualified, a distribution must satisfy both of the following requirements:

Are You Required to Take Distributions From Your Roth 401k?

Yes, the required distribution rules that force you to begin taking money out of your retirement plans and Traditional IRAs during your lifetime also apply to Roth 401k.
If you have leftover money in your Roth 401k after your death, the distributions will be directed to your beneficiaries.
Note: The rules for a Roth 401k plan are different from those for a Roth IRA. If you have a Roth 401k, you must begin taking distributions from the account when you reach age 70 and 1/2, or after you retire, whichever comes first.

How Should a Solo 401k Plan Trustee Administer a Plan With Roth Contributions?

A trustee of a Solo 401k plan with a qualified Roth contribution program must establish separate accounts including only designated Roth contributions and “earnings properly [allocated] to the contributions”.

Also, the plan administrator must maintain separate records for these accounts.

Since distributions from accounts containing elective deferrals are included in the distributees' gross income, while distributions from accounts containing designated Roth contributions are generally excluded from gross income, an employee's designated Roth contributions cannot be grouped with elective deferrals.

Note: Forfeitures may not be allocated to Roth accounts.

That's all for our FAQ on the Roth option. If you have any questions about your Solo 401k plan, take our financial freedom quiz now. We're happy to help with any concerns you may have.

A Beginner's Guide to Investing With Your Self-Directed IRA LLC

When it comes to making investments with a self-directed IRA LLC, the IRS doesn't tell you what you can invest in. What's funny is they only what you can't invest in. They made a few rules about the subject. These include prohibited transactions, and a series of other regulations.

What You Can't Do With Your Self-Directed IRA LLC

Besides the Prohibited Transaction rules, the IRS imposes a levy or tax on certain transactions involving IRA funds.
Let's say you use IRA funds to invest in an active business. Active businesses include restaurants, stores, and factories  operated through a pass through entity such as an LLC.
They could also be operating through nonrecourse financing, such as a nonrecourse loan or margin in a stock or trading account. In any case, a percentage of net profits or income generated by that activity could be subject to a tax.
The tax imposed is often referred to as Unrelated Business Taxable Income or UBIT/UBTI.  The UBTI rules are outlined in Internal Revenue Code Sections 512-514. For your convenience, we've broken down what self-directed investors should know about UBTI/UBIT in a separate article.

UBTI Taxes: What You Should Understand as a Self-Directed Investor

The reason the UBTI tax rules do not impact most retirement investors, is that Internal Revenue Code Section 512(b) provides a general exemption for the following categories of income generated by a retirement account:

Since the majority of retirement investors purchase publicly traded company stock, which is exempted from the UBTI tax, the UBTI tax rules are not widely known.
When it comes to investing in options with a self-directed IRA LLC, the question then becomes whether the investment would trigger the UBTI rules. This brings us to a fan-favorite UBTI exempt investment: stock options.

Avoiding UBTI When Investing in Options With Your Self-Directed IRA 

An option is a contract that gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a specific price on or before a certain date.
An option, just like a stock or bond, is a security. It is also a binding contract with strictly defined terms and properties.
According to the IRS, any gain from the lapse or termination of options to buy or sell securities is excluded from unrelated business taxable income.
Note: The exclusion is not available if the organization is engaged in the trade or business of writing options or if the options are held by the organization as inventory or for sale to customers in the ordinary course of a trade or business.
If option trading is not being done as an active trade or business, then using a self-directed IRA LLC to invest in options would not trigger the UBTI tax rules.

Learn More About Your IRA Investment Options From the Pros

Congratulations, you're on your way to a happier and more comfortable retirement.
If you have any more questions, fire them away in the comments below, or check out our other free resources about self-directed IRAs. You can also contact Royal Legal Solutions directly or explore our Self-Directed IRA LLC service. We'd love to help you!
 

Penalties For Prohibited Transaction With A Self-Directed IRA LLC or Roth IRA

You may already be aware of the many rules and penalties your friends at the IRS have when it comes to prohibited transactions. The penalty tax for prohibited transactions begins at 15% for most type of retirement plans.
But wait, there's more!
For those of us trying to pay less taxes by going the self directed route it comes as no surprise that the IRS has harsher penalties for self-directed IRAs who engage in prohibited transactions.
Here we go.

What happens when an IRA owner or beneficiary engages in a prohibited transaction?

 When a self-directed IRA or Roth IRA owner or beneficiary is involved in a transaction that is deemed prohibited pursuant to Internal Revenue Code Section 4975, pursuant to Internal Revenue Code Section 408(e), the IRA loses its tax-exempt status.

Also, the IRA holder (or beneficiary) is treated for tax purposes to have received a distribution on the first day of the tax year in which the prohibited transaction occurred.

The distribution amount that the IRA holder is deemed to have received is equal to the fair market value of the IRA as of the first day of such tax year, and is required to be included in the IRA holder’s income for the year.

Additionally, unless the IRA holder qualified for an exception to the early distribution penalty (i.e. over the age of 591/2, disabled, etc.), the 10% early distribution penalty would also apply. (Ouch!)

Summary of the above.

If you own an IRA or are a beneficiary of one, and you engage in a transaction that violates the prohibited transaction rules, your IRA will lose its tax exempt status. The entire fair market value of the IRA will also be treated as taxable distribution, subject to ordinary income tax.
 Note: You would also be subject to a 15% penalty as well as a 10% early distribution penalty if you're under the age of 59 and a half.

What happens if a non-IRA owner or non-IRA beneficiary engages in a prohibited transaction Under IRC 4975?

In the case where someone other than the IRA holder or IRA beneficiary (for example, another disqualified person) engages in a prohibited transaction, that disqualified person may be liable for certain penalties.
In general, a 15% penalty is imposed on the amount of the prohibited transaction and a 100% additional penalty could be imposed if the transaction is not corrected.
Note: fiduciaries to an IRA or plan are not subject to the 15% or 100% additional penalty.

What are the penalties for engaging in a prohibited transaction under internal revenue code section 408? (Yes, more sections!)

The penalty for engaging in an Internal Revenue Code Section 408 prohibited transaction differs from the Internal Revenue Code Section 4975 penalty. (Your friends at the IRS have many, many penalties dear reader.)
If an IRA assets are invested in collectibles or life insurance, only the assets used to purchase the investment are considered distributed, not the entire IRA.

In addition, pledging an IRA as a security for a loan is a prohibited transaction under Internal Revenue Code Section 408(e)(4). If an IRA holder pledges a portion of his or her as security for a loan, only the amount pledged is deemed distributed – not the entire IRA.

IRS penalties can be costly.

The prohibited transaction rules are extremely broad and the penalties extremely harsh. (Instant disbandment of your entire IRA plus a penalty fee.)

So yes, anyone using a self-directed IRA should be cautious in engaging in transactions that would anger their friends at the IRS, because angering them could cost you big time.

The New Real Estate IRA LLC

You can invest your money using a variety of cost effective methods. But if you already invest or are considering investing heavily in real estate, it's in your best interest to get a Real Estate IRA LLC.

What Is a Real Estate IRA LLC?

A Real Estate IRA LLC, AKA a Self-Directed IRA LLC, is an IRS and tax court approved structure that allows you to use your IRA funds to purchase real estate, or make almost any other type of investment, tax free.

With a Real Estate IRA LLC you will never have to seek the consent of a custodian to make a real estate investment or be subject to costly custodian account fees.

To establish a Real Estate IRA LLC, first you need to have an IRA. Then you establish an LLC which is owned by the IRA, which is in turn owned by you. The passive custodian then transfers your funds to the new IRA LLC bank account.

How Do I Buy Real Estate With My Real Estate IRA LLC?

When you find a real estate investment that you want to make with your IRA funds, simply write a check or wire the funds straight from your Self-Directed IRA LLC bank account to make the investment.

The Self Directed IRA LLC allows you to eliminate the delays associated with an IRA custodian, enabling you to act quickly when the right real estate investment opportunity presents itself.

This setup also gives you a great advantage when it comes to making real estate or tax liens investments, since custodian delays could cause you to lose an investment opportunity.

Real Estate Is an IRS-Approved Investment

 Investments with a Real Estate IRA are allowed under the Employee Retirement Income Security Act of 1974 (ERISA). IRS rules permit you to engage in almost any type of real estate investment, except from any investment involving a disqualified person.

Note: Disqualified persons are usually limited to your close family members, such as your parents and children.

What Types of Real Estate Investments Can I Make With a Real Estate IRA LLC?

With a Self-Directed IRA LLC you will have the ability to invest in almost any type of real estate investment, such as:

  1. Foreclosure property
  2. Condos or coops
  3. Mortgages
  4. Mortgage pools
  5. Deeds
  6. Farm land
  7. Tax liens
  8. Residential or commercial real estate
  9. Domestic real estate
  10. Foreign real estate
  11. Raw land
  12. Vacation homes
  13. Rental units

A Real Estate IRA LLC Offers You Growth Potential

A Self-Directed Real Estate IRA LLC offers you the opportunity to greatly accelerate the growth of your retirement portfolio. With a Real Estate IRA LLC you can take advantage of the high growth real estate investment sector while benefitting from the tax free IRA benefits.
Investing in real estate is a formidable alternative to the stock market. Why? Because real estate properties can provide steady income as well as long term gains through appreciation.  There are no limitations on the types of properties that can be held by a Real Estate IRA LLC.

Establish Your Real Estate IRA LLC While The Market is Investor-Friendly

You're no doubt well aware of how the residential and commercial real estate market has taken a dramatic downturn due to the subprime mortgage meltdown.

While it’s a bad real estate market for current owners and landlords, on the flip side it's a great investment market for real estate investors with capital. Also, the Real Estate IRA LLC is perfect for any person looking to diversify their retirement funds by investing in the high growth real estate market.

You Have Leverage With Your Real Estate IRA LLC

The Real Estate IRA LLC can be used when making a real estate investment using cash, or may be used when using a non-recourse loan to fund an investment. A non-recourse loan is the only type of loan allowed for a Self-Directed IRA.

A nonrecourse loan is a secured loan which is secured by a pledge of collateral, but for which the borrower is not personally liable. Whereas, a recourse loan is a loan for which the borrower is personally liable. Recourse loans are no permitted when using IRA funds.
 

Note: If non-recourse funds are used as leverage, the debt-financed portion of your investment will likely trigger the UDFI tax.

Opening a Real Estate IRA LLC Is Quick and Easy.

Royal Legal Solutions will take care of setting up your entire Real Estate IRA LLC structure. The whole process can be handled by phone, email, or mail, typically taking 2 weeks or less. The amount of time it takes to setup largely depends on the state you choose to form the IRA in and your current custodian.

Setting Up Your Real Estate IRA LLC: A Step By Step Guide

 

Step 1: Establish Your Account

Your Self-Directed IRA account is established with an IRS approved and FDIC backed passive custodian.

Step 2: Transfer Your Funds

Your retirement funds are transferred to the new Self-Directed IRA account tax free.

Step 3: Form Your LLC

A Limited Liability Company (LLC) is formed with you as the owner.

Step 4: Fund Your LLC

You decide what to invest in, and the passive custodian invests the IRA funds into the newly formed IRA LLC.
Note: One or more IRAs can be used to fund the IRA LLC, including Traditional, Roth, and SEP IRAs.

Step 5: Take Control

You direct the IRA funds held in the new LLC bank account for investment as you see fit.

Step 6: Invest

 Your LLC makes a real estate investment using IRA funds and all income and gains generally flow back to the LLC tax-free!

Learn More About Royal Legal Solutions' Real Estate IRA LLC 

If you still have questions about the Real Estate IRA LLC, contact us today. We're happy to help.
 

The Solo 401k Vs SEP IRA For Self-Employed Retirement Planning

Solo 401ks and SEP IRAs have both been around for awhile now. Previously, SEP IRAs were considered better only because they had lower administration cost and fees.

However, in recent years, competition among brokerages has made administration cost and fees much lower for Solo 401ks. Most brokerages no longer have fees, aside from for the initial setup.

This means that you, the self-employed business owner or real estate investor, are able to choose the retirement plan that's best for you based solely on the merits. Let's take a look at each.

What Is a Solo 401k Plan?

A Solo 401k plan is an IRS-approved retirement plan, which is suited for business owners who do not have any employees. These include consultants, freelancers, yoga instructors, Uber drivers ... and of course our favorite clients: real estate investors.

The Solo 401k, as its name implies, is a plan designed for one person who is a business owner. You can include your spouse on the plan if you have one. For example, a Solo 401k Plan allows you and your spouse to contribute a combined $60,000 annually.

Note: If you REALLY want to learn everything there is to know about the self-directed Solo 401(k), join our Tax, Legal, & Asset Protection Secrets For Real Estate Investors Facebook Group. Once you're in, go to "Units" and look for the Solo 401(k) Unit, where you'll find the "Know More Than Your Attorney" book by Scott Smith. It's 117 pages and nearly 40,000 words but designed to be skimmable so you can find exactly what you're looking for.

9 Reasons Why a Solo 401k is Better For Self-Employed Business Owners Than a SEP IRA 

1. You can open a Solo 401k at any bank.

With a Solo 401k, the 401k bank account can be opened at any local bank or trust company. However, in the case of a Simplified Employee Pension (SEP) IRA, a custodian is required to hold the IRA funds, which will eat into your bottom line whether your investments gain or lose.

2. Roth features are available.

A Solo 401k plan contribution can be made in pre-tax or Roth (after-tax) format. In the case of an SEP IRA, contributions can only be made in pre-tax format.

3. No annual paperwork.

With a Solo 401k, there is no annual paperwork required if your plan has less than $250,000 in plan assets.

4. You can use non-recourse leverage tax free.

With a Solo 401k Plan, you can make a real estate investment using non-recourse funds without triggering the Unrelated Debt Financed Income Rules and the Unrelated Business Taxable Income (UBTI or UBIT) tax.

However, the non-recourse leverage exception is only applicable to 401k qualified retirement plans and does not apply to IRAs. In other words, using a SEP IRA to make a real estate investment involving non-recourse financing would trigger the UBTI tax.

5. You can reach your maximum contribution limit quicker.

A Solo 401k includes both an employee and profit sharing contribution option, whereas, a SEP IRA is purely a profit sharing plan. Business owners with a Solo 401k plan can contribute to their plan both as owners and employees in two ways:

  1. Elective deferrals up to 100% of compensation (“earned income” in the case of a self-employed individual) up to the annual contribution limit:
    • $18,000 in 2016 and 2017, or $24,000 in 2016 and 2017 if age 50 or over.
  2. Employer non-elective contributions up to:
    • 25% of compensation as defined by the plan.

Note: Total contributions cannot exceed $54,000 unless catch up contributions are used by those over age 50.

6. You don't need an LLC.

With a Solo 401k Plan, the plan itself can make real estate and other investments without the need for an LLC.
Since a 401k plan is a trust, you can be the trustee on behalf of the trust and can take title to a real estate asset without the need for an LLC.

7. Better creditor protection.

 A Solo 401k Plan offers you greater creditor protection than a SEP IRA. The 2005 Bankruptcy Act protects all 401k Plan assets from creditor attack in a bankruptcy proceeding.

8. Tax free loan option.

With a Solo 401K Plan you can borrow up to $50,000 or 50% of your account value in the form of a loan for any purpose. If you tried to borrow money using a SEP IRA, it would be considered a prohibited transaction.

9. No catch up contributions.

Catch-up contributions allow you to make larger contributions than normal if you qualify. SEP IRA's do not allow for catch-up contributions.

With a Solo 401k Plan you can make a contribution of up to $54,000 to the plan each tax year ($60,000 if the participant is over the age of 50).

The Drawback of a Solo 401k

The only drawback to a Solo 401k is that there is slightly more paperwork required to initially set one up than a SEP IRA.

But investing requires more than just money, it also requires time. So what if a Solo 401k takes an extra hour or two to set up? That's time well spent.

Contact us or explore our Solo 401k offering if you're interested in learning more about a Solo 401k plan.