Charitable giving is a popular strategy among the wealthy for diminishing their tax payments. But this strategy doesn't just have to be for the Michael Dells and Kim Kardashians of the world. Wouldn't you like to reduce your taxable income and save money too?
Intelligent real estate investors, just like you, can use charitable giving too. But even savvy investors don't always know that they can make charitable gifts from retirement accounts.
The funds in IRAs and 401ks are among the most heavily taxed that the average investor will hold. Whether you want to donate money from your 401(k) to a cause close to your heart, save on your taxes or both, this article is for you. Read on to learn more about your options for giving charitable gifts with your Self-Directed 401(k).
Why You Should Designate Your Retirement Funds for Charitable Giving
Ultimately, it would be best to consider designating your retirement fund for charitable giving to reduce your taxable income and save money. The tax break is why many highly wealthy individuals donate in large quantities. Sure, many of them may be philanthropic at heart, but there is also a distinct tax advantage to making donations. The higher your taxable income, the greater your tax responsibilities when Uncle Sam comes to extract his pound of flesh and collect tax bills.
Giving to charity also qualifies you to receive a Charitable Gift Tax Credit. Anyone can take advantage of this deduction. Generally, the credit is figured by taking the market value of an item or the actual amount of cash donated, then subtracting the percentage of your tax bracket.
This strategy can lead to thousands returning to your pocket. Of course, there are limits: you cannot donate more than half of your income in a given year. Similarly, for these benefits to apply, you must itemize each donation.
What Options You Have for Giving to Charity
Some of these may already be familiar to you. Others are less obvious. Here are some, but not all, of the many methods you can use to donate funds to a charitable cause:
⦁ Real Property Gifts (includes real estate, stocks, etc.)
⦁ Trusts (Charitable Remainder Trusts, Charitable Lead Trusts, and more)
⦁ Charitable Sales (purchases will benefit a charitable organization or purpose)
⦁ Deferred or Traditional Charitable Annuities (the donor receives a tax deduction and a fixed income for the remainder of their life)
⦁ Life Estate Gifts (allows donors to claim a charitable deduction for the remainder value of real property donated to charity)
⦁ Retirement Plan Asset Gifts (passes the retirement plan assets to a charity)
⦁ Life Insurance Gifts (name the charity as a beneficiary, and it may reduce the donor's taxable estate)
Which Options Are the Most Beneficial?
Life estate gifts, retirement plan asset gifts, and life insurance gifts are the most beneficial options.
While any of the previously mentioned options are undoubtedly beneficial and generous, intelligent investors may be wondering which will benefit their bottom lines. You may be surprised to learn that the final items on the list are among your most robust and lesser-known gift choices.
Many potential donors do not know much about life insurance or retirement plan asset gifts simply because charities are less likely to request them. Many nonprofit organizations need immediate cash that these donations do not address. They are nonetheless useful for the organizations--and you.
Ways to Give to Charity from Your 401(k)
Option 1: Donate Directly from the Plan
You can liquidate an asset (or several) held by your plan, then directly donate the funds to the nonprofit group or cause of your choosing.
Option 2: Name a Charity as a Beneficiary of Your Plan
Naming the charity of your choice as a beneficiary works the same way as designating any other beneficiary. However, this option has the advantage of allowing plan funds to pass through to the charitable organization completely tax-free. If you have tax-deferred funds, this is a more intelligent expense than passing those same funds on to your heirs. Your heirs would have to pay the taxes, but the charity does not.
Key Takeaways for Effective Retirement Planning and Charitable Giving
Charitable giving is a popular and effective strategy to reduce your taxable income and save you money. One strategy that most people don't know about is the ability to make charitable gifts from retirement accounts.
It would help if you considered giving to charity from your retirement account for the following reasons:
Reduce your taxable income
Receive a Charitable Gift Tax Credit
Pay less in taxes
The tax benefits of charitable giving are multiple. It may result in you pocketing cash when tax season rolls around.
You have a lot of options available to you, but one of the most beneficial options is to give from your 401(k) by:
Donating directly from the plan
Naming a charity as your beneficiary
This strategy will reduce the tax burden on your estate and may save your heirs a hefty tax bill down the line.
Do you want to learn more about charitable giving or other strategic plays that may be useful to you? Join us and learn more! Register for your FREE Royal Investing Group Mentoring Wednesdays at 12:30 pm EST.
Invest in Carbon Credits to Diversify Your Portfolio
One area of investing that has taken off in the last few years is socially aware investing due to the dual influences of the environmental movement and the sustainability movement. Most people don't think of carbon emissions as an investment, but they are. And this is accomplished when you invest in carbon credits.
In this article, we will cover:
What are carbon credits?
Why should I invest in carbon credits?
How can I invest in carbon credits?
What do you predict for the carbon credit market?
What Are Carbon Credits?
A carbon credit is a bit like a stock certificate. It represents a certain amount of carbon emissions, for instance, one metric ton of carbon emissions. A company that emits a lot of carbon during its business process can offset its carbon output by purchasing carbon credits. If the company emits 30 metric tons of carbon, they buy 30 carbon credits to counteract this. This investment in carbon credits has become so common now that carbon credits are routinely traded in major markets worldwide.
Let's look at this a little bit more. Carbon credits are a function of the government's "cap and trade" policies. The "cap" refers to the amount of carbon emission (in metric tons) a company can produce as a part of its normal business process. The "trade" refers to the number of carbon credits a company is allowed to buy or sell to bring its carbon emissions under the "cap."
If you decide to invest in carbon credits, remember the market is relatively new. Still, it is a market that represents tens of billions of dollars per year and is growing. Environmental regulations on companies increase every year, and carbon credits have become the default mechanism for adhering to these regulations.
For instance, when Ford Motor Company is building cars, their factories emit a lot of carbon. The government allows Ford a certain amount of carbon pollution. If the carmaker goes over that allotment, it needs to purchase carbon credits to offset its overages.
Investing in carbon credits is attractive because the number of existing credits is relatively fixed; it's not infinite. There is a limited supply, but not limited demand.
Therefore, it's not just companies that can profit (by balancing their carbon emissions). There are also many opportunities for investors to benefit from this area. There are a few different ways to do this.
How Can I Invest In Carbon Credits?
One straightforward way is to invest in companies that trade carbon credits as part of their everyday business. Companies that have announced that they're going to become 'carbon negative,' such as Boeing, need to contract a certain amount of carbon offset credits to achieve these goals. Some companies, such as Shell, directly buy and sell carbon credits with other companies as a trading profit center.
Another mechanism is to invest in carbon credits through an exchange-traded fund (ETF). This investment pool tracks the performance of the assets that comprise it. For example, the QQQ exchange-traded fund mirrors the S&P 500's performance. There are existing ETFs benchmarked to different carbon indexes that track the performance of carbon credit-related futures contracts. ETF such as these commonly returned double-digits in 2021.
Probably the most active market for carbon credits exists in the futures market. Much as you can trade corn, gold, or hog bellies in the futures market, you can also trade carbon credits. This market is more complex, but returns can be much higher in the futures markets because you can use leverage. There are lots of risks and lots of potential rewards.
As with any investment, there is risk involved. There is some risk in investing in carbon credits through the aforementioned vehicles. Remember that investing in carbon credits is a very specialized and targeted investment. It does not by any means represent a diversified investment, but what it does represent is an asset class for an overall portfolio.
This particular investment is attractive because it is new and growing at a tremendous rate. Institutions at first did not invest in carbon credits; now, they do.
What Do You Predict For The Carbon Credit Market?
Here's where things get interesting:
Of the world's 20 largest countries that emit the bulk of the carbon, 19 of them have set a "date certain" for when their net emissions will reach 0. Hitting that goal means subsidizing lower emission activities, taxing higher emissions, or simply banning some activities. Essentially carbon credits are a "tax" on higher emission activities. Offsetting emissions with cash is the path most countries and companies will use to hit their emission targets.
Worldwide accounting standards will soon have standardized metrics for measuring carbon emissions. The new metrics will create explicit standardized targets that companies and countries must follow. It's the same principle that currently has oil trading settled in dollars. It's a standard. And the accounting of carbon credits will soon be standardized.
As more and more companies deal with the reality of reducing their carbon footprint, the easiest way for them to accomplish this reduction is to trade carbon credits. After all, it's much easier to pay a tax than shut down a factory or retool a factory to produce fewer emissions. Carbon credits are taxes in the form of a tradable asset.
The emerging asset invites speculation into the market as hedge funds and other portfolio managers invest in carbon credits. Since the number of carbon credits is limited, higher demand will create higher prices. Suppose a portfolio manager looks at a company and realizes that it has not set aside enough money to pay for its carbon credit targets. In that case, that portfolio manager can go for "long" carbon credits.
Or, more deviously, they could "short" carbon credits. A short squeeze would occur if companies went into the market and realized there weren't enough carbon credits to buy at their intended price. The companies would have to buy at any cost. In this scenario, the price of carbon credits could go parabolic. A short squeeze on carbon credits is inevitable at some point.
In 2021 we witnessed short squeezes in several stocks that caused prices to go straight up. There's no reason this cannot happen in the carbon credits market because:
able to be shorted
itis a tradeable
is a liquid investment with a limited supply
Carbon credits act just like stocks.
There's more potential for upside in carbon credits than in many other investments because governmental and institutional pressure drives the need for these carbon credits. It's artificial, but that doesn't mean that demand doesn't exist. It does exist and provides much of the momentum for rising carbon credit prices.
The opportunity to invest in carbon credits is relatively new and not very well understood. Hopefully, the discussion we had in this article gives you some actionable advice.
In this article, we:
defined carbon credits
explained why you might invest in carbon credits
predicted what the future may be for carbon credits
The market is not well known and relatively new.
Still, credit carbon investments will be part of any portfolio that follows the "prudent man" rule sooner rather than later. Being early will be much better than being late in this particular investment.
Do you still have questions? We have experts ready with answers. Join a community of like-minded investors. Register for your FREE Royal Investing Group Mentoring Wednesdays at 12:30 pm EST to learn more.
Year-End Tax Preparation: What You Need to Know
Are you ready for year-end tax preparation?
It's hard to believe that there are only a few days left between you and 2022. As 2021 ends and you forge your path forward into 2022, you must undertake some housekeeping to close out 2021 and start 2022 in the best position possible as a real estate investor.
As a real estate investor, it might not seem that there is much to do. However, each year, you need to assess your plans, goals, and the state of your investments. Before the year closes out, make sure to go over this essential end-of-year checklist.
To prepare for tax season, we strongly suggest you:
Organize your tax documents (this saves time and money)
Optimize your end of year deductions
Prepare your LLC for taxes
Read below to find out the best ways to accomplish the preceding tasks.
#1 Organize Your Tax Documents for Year-End Tax Preparation
You want to make sure you prepare everything for filing. Tax day seems far off in the distance, but April 15th comes fast in reality. As a result, it's never too early to get your documents in order.
Right now is the optimal time for real estate investors to collect all documents related to filing taxes. Some things you can do to make this process easier includes:
Meet with your CPA
Ask questions and clarify misconceptions
Discuss tax breaks
Ensuring that you have all your taxes settled ahead of time reduces stress and allows you to move past the financial commitments of 2021 and focus on growing your business in 2022.
Paper receipts can be burdensome, so it might be easier to pull out your bank records and highlight all your expenses. Some apps make tracking expenses more manageable. We like Expensify.
#2 Optimize End of Year Deductions for Year-End Tax Preparation
You plan on growing your business in 2022. One way to maximize your deductions is to purchase business vehicles and additional assets. Then you can schedule business meetings. Then, claim them as expenses on 2021's taxes.
As the year ends, you want to recheck your deductions to get your taxable income as close to zero as possible. One of the ways to lower your tax responsibility is to file deductions. You can file deductions on:
Being a real estate investor comes with plenty of tax deductions. The following list is not comprehensive but provides you with some ideas of what you can deduct in addition to the standard deduction:
Theft/Damage to real estate properties
Repairs and maintenance for your rental properties
Utilities (if you pay for them without reimbursement)
Property management fees
Real estate insurance
Tenant credit reports and background checks
It's hard to maximize your profit if it's getting eaten up by all the sales, properties, federal income, and state income taxes you must pay. As a savvy real estate investor, you need to finesse your documentation and deductions and realize the benefits of being a landlord.
An easy way to make sure that you are optimizing your end-of-year deduction is through Royal Legal Solutions' Peace of Mind Program. We hold all your tax accountability through the program, work with your account executive and CPA to maximize deductions, and shelter your assets.
Contact [email protected] to learn more about how the Peace of Mind Program will protect you and your assets.
#3 Prepare Your LLC for Tax Season
As a real estate investor, you know the importance of having your assets protected by an LLC. Depending on where you do business, having an LLC means paying a yearly franchise tax.
The franchise tax is a required fee that your LLC pays for the right to do business in any given state. This tax is separate from other federal or state income taxes required by government entities.
Franchise taxes are required:
regardless of profit
based on the state in which you do business
In addition to franchise tax considerations, as an LLC owner, you will want to:
adjust your operating agreement if you changed business partners
collect LLC Minutes
prepare tax documents
protect newly acquired assets with current or new LLC
When you began your real estate investing journey, you had a set of goals in mind. Now is the time to revisit those goals, assess your performance, and make needed adjustments to accomplish your goals.
As you enter the new year, you should focus on growing your business. That means putting 2021 tax burdens behind you. Make sure you finish 2021 strong by having a clear and detailed plan where you:
Organize tax documents
Optimize your LLC
A solid plan in place will allow you to earn more and grow your real estate portfolio.
To learn about powerful tax savings strategies that you can use to keep more of your earnings, book a tax consultation by taking our tax quiz. The information you provide will enable us to have a productive discussion the first time that we speak.
Why The Self-Directed IRA LLC Means You Don't Have To Pay IRA Custodian Fees
A Self-Directed IRA LLC is an IRS-approved tax structure that allows you to personally manage your retirement account without having to pay a custodian. It also offers several other benefits, such as ease of access and tax-free profits.
Self Directed IRA LLCs vs. Traditional IRAs
A Self-Directed IRA LLC allows you to take control of your retirement by giving you the ability to invest in anything you want. Except collectibles, such as art. The best part is, you won't have to ask a custodian for consent or pay any custodian fees.
With a traditional IRA, you must go through a custodian when you wish to make investments using your retirement funds, which often triggers high custodian fees and transaction delays.
With a Self-Directed IRA LLC, a special purpose limited liability company (“LLC”) is established that is owned by the IRA and managed by you or any third-party. As manager of the IRA LLC, you will have total control over the IRA assets to make the investments you want and understand – not just investments forced upon you by Wall Street.
Not THAT kind of custodian ...
A Self-Directed IRA LLC Gives You Control of Your Retirement
With a Self-Directed IRA LLC, you will have total control to make any approved investment, including a real estate purchase. You can even pay for improvements and then sell the property without ever talking to the IRA LLC custodian.
Since all your IRA funds will be held at a local bank in the name of the Self-Directed IRA LLC, all you would need to do to engage in a real estate transaction or other investment is write a check straight from the IRA LLC account or simply wire the funds from the IRA LLC bank account.
No longer will you need to ask an IRA custodian for permission or have the IRA custodian sign the real estate transaction documents. You will be able to make investments by simply writing a check.
With a Self-Directed IRA LLC you will never have to seek the consent of a custodian to make an investment or be subject to excessive custodian account fees based on account value and per transaction.
Self-Directed IRA LLC Benefits
#1 Invest in real estate & much more tax-free
With a Self-Directed IRA LLC, you will be able to invest in almost any type of investment opportunity, including real estate, tax free.
#2 Virtually no IRA custodian fees
With a Self-Directed IRA LLC you no longer have to pay excessive custodian fees based on account value and transaction fees. Instead, with a Self-Directed IRA LLC, you keep your money with a passive Self-Directed IRA custodian, often a bank.
Think of the passive custodian as a piggy bank for your Self-Directed IRA LLC. Whenever you need money for an investment, you just go to the piggy bank. You can write a check. You don't actually have to go or speak to your passive custodian.
#3 Tax deferral
With the Self-Directed IRA LLC structure, all income and gains from IRA investments will flow back to your Self-Directed IRA LLC tax free.
An LLC is treated as a pass-through entity for federal income tax purposes and your IRA, as the member of the LLC, is a tax exempt party. Which means all income and gains of the LLC will be tax free.
A Self-Directed IRA LLC allows you to enjoy many more advantages, including the following:
Better protect your retirement assets from a falling stock market or against inflation.
Make a real estate or other investment by simply writing a check( Truly it is that easy.)
Generate profits tax free when you use the same Self-Directed IRA LLC to purchase domestic and foreign real estate, private mortgages, gold and stocks, bonds and mutual funds inside the same plan.
Buy your future retirement home or vacation property now at today’s prices, rent it out, and then move in at the age of 59 and 1/2!
Diversify your retirement portfolio and invest in almost any type of investment tax free.
Take control of your retirement funds and hold them at a local bank or credit union.
Purchase real estate foreclosures and tax liens on the spot, or make personal loans by simply writing a check and generate profits tax-free.
To learn more Royal Legal Solutions' IRA LLC custodian services, call us now at (512) 757–3994 or start with our investor quiz and we'll take it from there.
Business Trusts: Your Key to Greater Control Over Your Investment Accounts
Business trusts can allow you to safely and inexpensively manage your Self-Directed IRA (SDIRA).
With typical IRAs, you’re at the mercy of the "custodian" (the financial institution that manages your investment). With a Self-Directed IRA business trust or LLC, you get access to different types of alternative investments (including real estate), that you otherwise wouldn’t be able to purchase with those funds.
So the SDIRA grants you the "checkbook control" you need, which means more direct authority and oversight over the investment and management decisions regarding the funds held in your retirement account.
With a business trust, there are even more benefits, as we'll see ...
LLC filing fees vary by state, but most states charge anywhere between $50-800 for annual filing fees and reports, creating an additional and unnecessary expense.
The states with the highest annual LLC filing fees are:
Washington DC ($300)
That’s not to mention the initial filing fee cost, which averages anywhere from $100-200. If you ignore or forget to pay your fees, your LLC gets shut down. If you’re managing a lot of money in that LLC, this could cause even bigger issues.
For Self-Directed IRA investors, business trusts offer the same checkbook control with fewer annual fees. That means a lower cost and generally less upkeep. A California business trust, for example, would save you $800 a year right off the bat (and an additional $70 if you count the initial filing fee). Instead, you could pay nothing annually.
But that isn’t the only benefit trusts afford you...
LLCs Can’t Offer the Same Level of Anonymity
Additionally, business trusts go beyond the protections afforded to you by an LLC. They don’t require that you file publicly. When you form an LLC, the Articles of Organization, along with your name and address as the trustee of that LLC, must be filed with your Secretary of State.
Business trusts don’t have that same requirement, giving you an additional layer of anonymity and asset protection in the event of a lawsuit. If the litigators can’t find who owns the trust, they can’t sue that person.
Finally, business trusts can be more tax-efficient than LLCs. A business trust is considered a “disregarded entity” separate from its owner. That’s also true for LLCs—but there’s a key distinction: even if you file taxes as a partnership, most states require LLCs to file income taxes. If you choose to use an LLC, that’s an additional headache.
This also ties in with the anonymity. Business trusts don’t have to be filed publicly, they don’t have to be updated annually with any reports, and they don’t have to report income taxes. If you use them to shield your Self-Directed IRA, you’re protecting against legal trouble to the greatest possible extent while minimizing costs.
What Can You Hold in a Self Directed IRA Business Trust?
To give you an idea of the types of assets that you could invest in with your retirement funds using a business trust, here’s a short list:
Silver and Gold
Tax lien certificates
However, just because you have access to more investments doesn’t mean there aren’t rules to what you’re allowed to do and what you aren’t allowed to do. We actually have a specific list of prohibited transactions.
For one, you aren’t allowed to self-deal in any way. If you want to buy a vacation home using your Self-Directed IRA, that’s prohibited. The investment can’t serve you, and you aren’t allowed to work on it yourself. If you choose to purchase a fixer-upper, you also need to hire contractors for that fixer-upper. DIY is expressly prohibited.
Your Key to Greater Control Over Your Investment Accounts
Here are some of the biggest takeaways from this article:
Both LLCs and business trusts give you an additional layer of asset protection.
Business trusts can save you money by cutting back on annual fees. Unlike a Traditional LLC, there is no registered agent, no franchise taxes, and no yearly fees.
They offer the same checkbook control as self-directed IRA LLCs with even more protection. They’re relatively simple to set up and there’s no legal requirement for you to publicly file your business trust, offering you additional anonymity.
You can use either a business trust or LLC to separate your personal assets from the holdings in either entity, protecting them in the event that you get sued.
How Does A Reverse Mortgage Work?
Actor Tom Selleck (Magnum, P.I.) is the latest celebrity shilling for them on television.
Maybe you have an older family member or neighbor who has gotten a phone call from a financial institution offering them.
But what are reverse mortgages and how do they work?
If you are a senior homeowner with most of your net worth tied up in your home, these loans can sound pretty appealing. If you're a real estate investor, you may be wondering if you can use a reverse mortgage to your advantage.
In this article, we'll explain what a reverse mortgage is, the pros and cons this cashflow option can offer to some older Americans, and how you can decide if it's right for your financial strategy now or in the future.
WHAT IS A REVERSE MORTGAGE?
A reverse mortgage is a type of federally insured loan available to Americans age 62 and over. It gets its name because it works in the opposite way as a standard home loan.
With a regular mortgage, the bank gives you a lump sum that you pay back with interest over a set period of time.
With a reverse mortgage, the lender makes payments to YOU based on the equity you have built in your home. You have the option of receiving monthly payments, a lump sum, a line of credit, or a combination of the different options.
Over time, the amount you owe in interest and fees on the loan grows while your home equity declines. You retain the title to your home, and the balance isn't due until you or your heirs sell your home.
WHO QUALIFIES FOR A REVERSE MORTGAGE?
Reverse mortgages are only available to a specific set of homeowners. In order to qualify for a reverse mortgage, you must:
be at least 62 years old
own the home outright or have built up a considerable amount of equity in the home
live in the home as your principal residence
not be delinquent on any federal debt
be current on property taxes, insurance, and any homeowners' association fees
pass a credit check
complete counseling session about reverse mortgages from an approved counselor
Reverse mortgage loan values may be influenced by the home's value, how much equity is in the house, and other factors. And older borrowers are eligible for greater total loan amounts because age directly correlates with limits.
WHAT ARE THE ADVANTAGES OF A REVERSE MORTGAGE?
With life expectancy in the U.S. growing closer to 80 years, many Americans are outliving their personal retirement savings. As a result, they may be unprepared for the rising cost of living and the mounting medical expenses that often accompany aging.
Reverse mortgages are ideal for older homeowners who may not have much in the way of savings or investments but who have built up wealth in their homes. In other words, this type of loan allows you to turn an otherwise illiquid asset into a liquid asset without having to move out of your home.
Whether they're living with the results of an investment gone awry or the difficulties of a fixed income, any senior with cash flow issues may want to consider a reverse mortgage.
Here are some of the other attractive features of these home loans.
FLEXIBLE LENDING OPTIONS
This type of loan offers flexible disbursement options, meaning you can borrow only the amount you need. Investors may choose to accept the loan as a single lump sum, in monthly installments, or even as a line of credit. This amount of control the borrower has in this regard is greater than most loans.
If your need is more about your long-term budget, try to put a number on what you need for, say, one year. This amount will help you and anyone helping with your financial planning determine what a conservative loan amount for you might be.
MORE CASH ON HAND
For some cash-strapped retirees, a reverse mortgage allows them to remain in their long-time homes without having to downsize. Some borrowers even use the proceeds of a reverse mortgage to pay off their existing home loan.
You can use the money from your reverse mortgage for any purpose, including:
Paying off other debts
Investing in mortgage notes
Taking a bucket list trip
Investing in assisted living facilities
Acquiring investment property
Starting a charitable trust
We'll discuss below why you'll need to account for reverse mortgages in your estate plan. However, if you just want to live out your golden years comfortably, you can do so and even plan to pay off your mortgage at the same time.
Lock In the Value Of Your Home
If we've learned anything about the economy in recent years, it's that anything can happen. If for whatever reason, the value of your home ends up being less than the amount owed on the reverse mortgage, you are protected. In practical terms, that means, if home prices fall in your area, you or your heirs won't have to worry about paying the balance.
The reverse mortgage has an interesting set of rules regarding interest. On the plus side, you're not charged interest while you continue to live in the reverse-mortgaged home as your primary residence. Interest is also capped on the first $100,000 worth of debt.
NO TAX LIABILITY
The IRS considers the funds you receive from a reverse mortgage as a loan advance rather than income. That distinction means the money is not taxed, unlike other retirement income from distributions from a 401(k) or an IRA.
WHAT ARE THE DISADVANTAGES OF REVERSE MORTGAGES?
A reverse mortgage isn't for everyone. There are some risks to this type of loan that you should carefully consider.
Here are some of the potential downsides of taking out a reverse mortgage.
DECEPTIVE OR INFLEXIBLE TERMS
Although we have come a long way since the unscrupulous practices by some lenders in the 1990s and early 2000s, not all reverse mortgage providers are ethical. Some will assume you won't do your due diligence and will take advantage of you.
Carefully vet a financial company before considering a loan, and have someone you trust to read the fine print. This person could be a CPA, financial planner, family member working in the industry, or even another investor you know who's successfully used a reverse mortgage and knows what to look for in a loan agreement.
You're examining the documents for any terms that the sales reps haven't disclosed. Any added terms should serve as red flags that you need to shop around with other lenders.
Also, be on the lookout for inflexibilities. For instance, reverse mortgages are often challenging to refinance. Ask your salesperson about your refinancing options, and then be sure to see how these claims compare with the written agreement. Any time a salesperson's word vastly differs from a written offer, it may be time to walk away.
Do not respond to unsolicited ads for reverse mortgages.
Be wary of anyone claiming that you can own a home with no down payment.
Do not sign any agreement that includes terms that you do not understand.
Do not accept any payment for a house you do not own.
Get advice from a reverse mortgage counselor of your own choosing.
REVERSE MORTGAGES ARE NOT FREE
Some of the unscrupulous ads of the past have promoted reverse mortgages as a means to get free access to your own money. These loans do have the following costs associated with them:
Counseling fee. Before getting the loan, you must participate in a counseling session with a nonprofit housing counseling agency. The typical counseling fee is around $125.
Lender fee. You'll pay an origination fee of either 2% of the first $200,000 of your home's value or $2,500 or (whichever amount is higher) plus 1% of your home's value above $200,000. (There's a cap of $6,000).
Closing costs. You'll need to pay for a home appraisal, home inspection, and title search. In some cases, you may also have charges for a credit check, escrow services, land survey, flood certification, and pest inspection.
Insurance premiums. The Federal Housing Administration (FHA) charges an upfront mortgage insurance premium equal to 2% of your home's value. These loans also have annual mortgage insurance premiums equal to 0.5% of the outstanding loan amount.
You may have the option of rolling some or all of these fees into your loan balance, but, of course, if you choose to do that, you'll receive less money.
YOUR LOAN MAY BECOME YOUR FAMILY'S DEBT
If you fail to make an estate plan or somehow account for a way to pay your debt after your death, your reverse mortgage may be subject to probate. Probate can take time and cost money, and in the meantime, your heirs do not have access to your estate.
If you die with debt, the debt gets passed on, just like your assets and earnings do. You can offset this downside of a reverse mortgage in two ways:
By minimizing your loan to what you're confident you can pay directly from your estate
By updating your estate plan to account for the reverse mortgage
Our suggestion is to take care of this critical detail immediately after seeking the loan. You may pay it off during your lifetime or pre-arrange for your estate to make payments. However, interest is likely to increase if you delay, and your beneficiaries must pay off the debt.
ASSETS ENCUMBERED BY DEBT CAN'T PASS TO HEIRS
Let's say you take out a substantial loan against your home's equity. If you pass away before making payment or fail to update your estate plan, your heirs may be unable to inherit the home until the loan is paid off in full. If you lack the funds in your estate, that could mean one less asset for your heirs.
Also, it's important to remember that a reverse mortgage diminishes the equity you have in your home. By the time the loan needs to be paid off, there may much equity left for your heirs to inherit.
Difficulty SECURING OTHER LOANS
A reverse mortgage is relatively easy to obtain if you meet the qualifications, but it doesn't necessarily "look good" to traditional hard lenders. Some seniors who take out reverse mortgages may find it difficult to secure additional lending elsewhere. This factor can be problematic for investors who rely on good terms to make their deals profitable.
This type of loan also could limit your ability to qualify for other need-based government programs such as Medicaid or Supplemental Security Income (SSI).
SHOULD YOU GET A REVERSE MORTGAGE?
If, after weighing the pros and cons of a reverse mortgage, you're still unsure if it is right for you, here are some factors to consider. A reverse mortgage could be a good option for you if:
Your home is increasing in value. In this case, you may be able to take out a reverse mortgage and still have money left over for your estate.
You plan to live in your home for a long time. The longer you live there, the more the upfront costs associated with the loan are worth it.
You can cover the current cash expenses – including property tax, insurance, and maintenance -- of living in your home.
As with taking on any form of debt, you should take your time deciding on a reverse mortgage. Although it is a relatively easy way to boost your cash flow in the short term, it could put your finances at risk down the road.
Make sure you fully understand the pros and cons of reverse mortgages and enlist the help of professionals to help you make the judgment call. Even a close network of fellow homeowners and savvy borrowers with experience in reverse mortgages can be a valuable source of information.
Learn everything you can about these financial tools, shop smart for a lender, read the written loan terms carefully, and be sure to ask plenty of questions. If a reverse mortgage doesn't feel like it's for you, you can always explore other financial options.
How The Qualified Personal Residence Trust (QPRT) Shields Your Home From Estate Taxes
A Qualified Personal Residence Trust (QPRT) is a specific type of irrevocable trust that allows you to remove your primary residence or another personal home from your taxable estate. While creating can be a QPRT complicated process, doing so lets you avoid estate taxes and reduce the amount of gift taxes you have to pay.
And guess what? When the feds take less, your heirs get to keep more of the wealth you’ve worked your whole life to accumulate.
For estates of several million dollars or more, a QPRT can allow you to keep the value of the home out of part of your estate that is subject to estate taxes. Although the QPRT is not used as often as other estate planning tools, it can save you a significant amount in taxes.
In order to create a QPRT, you have to transfer the title to your home to a trust. However, as part of the terms of the trust, you’ll include a provision that allows you to continue to live in the home for a specific period of time before passing to your heirs. The time in which you can continue to live in the home is known as a qualified term interest or a retained income period. So, while you won’t own your home anymore, you can still live there until this period expires.
How Does a QPRT Avoid Estate Taxes?
While there is technically no limit on how long you can keep your interest in the home, if you pass away before the end of your qualified term interest, the value of the home will be included in your taxable estate. So, you should always make sure the term chosen makes sense given your age and future life expectancy.
If you survive until the interest expires, the title to the home will pass to your heirs and will not be included as part of your estate upon your death. After your heirs inherit the property, you can pay rent, relocate, or figure out other living arrangements. Any rent payments you make to continue living in the home will further reduce the value of your taxable estate.
QPRTs and Gift Taxes
Although a QPRT can help you avoid estate taxes, Uncle Sam isn’t going to let you get off scot-free: the transfer of your home is subject to gift taxes. However, since you’re retaining a qualified term interest, the property’s gift value will be lower than its fair market value, which means you’ll owe less in gift taxes.
This deduction can translate to significant savings, particularly when younger homeowners set up QPRTs with extensive qualified term interests. The longer the retained income period, the lower the gift value of the home, the lower your tax bill from the IRS. Just remember that you have to outlive the qualified term interest for your heirs to reap the rewards of your estate planning. An experienced estate planning professional can help you decide on the most strategic term for your situation.
Another way a QPRT saves you money is by avoiding gift taxes on appreciation. When you transfer your home to the trust, you pay the gift tax on its current value, even though the title won’t pass to your heirs for years to come. That means that any increase in your home’s value during your qualified term interest won’t be subject to the gift tax, which can also save you a substantial chunk of change.
Why You Should Talk To A Pro
While the QPRT can be a great estate planning tool for shielding your home from estate taxes, it’s not the right solution for everyone. It’s important to keep in mind that specific requirements must be met to qualify for the tax savings. There is also a complicated set of special QPRT/grantor trust valuation rules for estate and gift tax purposes, which are outlined in Internal Revenue Code §2702 and related regulations.
As with most estate planning strategies, you should consult with an attorney who specializes in this type of law to determine if a QPRT is right for your situation. An estate planning lawyer who knows their stuff can help you decide on the best methods for saving your money from the IRS, determine if you can qualify for a QPRT and make sure it’s set up correctly if you choose to take that path.
Self-Directed IRA Options: Choosing the Best Investment Plan
Everyone has a vision for their retirement, but planning how to fund your post-work years is a puzzle that too many people fail to solve.
You already know about the individual retirement account (IRA), which lets you make tax-deferred investments in mutual funds, stocks and bonds. Typically, someone else (a custodian) manages those investments.
But if you’re a smart real estate investor, you’re probably interested in knowing how to invest your retirement funds in real estate, right? A Self-Directed IRA (SDIRA) opens up investment options like real estate, precious metals, renewable energy sources and more.
What are the best Self-Directed IRA options? It depends on what investments you’re trying to buy. The SDIRA gives investors access to many different types of investments.
In this article, we’ll show you how that works and give you an overview of the best self-directed IRA options for your particular scenario.
What’s the Difference Between an IRA and a Self-Directed IRA?
The difference between an IRA and a Self-Directed IRA, in short, is what you’re allowed to buy using the IRA. This depends upon the IRA “custodian,” which is just another word for the financial institution that manages the IRA. When you open up a SDIRA, you can get many more options than when you open up a normal IRA.
Most brokers, financial planners and attorneys aren’t familiar with the tools that give you "checkbook control," letting you choose your investments yourself.
Let's start with the basics ...
What’s an IRA? What Can You Buy with an IRA?
An IRA, in case you didn’t know, is an individual retirement account.
It might refer to a traditional IRA, SEP-IRA, Roth IRA, or something else. IRAs can help investors save on their tax bill, either by lowering their taxable income and letting the gains grow tax-deferred or by paying taxes upfront and withdrawing the gains tax-free come retirement.
Typically, if you’ve opened up an IRA through your employer to get a match on your contributions, your employer will restrict the types of investments that you can make using that IRA. Usually, you can only buy low-risk investments—or ones that major lenders can easily collect money on through management fees (even if they’re low management fees, like for index funds).
Here’s a short list of assets that you can buy using an IRA:
Real Estate Investment Trusts (REITs)
Exchange-Traded Funds (ETFs)
If you’re interested in investing in different assets, that’s where a Self-Directed IRA comes in.
What’s a Self-Directed IRA? What Can You Buy Using a Self-Directed IRA?
If you’re self-employed or you have an old IRA from a previous employer, then you can open up the self-directed version. This will greatly expand your investment possibilities. For example, here’s a short list of assets that you can buy that you typically wouldn’t be allowed to buy using an employer-sponsored active IRA:
With a traditional IRA account, making specific investments means directing the custodian to execute a specific transaction. There are custodian fees involved (assuming your IRA custodian even approves the purchase), and there are delays that can cost you the investment in certain time-sensitive cases..
An SDIRA is a checkbook control IRA, meaning you can take over some of the responsibilities of the custodian. You do not need the consent of a custodian to execute a purchase.
What CAN’T You Do With a Self-Directed IRA?
There are some things you need to know before opening an SDIRA: the investment isn’t allowed to be used for personal use. It’s called “self-serving,” and it’s explicitly banned by the IRS.
What does that mean? Isn’t everything “personal use?” Not really.
If you’re looking to use a Self-Directed IRA to buy your next vacation house or to buy a property for a loved one, for example, you’re going to possibly open up your entire IRA to taxation. Additionally, you can forget about DIY. If you work on the property yourself, that’s technically considered “self-serving” (or “self-dealing”). All business expenses need to stay inside the IRA.
You also can’t invest in collectibles or life insurance using a SDIRA. If you’re interested in using a Self-Directed IRA to fund those investments, you’re out of luck.
Altogether, managing a Self-Directed IRA can be difficult—but for some investors, the difficulty is more than worth it. The only problem is finding a custodian who will allow you to make your own investments without constantly checking in with them.
Luckily, Royal Legal Solutions offers you that freedom and independence. When you want to make a new real estate investment using your IRA, we make it as simple as writing a check.
Buying Real Estate with a Self-Directed IRA
When you buy real estate with cash, you get the benefits of depreciation (and other deductions) on your tax bill. That means real estate can potentially save you quite a bit of money in taxes.
However, when you buy real estate using a Self-Directed IRA, all of your gains could potentially be tax-free. Although you won’t get the benefit of depreciation, you can possibly earn real estate investment income through your IRA that can then grow tax-deferred (or tax-free, in the case of a Roth) forever.
Buying real estate with a Self-Directed IRA, then, can be incredibly lucrative.
Self-Directed IRA Options
At Royal Legal Solutions, we offer two products for investors who are looking to buy real estate using a Self-Directed IRA: the SDIRA-owned Business Trust and the SDIRA-owned LLC.
Asset protection is an added bonus of these structures; opening a business trust or LLC with your SDIRA allows you to shield your account assets and personal assets from lawsuits and bankruptcy rulings.
Self-Directed IRA-Owned Business Trust for Real Estate Investors
When you exercise "checkbook control" over your own retirement accounts, what you are doing is using a business structure that is owned by the IRA to execute transactions. Since you are authorized to act on behalf of that entity, you essentially have complete control of your IRA.
You’ll be able to diversify your portfolio while shielding your investment from possible litigation. You get to keep your anonymity while we ensure that your retirement/investment account is in line with everything the IRS demands, so you can focus on the investment itself.
Self Directed IRA-Owned LLC for Real Estate Investors
The self-directed IRA-owned LLC is another great option for real estate investors and anyone looking to invest in assets that you typically wouldn’t be able to purchase using a traditional IRA.
The IRA will own the LLC and you’ll be set up as the manager of the LLC.
Unlike with a business trust, you’ll have to pay for a registered agent fee because the IRS demands that you have an agent representing the LLC.
Self-Directed IRA Options: Choosing the Best Investment Plan
The best SDIRA options depend on what you’re looking to invest in, as well as your individual risk tolerance.
Again, with a traditional IRA, you only have access to certain assets (like stocks or bonds). With an SDIRA, you can invest in real estate, tax liens, gold, cryptocurrencies, and more.
If you’re a real estate investor, you might want to look into our SDIRA-owned business trust or SDIRA-owned LLC. They give you access all of the benefits of using a SDIRA (earning money completely tax-free or growing it tax-deferred) while protecting your anonymity and minimizing your exposure to litigation.
Thinking About Buying Real Estate with Your IRA? Read This First
Thinking about buying real estate with your IRA? Read this before you do.
An individual retirement account (IRA) typically offers massive tax-saving benefits while you’re planning for your retirement, like tax-deferred growth or tax-free withdrawals after a certain age—and they can even allow you to lower your taxable income.
So, naturally, just about every personal finance guru will give you the same advice when it comes to withdrawing money from your IRA before retirement: Never do it.
So why is buying real estate with your IRA any different?
First, you’re not actually withdrawing money from the account. If you’re a responsible real estate investor, you can use your IRA in a way that allows you to utilize the account’s tax-saving benefits, potentially saving you thousands, if not tens of thousands, of dollars.
But there are drawbacks (which we'll cover below).
Second, using your IRA to fund a real estate investment isn’t all that different than using your IRA to purchase any other investment, like bonds or shares, but you need to know how to do it responsibly so you don’t end up disqualifying your IRA.
In this article, we’re going to explain how to go about buying real estate with an IRA.
How to Buy Real Estate with a Self-Directed IRA
Using a self-directed IRA for real estate can be a bit more complicated than opening your Vanguard account and buying VTSAX.
Most financial institutions won’t allow real estate investors to use their IRA to purchase real estate, since it doesn’t generate any income for the bank. So, you’ll have two options:
“Custodian controlled’ self-directed IRA
“Checkbook controlled” self-directed IRA
What is an IRA Custodian?
A custodian is any financial institution that the Internal Revenue Service has approved to take care of an IRA. As we mentioned before, most custodians restrict the use of the IRA for certain investments.
“A self-directed IRA is an IRA held by a custodian that allows investment in a broader set of assets than is permitted by most IRA custodians. Custodians for self-directed IRAs disclaim most duties to investors, and may allow investors to invest retirement funds in “alternative assets.’”
What does this all mean in layman’s terms? If you want to set up a self-directed IRA for real estate, you have to go with a bank that’s going to allow you to do that.
What is a Checkbook-Controlled IRA?
On the other hand, if you go with a checkbook-controlled IRA, you’re setting up a real estate IRA LLC for, of course, the purpose of buying and holding your real estate, and then you’re using the funds from your IRA to invest in that LLC, which is then investing in the property you wish to purchase.
In this case, the IRA needs 100% ownership over the LLC, but it opens up the possibility for making quick cash deals using the money in your IRA.
Can an IRA Be Held in a Brokerage Account?
Since we’re on the topic of alternative investments that you can make with your IRA, you might be wondering, “Can an IRA be held in a traditional brokerage account?”
The simple answer is yes. You can hold an IRA in a brokerage account, but the IRA is its own account. Most of the time, when you open a brokerage account—or any additional account within your current brokerage—they’ll typically ask you whether or not you want to open it as a traditional (taxed) account or a tax-deferred IRA (or a Roth, or SEP, or any of the other types of IRAs).
6 Things to Keep in Mind While Using a Self-Directed IRA to Buy Real Estate
Finally, here are some important things to keep in mind if you’re interested in using an IRA to buy a property:
You can’t mortgage a property using the funds in your IRA. Since you can’t borrow money against your IRA, you’ll need to make the purchase in cash using the funds that you have available.
Your IRA needs to be large enough to cover the investment’s ongoing expenses. Not only do you need enough money to cover the down payment and closing costs, but you also need to make sure you have enough money in the IRA to keep running the business before it starts generating income itself (if ever). Crunch the numbers on the property taxes, special assessments, HOA fees, home insurance, and maintenance. Make sure you have enough stashed away in the IRA to cover those costs.
You can’t personally use the investment. If you’re looking to use your IRA to purchase a primary residence (or a vacation home or anything for your relatives), you’re out of luck. It needs to be strictly arm’s length, and you can’t receive any direct or indirect benefit from it.
You can’t withdraw any of the gains from your IRA until you’re 59.5 years old without incurring penalties—and that number may go higher in the coming years.
As soon as you reach 70.5 years old, you’re required to start taking required minimum distributions regardless of whether or not you need them (unless your IRA is a Roth). This could cause you to sell your IRA-funded property in a down market.
If you break any of the IRS’s rules on managing your IRA, you subject the entire IRA to taxation.
In this article, we examined the relationship between the IRA and real estate. This includes opening up a self-directed IRA with a custodian (a financial institution) that will allow you to use the IRA for “alternative investments” and to set up a real estate IRA LLC so that you can then buy that LLC through your IRA, which is known as a “checkbook-controlled IRA.”
Sometimes it might sound like a bunch of alphabet soup, but if you’re an experienced real estate investor who doesn’t need access to the gains until you’re past 60 or so, you can save a bundle on your tax bill by using your IRA to fund your real estate investment. It’s really no different than using your IRA to fund any other investment, it’s just a bit different than what most investors use the account to do.
Remember, though, there are some drawbacks. First off, depending on the real estate you’re looking at, you’ll need quite a bit of money inside the IRA to start, and this can take some time to build up. Second, you can’t use the property yourself, or for your relatives. Finally, if you break any of the IRS’s rules, you could possibly subject your entire IRA to taxation, so make sure you know what you’re doing by working with an experienced professional.
IRA Rollovers: Yes, Rolling Over Your 401(k) Into An IRA Is Smart!
There are a number of good reasons for this, and we'll be looking at seven of them here in a minute. But first ...
What Exactly is a Rollover IRA?
IRA rollovers can be deposited into an IRA from another retirement fund, such as a 401(k). Those who don’t already have an IRA can open one for the express purpose of rolling over funds from a previous employer’s retirement plan. Those who already have an IRA can simply roll over the money into the existing IRA.
7 Reasons an IRA Rollover Makes Sense
Many folks are content to let their 401(k) plans accrue money over time, and there’s nothing wrong with that option. Why would you fix something that isn’t broke?
Well in this instance, you would not be fixing something that is broken so much as replacing it with something better.
What do we mean?
Those who have just switched jobs have a short list of options concerning their retirement funds. These include:
Cashing out the funds immediately
Leaving the money alone
Rolling the money over into the new 401k
Rolling the money over into an IRA
Cashing the funds out immediately is not advisable. While leaving the money in the original 401(k) or rolling it over into the new one aren’t bad options, there are a number of reasons why an IRA rollover is the best option on the list.
Reason #1: Rollovers Can Preserve Tax-Favored Status
Those who choose to cash out their accounts early are not only subject to a 10% early withdrawal penalty if they are under the age of 59 ½ but will also need to pay income tax on the balance.
By contrast, rollovers can preserve tax-favored status so long as they’re transferred from one trustee to another. In other words, the IRA will continue to grow tax-deferred until a retiree begins collecting on their investment.
Reason #2: IRA Rollovers Can Increase Investment Options
Some folks choose to leave the funds in their old plan alone or roll the funds over into a new employer-offered plan. There’s nothing wrong with this per se, but rolling the money over into an IRA can increase the number of options that are available to you. For instance, IRAs typically offer a broader range of investments. 401(k) plans, on the other hand, may be limited to a handful of mutual funds.
This advantage will contribute to a better investment strategy and can prove more lucrative in the long run.
Reason #3: IRAs Have Lower Fees
Generally speaking, employer-sponsored 401(k) plans typically have higher administrative fees than IRAs.
Reason #4: An IRA Centralizes Control of Your Retirement Monies
There might some good reasons to keep your old 401(k) open, particularly if you’re satisfied with the returns. On the other hand, it’s much more convenient to have one centralized location from which to manage all of your retirement funds. IRAs are easy to figure out and significantly reduce the complexity of managing separate accounts.
From one centralized location you can access:
Your recent performance
Your investment selections
Reason #5: Brokers Will Compete For Your Business
Brokerage firms are more than willing to offer incentives to bring your business to them. In some instances, this could even mean free cash. In other instances, you may be entitled to free trades. It’s certainly something to look into as you figure out how you want to invest your retirement money.
Reason #6: 401(k) Plans are Subject to Rules an Individual Company Establishes
Every company has a great deal of wiggle room when it comes to setting up a 401(k) plan for their employees. IRAs, on the other hand, are subject to a centralized set of rules established by the IRS.
This is better for two reasons:
Different 401(k) plans will have different rules, meaning you need to familiarize yourself with the fine print.
IRA brokers are all bound by the same set of rules meaning that there is more transparency.
Reason #7: The Rollover Itself is Free
While there are other costs to consider, rolling over a 401(k) into an IRA is free. There will be transaction costs for individual investments and other costs to bear in mind, but setting up and rolling over the money is a relatively pain-free process.
The Bottom Line
The advantages of rolling over your 401(k) into an IRA far exceed the risks. It makes sense not because the other options are bad, but simply because IRAs are better for some. With more investment options to choose from, lower administrative costs associated with the account, a simple centralized location from which to access your retirement investments, and more transparency regarding how the fund operates, IRAs make the most sense for your retirement plan.
How You Can Bypass The 20% Withholding Tax On 401(K) Distributions Using Your IRA
You have to think of the IRS like they’re pirates out to steal your money. They want to get into your home. They want to carry off your daughter. They are the barbarians at the gate.
Our clients are wealthy investors who will pay their fair share when and where they are obligated.
But there are ethical and legal means to keeping more of their money, and it's our job to help them find those means.
Here’s one way to keep the government’s greasy fingers off of your retirement savings by bypassing the withholding tax on 401(k) distributions.
Tax Advantage of Retirement Tax Savings
Your 401k is subject to a 20% withholding tax when you cash in. IRA distributions, however, aren’t subject to taxation at the time of distribution.
That means you have a head start against the pirates.
Everything in your 401(k) is going to take this hit. But your IRA is all yours.
Now, this isn’t a complete get-out-of-jail free card. The real world isn’t Monopoly and you’re going to look like an idiot if you start wearing a monocle.
The tax owed on the distribution of an IRA or 401(k) is identical. You will still receive a 1099-R.
The difference is when you have to pay the piper. If you keep your 401(k), you pay the Man up front.
The Difference 20 Percent Can Make
You may not think 20 percent is a big deal, but with a little creativity, 20 percent is going to add up. There’s nothing wrong with retiring on the beach. My buddy (we'll call him John) took $500,000 from his 401(k) and he went got himself a fine little spot with plenty of sun and plenty of surf.
My buddy Sam, on the other hand, talked to me first. So, when he pulled his half a million bucks out of his IRA, we figured out how to get him a beach house like John. We also figured out how to put a little boat at the end of the pier for him. Sam loves to fish, so we invested a little in a fishing business too. Sam doesn’t care if the fishing business makes any money, but he got to keep enough money to buy a boat and make it a business expense. He also got to retire with a nice expensive Dunhill cigar in his hand.
John only gets a nice smoke when Sam is feeling generous.
It’s no contest folks. IRA or give your money away.
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
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 401(k) or IRA you should weigh the following tax options:
You can report the distribution as ordinary income. Anyone who receives a distribution from a 401k or IRA can choose to pay ordinary income tax on the distribution—unless you have a Roth IRA.
You can roll over the distribution to a traditional IRA or other retirement plan. Rather than paying ordinary income tax on distributions from your retirement account, you can roll over into a traditional IRA or self-directed IRA, also known as a SDIRA or solo IRA. If the funds are distributed directly to you, you have 60 days to deposit them into another plan or an IRA. The portion that is rolled over will continue to be tax deferred and will be subject to all the rules of the new plan or IRA. See our article, How to Take Distributions From Your Self-Directed IRA for more information.
You can take advantage of forward averaging. You are eligible to use forward averaging if you satisfy all of the following:
You were born before 1936.
You have not used ten-year averaging on any distribution since 1986.
You participated in your plan for at least five years.
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 401(k), the following income tax rules apply.
Your distributions are taxable immediately. All distributions will be taxed in the year they come out of the plan. There is an exception when you roll over your distribution into another retirement plan or a traditional IRA or when your employer transfers the distribution directly into another plan or traditional IRA.
Your basis is not taxable. If you made contributions to an IRA or 401k and you were not permitted to take a tax deduction on your tax return, then you will have what is called "basis" for tax purposes. You will not have to pay taxes on those amounts a second time when you take the money out of your plan. However, if you have a traditional IRA every time you take a distribution, part of it is taxable and part of it is not.
You don't have to withdraw cash. When you take a distribution from an IRA, you may choose the assets you want to withdraw - you are not required to take cash.
You may not claim a loss. You may not claim a loss on your tax return for any loss incurred inside your IRA or 401k. Instead, you pay tax on each distribution based on the cash value or the fair market value of the property on the date it is distributed from the plan.
How Are Distributions From a Traditional IRA Taxed?
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:
Qualified first time homebuyer distributions.
Distributions to the estate or beneficiary of an IRA contributor after the contributor's death.
Distributions not exceeding the deduction allowed to the taxpayer for the year for medical expenses.
Distributions to alternate payees under qualified domestic relations orders.
Distributions after the owner's “separation from employment” not exceeding amounts he or she pays for health insurance (assuming the owner has received 12 weeks of unemployment compensation and not been employed for a period of more than 60 days since receiving unemployment compensation.)
Distributions to an IRA contributor after age 59 1/2 or on account of his or her disability.
Distributions not in excess of the owner's “qualified higher education expenses” for the taxable year.
A series of substantially equal periodic payments, regardless of the taxpayer's age when they begin.
A distribution on account of the IRS. (Levies, etc.)
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:
Pay ordinary income tax. (Unless you have a Roth, but there will be some sort of tax still.)
Roll over your distribution: If you have not yet reached age 59 and 1/2 and you receive a distribution from a qualified plan, you can roll over the distribution into a traditional IRA or another retirement plan to continue deferring tax.
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.
What's The Difference Between A Roth IRA And A 401(k)?
Sometimes saving for retirement seems more complicated than it should be, and even more so when you work for yourself. There are a seemingly endless number of retirement accounts to choose from, and you want to make the best decision for your future (and for your family's security).
As a self-employed real estate investor, we know you like to make smart money moves, and we're committed to helping you make that happen. So let's talk about two of the most common types of retirement savings plans: what’s the difference between Roth IRA and 401k?
What You Need To Know About Roth IRAs
Roth IRAs are a type of Individual Retirement Account (IRA), a retirement savings account you can use to invest in common securities such as stocks, bonds, certificates of deposit, and mutual funds. A traditional IRA allows you to contribute to your account with pre-tax moolah, but you'll have to take required minimum distributions (RMDs) once you turn 72, and pay taxes on the money you receive.
With a Roth IRA, you pay your taxes up-front and then invest. Because Uncle Sam already got his cut, you won't be required to take RMDs. You also don't have to pay taxes when you choose to take distributions, as long as you're older than age 59½, and you've had the Roth IRA for more than five years.
Roth IRAs are an exceptional choice if you're self-employed or if your employer doesn't offer a 401(k) plan. Even if you have a 401(k), you can use a Roth IRA to increase your retirement savings once you hit your 401(k) contribution limit.
Income and Contribution Limits
Unfortunately, the government puts income limits on who can invest in a Roth IRA and contribution limits on how much you can invest.
If you're married and file taxes jointly, you can't use a Roth IRA if your combined modified adjusted gross income (MAGI) is $206,000 or higher. Roth IRAs are also unavailable if you're single and your MAGI is $139,000 or more.
If you meet the income requirements, you can open a Roth IRA, but you can't contribute more than $6,000 each year, or $7,000 if you are 50 or older.
Self-Directed Roth IRAs
A self-directed IRA (SDIRA) is a type of IRA that enables you to make investments that a regular IRA won't allow. While IRAs can only accommodate common types of securities, an SDIRA can hold a much broader array of investment options.
Investments types available for SDIRAs but not regular IRAs include:
Tax lien certificates
.... and more
An SDIRA is administered by a custodian or trustee, but you'll manage the account directly. (That's why they call it a "self-directed" account.) An SDIRA is available as either a traditional IRA or a Roth IRA and is an attractive choice for savvy real estate investors who want to use a tax-advantaged account.
What You Need To Know About 401(k)s
A 401(k) is a retirement savings plan that employers can offer, but there's also a variation for you self-employed folks out there. As with a traditional IRA, a 401(k) allows you to invest pre-tax money in mutual funds, and then you'll pay taxes on your distributions.
401(k)s are usually funded through paycheck deductions from your gross pay. Many employers will also match contributions you make to your 401(k), which allows you to invest even more. You should always take advantage of an employer match if one's available: it's free money!
Like the Roth IRA, 401(k)s also have contribution restrictions. There are personal contribution limits and a total contribution limit for combined individual and employer contributions.
The annual 401(k) personal contribution limits for 2020 and 2021 are:
$19,500 if you're younger than 50.
$26,000 if you are 50 plus.
The annual 401(k) total contribution limits for 2020 and 2021 are:
$57,000 in 2020 if you're younger than 50.
$63,500 in 2020 if you are 50 plus.
$58,000 in 2021 if you're younger than 50.
$64,500 in 2020 if you are 50 plus.
A Solo 401(k) is a 401(k) plan for self-employed people and their spouses. Solo 401(k)s follow the same rules as an ordinary 401(k) plan, but are only available to business owners with no employees. A significant advantage of the Solo 401(k) is that you can contribute to the account as both an "employee" and an "employer."
What Is The Difference Between Roth IRA And 401(k)?
When comparing Roth IRA vs. 401k, the main difference is the tax benefits offered. With a Roth account, you pay taxes now and then take tax-free distributions later in life. A 401(k)s allows you to contribute pre-tax money, reducing your taxable income and giving you a tax break now, but you'll have to pay taxes when you take distributions.
The differences between Roth SDIRAs and Solo 401(k)s are even more apparent.
Roth SDIRAs allow you to invest in diverse types of assets, including real estate. Unfortunately, income and contribution limits can limit a Roth SDIRA's effectiveness as an investment tool.
Solo 401(k)s are much more limited in the type of investments you can make, with your choices usually restricted to various mutual funds. However, you can invest much more money each year since you can contribute as both the employee AND the employer.
Given the advantages and disadvantages of these retirement plans, your best course of action may just be to invest in both. There's no rule that you can only pick one! You can evenconvert your IRA or 401(k) into a Roth account if you change your mind later. Creating a diverse retirement savings plan can help you maximize your investment opportunities and better prepare for your future.
Top 10 Things You Need To Know About Distributions From Your Retirement Account
Congratulations! You've lived long enough to retire or you're almost there.
But before you "cash out" and get your money via distributions from your retirement account, you may want to know what some people learn the hard way.
Let's start with distributions from traditional IRAs and 401(k)s. The first five questions will relate to these traditional accounts. If you have either a Roth account (IRA or 401k), you can skip to number 6 on the list below.
And whether you're getting ready to retire or you have a long way to go, the information below can benefit everyone.
Traditional IRA and 401k Accounts
1. Early Withdrawal Penalty.
A distribution from your traditional IRA or 401k before you reach the age of 59 1/2 will cause a 10% early withdrawal penalty on the money distributed. And yes, you're paying taxes too, so you're losing a big chunk of money if you withdrawal early.
Let's say you take a $5,000 distribution from your traditional IRA at age 50. You will be subject to a $500 penalty and you will also receive a 1099-R from your IRA custodian. You will then need to report $5000 of income on your tax returns.
Long story short: Don't withdraw early unless you really need the money.
2. Required Minimum Distributions (RMD).
But whether you need the money or not, at age 70 1/2, your friends at the IRS will force you to begin taking distributions from your retirement account. Unless you're still employed.
Your distributions will be subject to tax and you will also receive a 1099-R of the amount of money distributed which will be included on your tax return. The amount of your distribution is based on your age and your account’s value.
For example, if you have a $150k IRA & you've just hit the age of 70 1/2, your first RMD would be $5,685 (3.79% of $150k).
3. Don't Take Large Distributions In One Year.
Unfortunately, money from your traditional retirement account is subject to tax at the time of distribution. With this in mind, it would be wise of you to be careful about how much money you take out in one year. Why? Because a large distribution can push your distribution income and your other income into a higher tax bracket.
Let's say you have employment or rental/investment income of $100,000 yearly. That would mean you're in a joint income tax bracket of 15% on additional income.
However, if you take $100,000 as a lump sum that year this will push your annual income to $150K and you will be in a 28% income tax bracket.
If you chose to instead break up that $100K over two years, then you could stay in the 15% to 25% tax bracket. This way, you reduce your overall tax liability.
Long story short: When it comes time for you to start enjoying retirement, don't take out too much money or the IRS will be enjoying it instead.
4. Distribution Withholding.
Most distributions from an employer 401k or pension plan will be subject to a 20% withholding, unless you're at the age of 59 1/2. This withholding will be sent to your friends at the IRS in anticipation of tax and penalty that will be owed.
In the case of an early distribution from your IRA, a 10% withholding for the penalty amount can be made.
5. If You Ever Have Tax Losses Consider Converting to a Roth IRA.
When you convert a traditional account to a Roth account, you pay tax on the amount of the conversion. This is usually worth it, because you’ll have a Roth account that grows entirely tax free which you won't pay taxes on when you distribute the money.
Interesting fact: Some tax savvy people use tax losses so that they end up paying less in taxes later on.
Tips For Roth IRAs and Roth 401(k)s
6. Roth IRAs Are Exempt from RMD.
It's amazing right? While traditional IRA owners must take required minimum distributions (RMD) when they reach the age of 70 1/2, Roth IRAs are exempt from RMD rules. This allows you to keep your money invested for as long as you wish.
7. "Designated" Roth 401ks Must Take RMD.
Yea, tax code can be confusing. "Designated" Roth 401k accounts are subject to RMD. These kinds of Roth accounts are part of a 401k/employer plan, which is where the word "designated" comes from.
Anyway, so how do you avoid this you may ask? By rolling your Roth 401k funds over to a Roth IRA when you reach the age of 70 1/2.
8. Distributions of Contributions Are Always Tax Free (Unless The Government Changes That)
Unless the government makes major changes, distributions of contributions to a Roth IRA are always tax-free. No matter your age, you can always take a distribution of your Roth IRA contributions without penalty or tax.
9. Tax-Free Distributions of Roth IRA Earnings.
However, in order to take a tax free distribution from your Roth IRA, you must be age 59 1/2 or older and you must have had your Roth IRA for five years or longer.
As long as those two criteria are met, all amounts (contributions and earnings) may be distributed from your Roth IRA tax free.
Note: If your funds in the Roth IRA are from a conversion, then you must have converted the funds at least 5 years ago and must be 59 1/2 or older in order to take a tax-free distribution.
10. Delay Your Roth Distributions.
Don't be so quick to use the funds in your Roth account. It's usually better to distribute and use other funds and assets that are at your disposal. Why? Because those funds aren’t as tax efficient while invested.
That's all folks. As always, if you have any questions, please don't hesitate to ask in the comments below.
How The SECURE Act Impacts Inherited IRAs
The Setting Every Community Up for Retirement Enhancement (SECURE) Act went into effect on January 1, 2020. While the law was touted as a way to encourage retirement savings, some of the changes created by theSECURE Act actually limit the use of IRAs to build family wealth.
One of the major impacts of the new law is the partial elimination of the “Stretch IRA”, which has long been used to pass down family savings from generation to generation.
We want to make sure you understand just what the SECURE Act changed and how the new rules will impact your IRA, so we’ve broken it all down for you in this article.
What Is An IRA?
An Individual Retirement Account, which we usually just called an IRA, is a type of personal retirement savings account that is not sponsored by an employer. If you invest in a traditional IRA, you can annually contribute up to $6,000 of your pre-tax income, or $7,000 annually after you turn 50.
Traditional IRAs are a type of "tax-deferred retirement account". This means that, even though you can initially invest in a traditional IRA with your pre-tax income, our pals at the IRS will eventually come knocking on your door. Once you reach a certain age, the IRS forces you to take required minimum distributions (RMDs) AND forces you to pay income taxes on those distributions.
Roth IRAs are a little different. With a Roth IRA, you can only invest post-tax income. Since you already paid taxes on the income, you won't be required to take minimum distributions. Once Uncle Sam gets his cut, he doesn’t care if you decide to keep your money in your Roth IRA.
What Are Inherited IRAs?
When the owner of an IRA passes away, the remaining balance of the account is inherited by the designated account beneficiary. Just like the original account holder, owners of inherited IRAs must also take RMDs. However, the rules are a little different for beneficiaries.
A great example of how the rules are different for Inherited IRAs is that people who inherit Roth IRAs must receive RMDs from the accounts. Even though an original account owner does not have to take RMDs, if you inherit a Roth IRA and transfer the assets into an Inherited Roth IRA, you will have to take them.
The silver lining is that your RMDs will not be taxed as long as the funds have been in the account for five or more years. Since the original account owner paid income taxes on the money they invested in the Roth IRA, you get to make withdrawals from your inherited Roth IRA tax-free.
The Impact Of The SECURE Act
The SECURE Act made some drastic changes to how the designated account beneficiaries could choose to access funds from Inherited IRAs. First, we'll take a look at what the rules were before, and then we can talk about what the SECURE Act changed.
Inherited IRAs Before The SECURE Act
Before the SECURE Act went into effect, there were two sets of rules for account beneficiaries of inherited IRAs: one set of rules for spouses, and another set of rules for non-spouses.
Before 2020, if you inherited an IRA from your spouse, you had three choices:
Become the new account owner of the IRA
Roll the balance into your own IRA.
Transfer the balance to an Inherited IRA.
A spouse who assumed ownership of the inherited account or rolled the balance over into their own account would just follow the standard RMD rules for themselves. The RMD age was 70½ before the SECURE Act came along, so spouses who chose either of these options would not have to take RMDs from the inherited balance before that age.
If a spouse decided to transfer the balance into an Inherited IRA, they would have to start taking RMDs regardless of their age. The RMD amount would be calculated each year using the IRS Single Life Expectancy Table.
Before the SECURE Act took effect, non spouse beneficiaries could transfer the balance into an inherited IRA and then select one of the following options:
Withdraw all funds from the account within five years (Five Year Rule).
Withdraw RMDs over their lifetime (Stretch IRA).
What is a Stretch IRA? A Stretch IRA is not a specific kind of IRA, but an estate planning strategy that made use of a child beneficiary's ability to receive RMDs over their lifetime. Choosing this option would allow the funds in an IRA to maintain tax-deferred status for decades, with each IRA owner passing the account on to the next generation. By stretching out the lifespan of the IRA, families could avoid taxation on the funds in the account while accumulating wealth.
Inherited IRAs After The SECURE Act
The amendments included in the SECURE Act raised the RMD age from 70½ to 72. They also drastically changed the options for accessing account funds available to certain types of Inherited IRA beneficiaries.
Eligible Designated Beneficiaries
The SECURE Act identified several categories of people who were considered eligible designated beneficiaries:
The original account owner's spouse.
The original account owner's minor child.
A disabled or chronically ill person.
Any other person who is not more than 10 years younger than the original account owner.
In 2020, any eligible designated beneficiary who inherits an IRA still has the option to receive RMDs based on their life expectancy. Spouses can also still choose to assume ownership of the account or roll the balance over into their own account.
Any beneficiary who is not an eligible designated beneficiary must follow the 10-year rule instituted by the SECURE Act. The 10-year rule requires that beneficiaries withdraw (and pay taxes on) all of the funds in the account within 10 years. Once minor child beneficiaries turn 18, they are also subject to the 10-year rule.
In short, under the SECURE Act, any Inherited IRA beneficiary who is NOT an eligible designated beneficiary CANNOT choose to take RMDs over their lifetime.
The Partial Elimination Of The Stretch IRA
By excluding adult children from the list of eligible designated beneficiaries, the SECURE Act drastically limited the usefulness of the Stretch IRA technique. While a surviving spouse can still elect to receive RMDs over their lifetime, children who are not disabled or chronically ill must follow the 10-year rule. This rule change eliminates the generational benefits of using a Stretch IRA and complicatesremarriage estate planning. The changes made by the SECURE Act which will require many families to rework their estate planning strategies, and some may choose to divert their IRA investments to a different type retirement savings account.
Roth IRA Vs. 401K: Which Is Right For Me?
Deciding the best way to save for retirement can be confusing. Many investment options seem remarkably similar and trying to understand the differences feel like trying to decipher the Rosetta Stone.
Choosing between the different types of retirement plans can be stressful when you’re a self-employed real estate investor, especially when you don't really understand what your options are. This article will help you out by making things as simple as possible.
Two of the most popular types of retirement accounts are Roth IRAs and 401(k)s. These two retirement savings options have a lot in common, but once you learn a little more about them, you'll see that the differences are as clear as day.
We created this guide to help you understand how Roth IRAs and 401(k)s work, the differences between them, and how to decide which one is right for you.
What Is A 401(k)?
A 401(k) is a retirement savings plan that is offered by your employer (though there is a version for the self-employed, as we’ll see). The plan allows you to invest money into the account, usually by deducting a certain percentage or a specific dollar amount from each paycheck. Any money you contribute will be invested in various mutual funds. Many employers will also match the contributions you make up to a certain percentage of your salary, which allows your account to grow even faster.
What makes a 401(k) plan special is that you can contribute to the account without being taxed on your investments. Your 401(k) investments will be deducted from your gross pay before taxes are calculated, so any money that you put in your 401(k) is not taxed in any way.
If you are thinking this is all sounding too good to be true, you're right. Of course, there is a catch. And that catch is the contribution limit. Unfortunately, you can't invest unlimited tax-free money into your 401(k). In 2020, the annual contribution limit to a 401(k) is $19,500, not including any employer match. However, if you are over the age of 50, you can make an additional $6,500 in annual catch-up contributions, for a total annual limit of $26,000.
What Is An IRA?
Before we talk about Roth IRAs, we should probably at least cover the basics of what an IRA is. An Individual Retirement Account (IRA) is a type of retirement savings account that you open personally and is not provided by an employer. A traditional IRA may allow you to make pre-tax contributions, but there are required minimum distributions after age 72 and your withdrawals will be taxed as current income after age 59½.
IRAs are an excellent option for people who own their own businesses, or who work for employers who don’t offer 401(k)s. Even if you do have a 401(k), an IRA can be a useful retirement savings tool once you max out your 401(k) contributions.
What Is A Roth IRA?
Similar to a traditional IRA, a Roth IRA is an individual account that is not employer-sponsored. However, a Roth IRA only permits you to contribute post-tax money.
This doesn't mean that Roth accounts don't have tax benefits. Any withdrawals from your account are tax-free after five years and age 59½. This can result in a substantial tax break for people who plan to be in a higher tax bracket when they start receiving retirement plan distributions.
Some disadvantages of a Roth IRA are that there are income limits on who can use a Roth account, and, like 401(k)s, there are also contribution limits to how much money you can invest.
Married couples who file taxes jointly and have a combined modified adjusted gross income (MAGI) of at least $206,000 and single people with a MAGI of $139,000 cannot invest in a Roth IRA.
People whose incomes qualify them to use a Roth IRA cannot contribute more than $6,000 per year, or $7,000 if they are over the age of 50.
What Is The Difference Between Roth IRA And 401(k)?
Let’s quickly review the main attributes of Roth IRAs and 401(k).
Contribute pre-tax dollars
Contribution limit of $19,500 or $26,000 if you’re over 50
No income limits to qualify
Contribute post-tax dollars
Contribution limit of $6,000 or $7,000 if you’re over 50
Income limits for who can use
The primary difference between IRA and 401(k) accounts is that IRAs are personally-owned individual retirement accounts, whereas 401(k)s are profit-sharing plans provided by employers.
On top of that, when it comes to Roth IRAs and 401(k)s, the accounts offer different tax advantages. 401(k)s allow you to contribute pre-tax, which reduces your taxable income so that you owe a lower amount of taxes today. Roth IRAs, on the other hand, only allow you to contribute post-tax funds, but your withdrawals later in life are then tax-free.
While it's always wise to seek the advice of an expert, one of the primary factors when deciding whether a Roth IRA or a 401(k) is right for you is whether you want to save on taxes now or later.
Other Types of 401(k)s and IRAs
As part of our quest to demystify retirement savings accounts, we wanted to go over a few other types of 401(k)s and IRAs that may be better suited for your personal situation. Let's compare and explain some additional options that you use when saving for retirement.
Savings Incentive Match Plan for Employees (SIMPLE) IRAs are essentially traditional IRAs that are set up by an employer or a self-employed person. To qualify to establish a SIMPLE IRA program, an employer must have 100 or fewer employees who were paid $5,000 or more in the last year.
Here are some of the defining features of a SIMPLE IRA:
SIMPLE IRAs and 401(k)s are both types of employer-sponsored retirement accounts. The main difference between the two is that SIMPLE IRAs are simpler and easier for small businesses, whereas 401(k)s are more administratively complex but offer more flexibility and investment opportunities.
A Roth 401(k) is essentially a fusion of a standard 401(k) and a Roth IRA. Roth 401(k)s are employer-provided investment savings plans that only allow after-tax contributions, allowing for tax-free withdrawals later in life.
Roth 401(k) Vs. Roth IRA
While both Roth 401(k)s and Roth IRAs allow for post-tax contributions with tax-free distributions, the fundamental difference is that Roth 401(k)s are employer-sponsored and Roth IRAs are personal accounts.
A Solo 401(k) is a traditional 401(k) for business owners who have no employees and their spouses. Besides this one distinguishing factor, Solo 401(k)s follow the same rules and requirements as an ordinary 401(k) plan.
Solo 401(k)s and SEP IRAs are both alternative types of employer-sponsored retirement plans. However, Solo 401(k)s are only available to business owners who have no employees, whereas SEP IRAs may be established by both employers and the self-employed.
Calculating RMD For An Inherited IRA
If a loved one passes away and you are the beneficiary of their IRA, you might not know what you need to do next. The IRS has a lot of complicated rules about inherited IRAs, and you can be subject to large penalties if you don’t follow them.
While it’s always a good idea to get tax advice from an attorney or accountant, we’ve put together a handy guide to help you figure out what you need to do to stay on the IRS’s good side when calculating RMD an inherited IRA. That's the "required minimum distribution," and it can get confusing!
Note: The information here pertains to Charles Schwab, eTrade and Ameritrade IRAs .... or even an inherited self-directed IRA (SDIRA) ... But, as always, you should check with someone on our team for the solution that will apply to you and your situation.
What Is An IRA?
Let’s start from the beginning. An IRA, which is short for Individual Retirement Account, is a retirement savings account that is not provided by your employer. You open the account yourself and can contribute up to $6,000 a year of pre-tax income, or $7,000 a year if you're 50 or older. Yes, that means you don't get taxed on the money you invest in your IRA.
But since Uncle Sam is involved, of course you know there must be a catch. A traditional IRA allows you to make pre-tax contributions, but you will be subject to required minimum distributions after you turn 72, and any withdrawals you take will be taxed as ordinary income after age 59½. Since you're skipping taxes now and paying them later, traditional IRAs are called "tax-deferred retirement accounts".
Another type of popular retirement account, the Roth IRA, is NOT a tax-deferred account. With Roth IRAs, you pay your taxes up-front by investing post-tax dollars, so you aren't subject to required minimum distributions later in life.
How Do Required Minimum Distributions Work?
While you can invest pre-tax funds in an IRA, you'll eventually have to pay taxes on that income. For this reason, the IRS is going to start making you take money out of your account once you turn 72, so that they can tax you on your distributions. However, if you're still working, you can get out of taking distributions until you retire.
These mandatory annual withdrawals are fittingly called required minimum distributions, or RMDs for short. Your RMD requirement is calculated based on your age and the amount of money in your account.
Before 2020, the RMD age for IRAs was 70½, but when the SECURE Act passed in 2019, they raised the age to 72. If you turned 70½ before January 1, 2020, you may be subject to RMDs. A tax advisor can tell you if you are required to take RMDs now or when you turn 72.
If you try to skip an RMD, you can receive a whopping 50% tax penalty from the IRS. However, you may be able to receive anRMD Penalty Waiver to avoid IRS penalties under certain circumstances.
Upon an IRA owner's death, the remaining balance of the account will be inherited by their designated account beneficiary. The rules are different for spouse beneficiaries and non-spouse beneficiaries, so we'll talk about them separately.
A quick note before we get into the nitty-gritty of calculating these things. These rules apply to BOTH traditional IRAs and Roth IRAs. While the original account owner was not required to take RMDs from their Roth IRAs, if you inherit a Roth IRA and transfer the assets into an Inherited Roth IRA, you will be required to take RMDs. However, as long as the funds have been invested in the Roth IRA for at least five years, your RMDs will not be taxed.
If you inherit an IRA from your spouse, you have three options:
Treat the IRA as your own by becoming the account owner.
If you decide to treat the IRA as your own or roll over the balance into your own IRA, you would simply follow the regular RMD rules for your IRA. If you choose to transfer the balance into an inherited IRA, your RMD amount will be based on your age and be recalculated each year.
If you inherit an IRA from someone who is not a spouse, you cannot roll the inherited balance into your own IRA and must transfer the balance to an Inherited IRA.
If The Original Account Owner Died Before January 1, 2020
If the original account owner died before January 1, 2020 and was younger than 70½, you have two options:
Deplete the account within five years.
Take RMDs over your lifetime.
However, if the original account owner was 70½ or older at the time of death, then you must receive RMDs over your lifetime.
If The Original Account Owner Died On January 1, 2020 Or Later
If the original account owner died on January 1, 2020, or later and you are not an eligible designated beneficiary, under the 10-year rule instituted by the SECURE Act, you must deplete the account within 10 years.
Eligible designated beneficiaries include:
The original account owner's spouse.
The original account owner's minor child.
A disabled or chronically ill person.
Any other person who is not more than 10 years younger than the original account owner.
Under the SECURE Act, eligible designated beneficiaries still have the option to take RMDs based on their life expectancy.
How To Calculate RMD For Inherited IRAs
RMDs for Inherited IRAs are calculated based on two factors:
The account balance as of December 31 of the previous year.
The life expectancy factor for your current age.
Your life expectancy factor will be recalculated each year based on the IRS Single Life Expectancy Table. This table provides a life expectancy factor based on your current age. The older you are, the lower your life expectancy factor will be.
Once you determine the life expectancy factor for your age, you can do the following calculation:
Account Balance ÷ Life Expectancy Factor = RMD
You can also use an online RMD calculator to determine annual RMDs for you. We've linked a few good ones below:
How the SECURE Act Weakens 401(k) Protections (& What You Can Do)
It’s hard to deny that one in five Americans not having put a single cent towards retirement is a social problem. But the policy solution Congress is enacting to address this issue may affect your 401(k).
As investors, we love the 401(k), the 1978 amendment in the Tax Code that quickly became one of America’s favorite retirement savings vehicles. But Congress is actively changing your 401(k)s legal protections. We’re not letting any of our readers get blindsided by changes in law. Unfortunately, the well-intended GOP bill with the stated goal of encouraging more Americans to save has real consequences that threaten all account holders. Here’s what the folks in Washington are up to, and why some policy experts and scholars fear the 401(k) will be ultimately weakened and undermined by the SECURE Act.
Summer of Savings or Losses 2019? Congress’s SECURE Act Threatens 401(k) Protections
As of August 1, 2019, the Setting Every Community Up for Retirement Enhancement (SECURE) Act passed the House of Representatives. “Passed” is actually an understatement, given the bill flew through the House with a landslide 417-3 vote in favor of passage. We feel current projections anticipating a similar cruise through the Senate are likely accurate, and time will tell.
That said, keep in mind a bill can change substantially in the days, even hours, before its passage. Whether it’s amended in committee, filibustered, or provisions shuffle in and out at the last minute, there are many ways a bill can change in the moments before it becomes law. There is a distinct possibility that the bill at the time of this writing won’t be the exact version that passes, so confirm any effects you expect to personally impact your retirement plans.
Now’s a great time to remember that not every legislator reads or fully endorses every item in every bill they pass. Doing so takes hours of specialized time. So often, tucked within popular provisions are smaller edits and amendments that can actually make a massive impact if they become law. The changes to 401(k) protections are simply an example of this phenomenon.
Your IRA’s Not Safe Either: Certain Beneficiaries Can Kiss Stretch IRA Strategies Goodbye
The long-beloved stretch IRA is no longer a viable strategy for children of IRA beneficiaries. The conventional estate planning and asset protection wisdom that has historically worked in these cases must change with the law. Even our attorneys used to recommend stretch IRAs for child beneficiaries, who are now excluded from stretching IRAs along with other non-spouse beneficiaries. Fortunately, there are reasonable accommodations for certain situations, such as beneficiaries with chronic illnesses or disabilities or beneficiaries within 10 years of the decedent’s age, but otherwise, if you are the beneficiary of an IRA, you have to take your distributions within 10 years now. You no longer can rely on the stretch method to spread a large IRA over a lifetime, a tactic long used to preserve wealth within families. Now, you have to use it within a decade or lose it.
Update Your Estate Plan and Asset Protection Strategies to Account for New Changes
The best way to prevent any of SECURE’s possible negative effects in your own life is to plan around them. Keep eyes on the law, especially in its final form, and don’t be afraid to ask your own trusted professionals about possible impacts on either your asset protection strategy or estate plan. After all, the two are linked.
Given we can no longer fully endorse the same-old 401(k) asset protection advice, we encourage investors seeking alternative asset protection vehicles to consider forming a living trust to address estate planning needs. This flexible vehicle remains unaffected by these legislative changes.
Most Americans who participate in 401(k) plans will likely need to make some adjustments to their estate planning, and some may opt to change course in their retirement savings altogether. Whether changes will drive Americans away from the enduring 401(k) or legitimately promote access to retirement accounts is a policy question that only time will answer.
Future Retirement Health Care Costs Expected To Fluctuate
One of the reasons we save for retirement is because medical costs invariably go up with age. Saving for your own eventual care, even if you’re healthy as a horse now, is wise. But recent projections suggest you may actually want to save a little more. Cost of care is expected to continue fluctuating, and after all, there’s no such thing as too much savings. Here’s what you need to know about how to prepare.
Why Your Retirement Plan Should Include Healthcare Plans
Healthcare is a substantial cost for most of us in our golden years. These costs tend to escalate across all demographics with age. The prudent investor, therefore, should be both informed and proactive.
Consider the wide variety of things you can expect to go wrong as you age. Frankly, we will all need care to some degree. If you’re very fortunate, that period may be confined to the end of your life. But if you’re like most Americans, you’ll likely experience a slower decline in general health. This is simply the price we all pay for living rich, full lives: aging gets us all regardless. But let’s delve a little deeper into what types of circumstances can influence your personal healthcare costs. The sad reality is simply that those who manage chronic conditions or experience catastrophic events (the sort you’d associate with hefty insurance claims--accidents, sudden events like heart attacks or strokes, etc.) will face challenges on top of those that we all must. Every person reading this has good reason to save more than what seems essential for health care. That said, knowing that costs will be higher (or lower) for you can help you prepare properly and never have to worry about getting the care you need.
What Influences Healthcare Costs?
Health is deeply personal, and often frustratingly beyond our control. Here’s a shortlist of some of the things that determine these costs.
Known by the insurance world as “pre-existing conditions,” this category can cover a broad range of items. The extent and severity of a person’s health complications is the main factor that will determine costs for health insurance and routine care. Perfectly controlled conditions may even be costly to treat for populations like chronic pain patients and diabetics, who are often dependent on medications and require more frequent doctor’s visits (often with pricey specialists). Even if you’re lucky enough to be 100% able-bodied without so much as high blood pressure, congratulations. But that can change at any moment, as mere aging causes its own health issues.
Sex and gender.
Costs for women and female-identified individuals tend to be higher. One highly comprehensive 2016 study predicted a 30-year-old healthy woman can expect to pay $120,000 more for healthcare upon retirement.
None of us are safe from this one. The simple reality that $100 today won’t be the same as the day you retire is inescapable. Certain vehicles can help protect your dollars from inflation--both your CPA and attorney should be able to give personalized advice on these matters.
While none of us can make perfect predictions, it’s generally wise to estimate costs and figure in a 10-20% “buffer” for the unexpected. Just like when you’re building a pro forma for an investment. Your future care is absolutely a type of investment. Let’s look at some smart ways to plan ahead.
The Solo 401(k): The Healthcare Payment Tool You Didn’t Expect
Building up a retirement savings account sufficiently is no small feat. So it’s completely fair to use every single tool at your disposal. The thing is, most of the tools you can use aren’t going to be advertised as healthcare solutions. The Solo 401(k) is a precise example of this type of tool: underrated, under-used, and underappreciated. Well, by most. You and I are about to know better. The Solo 401(k) isn’t really that different from your typical 401(k) account. The essential feature that makes a Solo 401(k) a viable healthcare savings vehicle is Checkbook Control. Checkbook Control is finance slang for the ability to make nontraditional investments. While most accounts are going to be confined exclusively to the offerings of the institution in question, this isn’t so with self-directed accounts.
Note: Don’t let terms confuse you too badly here. The self-directed 401(k) is the same thing as the Solo-K. You may see variations in spelling or even fancy verbiage thrown around, but it’s the same type of Qualified Retirement Plan. There are however other self-directed accounts, but they tend to be IRAs. You can learn more about the self-directed IRA LLC and the IRA-Owned Self-Directed Business Trust right here on the Royal Legal Solutions site. These vehicles may also prove to be effective choices for you, as they share many key benefits. Learning about all of your retirement options, time permitting, is always a smart idea.
The solo-K can help you beef up your retirement savings easily because it confers these benefits (among many others):
Flexibility. Solo-K’s may be used alongside other traditional retirement plans.
Remarkably high contribution limits.
Endless opportunities for diversification of retirement dollars.
Tax-deferred and Roth options.
May be used as a part of your real estate business.
May play a role in your asset and creditor protection plan.
Smart Retirement Planning: Your Solution to Future Uncertainty
Amidst both the expected fluctuations and life’s unexpected curveballs, the smart play is to do what you can to get the most out of your retirement savings. Of course, this begins with planning ahead. If you need some general retirement saving advice, check out this resource of tips that can help at any age. But let’s take the time to glance at some methods for saving.
5 Times in Life to Update an Estate Plan
When asked by someone without an estate plan when they should plan their estate, we tend to give a variation of the answer, “Right away.” But updating your estate plan is a little more complex. There are major life events that are critical times to update your estate plan and make any necessary adjustments.
1: You Got Married
Congratulations! But before you tie the knot, you’ll likely want to ensure your intended spouse will be a part of your estate plan. Spouses are often beneficiaries of wills and life insurance, and may be listed on titles to shared investments or homes. For this reason, it is particularly important to update your plan if this isn’t your first wedding. You don’t want things going to your ex that are more appropriate for your current spouse. Even for first marriages, your spouse may not be fully protected or presumed to be an heir if the plan omits them.
2: You Had a Child
Kids, accompanied by marriage or not, really do change everything. One massive reason children can affect estate planning is because this documentation lets you dictate guardianship: who gets your children if you and the co-parent both pass away. It’s a situation nobody wants to be in, but one to plan for. Otherwise, the judgment call could be left up to the state. States also have different laws about whether “natural children” are heirs. Keeping your plan current is critical if you want to retain control.
Your children turning 18 also matters. As adults, they can directly inherit assets, and your plan should evolve accordingly.
3: You Got Divorced or Were Widowed
Removing an ex from estate planning documents is one of many legal considerations during a divorce. All changes in marital status, including a spouse’s death, should at least be cause for reviewing if not amending your estate plan. The detail to focus on is where a former spouse may be a beneficiary, and skilled estate planning attorneys can also inform you of other concerns for your unique situation.
4: You Bought or Sold a Home or Other Major Asset
This includes investment properties, and one major reason why estate planning for real estate investors is approached differently. Those with investment properties may consider the living trust and pour-over will, which an attorney can craft to ensure the seamless transition of assets without the need for probate court. A new home of any kind can drive up your estate’s value, but fortunately asset protection strategies including titling property to a land trust may help prevent this and other potential legal issues surrounding titling.
5: You Got a New Business
Whether you started or purchased the business, understand it’s also an asset. You’ll need to decide who owns the business, and a succession plan is wise for particularly successful and profitable businesses. If you want to make the decisions around your legacy without incurring unnecessary probate court fees, updating your estate plan is the vital.
Crowdfunding Real Estate: Is it A Safe Investment Strategy?
As with anything new that breaks from tradition, crowdfunding real estate investments stokes fear in some. We find many of the more irrational fears to be iterations of Internet-phobia backed by little evidence. Some people simply hear words like “Internet-based” and assume risk without actually getting the facts about crowdfunding for investors. The truth is, as usual, more complex. Like anything in the world of real estate or investing, crowdfunding is not without risks. But those risks can be mitigated, and there are also benefits to using crowdfunding platforms.
What is Crowdfunding? How Does Crowdfunded Real Estate Investing Work?
Crowdfunding is a concept you may already be familiar with through sites such as GoFundMe, Kickstarter, and certain charity platforms. If not, these are sites that allow a person’s social network to contribute toward a pre-selected cause, whether that’s helping a friend repair a car or kicking in on another’s healthcare costs. The same principle can be applied in real estate since 2012 legislation made some critical changes in law that permit crowdfunded real estate investing.
Prior to that point, investors were usually career pros who had plenty of capital that many Americans simply don’t have access to. Crowdfunding has helped change this trend by opening up real estate.
As you many have gathered, this more open market makes it possible for more people to invest. With crowdfunding, you don’t need a lot of money to invest in a portion of a property. Other benefits include the fact that more established crowdfunding platforms are highly transparent, allowing you to do your own due diligence more easily, though many services give you a boost by also thoroughly vetting the investments listed. Crowdfunding allows for easy and flexible diversification. You can easily get in on a broad variety of types of assets, strategically spreading out your wealth and creating a safety net.
Risks of Crowdfunded Real Estate Investment Plans
Regular readers may recall that the only two ways to lose money in real estate are bad deals and lawsuits. Essentially, most of the risk of crowdfunding is that investors could make bad deals. The reason why actually has nothing to do with crowdfunding specifically. Any investor can make a bad deal for any number of reasons, regardless of how it’s funded. Another frequently expressed risk is that the investors who are getting into the market via crowdfunding platforms won’t be as knowledgeable, and therefore, more likely to make bad deals. Neither problem is insurmountable.
How to Address the Major Risks of REI Crowdfunding
Let’s take a closer look at the knowledge concern. Fortunately, you can always do things to increase your level of knowledge about this or any subject, and you’re actually already doing it right now for free. Keep reading. Perform your own research, talk to investors who have used the tactics and tools you’re thinking about using yourself, and vet potential platforms carefully. Due diligence is ultimately your responsibility. If still in doubt, contact an expert for help. Taking all these steps thoroughly and in earnest will close knowledge gaps. As for making good deals, experience is a fine teacher, but mentors help too. Having a qualified team of experts on hand to look at your deals, assist with business structures, and develop tax strategies can also be incredibly valuable. Our skilled real estate attorneys can assist you with all of this and the legal structures that will best protect your new assets.
Retirement Plan Options: All About Indexed Universal Life Insurance
When making business decisions that affect your long-term goals, like what types of investments to make with your retirement dollars and which vehicles to use, it really is best to be aware of all of your options. We frequently talk about the Solo 401(k) and Self-Directed IRA as tools for funding your retirement. But what about life insurance? And what about the stock market? What if we told you there is a tool that allows to to reap some benefits of both? It's called Indexed Universal Life Insurance--and some investors have found it a useful addition to their retirement plans.
What Is Indexed Universal Life Insurance?
Indexed Universal Life Insurance (IUL) plans are a variety of permanent life insurance plan that features a cash-building element. One primary benefit of these plans is that the policy holder gets some of the gains of being associated with the stock market without all of the risk Wall Street is famous for. This is in no small part because of how these policies are designed. IULs earn in part because they are directly linked to a market index, such as the Dow or the S&P 500. Any gains remain within the policy, albeit a cap rate will limit how much you can make. However, you are protected during a particularly bad year for your index with an IUL. The worst case scenario with these plans is that you make nothing, but you never actually lose money no matter how poorly your index performs. The protection of your principal is actually derived in part from the same cap rate that limits your gains.
How much money do policyholders stand to make? Historically, returns run between 5-9%. The S&P Index has actually returned at 9-11%, but the upside limit on UILs stems from the account's cap rate. For this reason, many advisors argue that the UIL can make a wise addition to a retirement or estate plan once more traditional and self-directed accounts are maxed out.
Tax Benefits of Indexed Universal Life Insurance (IUL) Plans
There are three key tax benefits of IULs. First, you may pay into the policy with pre-tax or after-tax funds. Withdrawals from the policy may be made tax-free if you are under 59 1/2. Such withdrawals are regarded as loans, with your death benefit serving as collateral. Any funds paid out to the beneficiary are also tax-free, including normal benefits upon your passing. This is true regardless of their value.
Ask the Experts at Royal Legal Solutions About Your Retirement Planning Options
Regardless of where you are in the retirement planning process, Royal Legal Solutions an assist you. We have extensive experience educating investors about self-directed investment options. Many of our investor-clients love our Solo 401k information, product, and compliance services. Our Self-Directed IRA services can also be helpful for retirement planning, as the SDIRA is yet another vehicle that allows you to diversify and take total control of your investments. To determine which of the available retirement planning strategies are best for you, consult with one of our experts at Royal Legal Solutions. You may also contact us with any questions you may have about your options.
Three Quick Estate Planning Tips to Avoid Later Problems
Approximately half of Americans fail to make an estate plan, which can be a major mistake. Real estate investors have even more to lose without thoughtful estate planning. So what are some of the tools that we use for an effective estate plan? What can you do today to make life easier for your heirs once you are gone?
Read on to learn about three tips that you can use now.
Get Your Estate Planning Paperwork in Order
This first tip pertains mostly to individuals who have already established an estate plan, or are using legal structures to protect real estate. You want to make sure all of your documents--deeds, trusts, and life insurance--match up with your estate plan. If you designated one person as the beneficiary of a land trust, for instance, naming another person in your estate planning documents will not "cancel" the original beneficiary designation. Taking the time to line up all of your legal documents with your wishes now will help ensure that they are carried out. Similarly, you want to keep your estate plan updated. Any time you buy or sell a major asset, you should update your estate plan.
Stay Out of Probate Court
Probate Court can be a miserable, emotionally experience for everyone involved. The good news is that you can spare your family from ever having to handle probate with a single document: a revocable living trust. Some people believe a will alone is sufficient, but this is a myth. A will must go through probate court. To make things easier on your grieving family, set up a living trust. You may specify in this document which assets go to whom. Some investors use this in conjunction with a "pour-over will" to easily transfer ownership of a business.
Use Trusts Strategically in Your Estate Plan
Trusts are a critical part of estate planning, particularly if you have children or other under-age benefeciaries. A trust allows you to designate funds for a particular individual. As an added bonus, when assets are transferred to heirs over the age of 18, the heir receives the benefits of asset protection and creditor protection. Such benefits are not available to heirs receiving assets in a Probate Court context.
Bottom Line: Get Professional Estate Planning Help and Use All of Your Tools
If the discussions about the finer points of Probate Court and the different types of trusts make your head spin, that's okay. That's where attorneys come in. When planning your estate, you will always want the guidance of an experienced lawyer familiar with these issues and more. If you have many assets or a high net worth, getting professional help is even more important.