My new article published in the Florida Association of Realtors® state magazine. Got a cover mention and 4 pages in the magazine itself. Great read for investors, entrepreneurs, as well as real estate agents and brokers.
Do you know which kind of IRA you have?
Most investors mistakenly believe they have a “self-directed IRA” when in fact they have one that limits their choices to a few investment types. Within your plan, you can choose stocks, mutual funds or bonds. And while you may have hundreds and even thousands of choices of where to put your money inside that account, chances are you won’t be able to invest in nontraditional retirement assets — especially if your IRA or 401(k) rollover is with a traditional brokerage house.
So just what is a true self-directed IRA? It’s an account allows you to invest in many other options with your IRA, including:
- Rental real estate.
- Fixer uppers to resell at a profit (flip).
- Private loans made at higher interest rates to other investors.
- Discounted private notes.
- Tax liens or tax deeds.
- Privately held companies and startups.
- Precious metals.
- Leases and lease options.
- Straight options (real estate options, not stock options).
Such investments receive the same tax treatment as more traditional IRA assets. Any tax due is deferred until withdrawal, typically at age 70½, when your are required to start drawing down your savings, or possibly sooner.
This is an account for hands-on active investors with unique knowledge of some of the asset classes in the approved list, not for a “set it and forget it” investor.
By using this type of account it is possible to make some sizable returns from a relatively small amount of money. Here’s an example:
You have an opportunity to buy a rundown house from an estate that would like a quick sale. You determine the house is worth $200,000 — after you have spent $40,000 in upgrades. You contract to purchase the property for $120,000. But lacking the $160,000 to proceed with the sale, you enlist a partner who agrees to provide the full amount, provided you handle all the details, including closing, rehabbing and reselling the home.
You further determine that you would like your share of the profits to go inside of your IRA for the obvious tax benefits. You only have $10,000 inside your IRA with which to invest. The proper play given these set of circumstances is to have your partner buy the property in his name or an entity he controls, such as a limited liability company. You enter into an option agreement to purchase half ownership in this property. You pay $100 from your self-directed IRA and fill out option paperwork and give all the papers to your plan administrator.
This deal now moves forward, and the property is rehabbed and ready for sale in 60 days and sells and closes quickly for $200,000. You have $10,000 worth of sales and holding expenses, netting a $30,000 profit on this deal in five months. The actual title owner to the property agrees to pay you $15,000 for you to close out your option. This $15,000 is a return on the $100 option investment and is deposited back inside your IRA tax-deferred or tax-free (for a Roth IRA).
Your investor put up $160,000 and received $15,000 for a five-month investment. This represents more than a 20 percent annualized return on his money, which is pleasing to almost every investor. If he used his IRA money for this investment, then his profit would be tax-deferred as well.
Here’s another example: An investor from New York became aware of the self-directed IRA and used some of his IRA to acquire four rental homes in Metro Detroit. Each home was purchased for around $55,000 and rents for about $900, and the cash flow goes back to the IRA on a tax-deferred basis. If he sells these for big gains years from now, that profit will also be tax-deferred.
Be warned: There are also some prohibited investments with your IRA (see IRS Publication 590):
- No loaning of money to yourself, your spouse or any family member in your direct linear family chain.
- No investing in collectibles.
- Your IRA can’t personally guarantee any loans in which it borrows money. This means that any money borrowed by your IRA must be “non-recourse” funds, which means that only the asset can be put up for collateral and may be foreclosed upon for nonpayment. The creditor may not file suit against the IRA for any shortfall in the loan goes delinquent.
A bad investment can be a serious wealth stealer, but as much as it matters how much you lose, it can matter equally when the loss occurs. As you approach or enter your retirement years, declines in the value of your portfolio can be especially devastating.
“Dollar-cost averaging” describes how you can benefit even when the market goes backwards — if you don’t need to withdraw your money anytime soon, and continue to regularly invest when prices are low. Let’s say you invest $500 a month in a mutual fund. When the fund is $15 a share, you’re buying more share than when it’s $20. Then when the market comes back and your fund hopefully goes up, you own more shares, so your gains will be bigger.
However, dollar-cost averaging assumes that you are in the accumulation phase of life and will keep putting in fresh money toward retirement for awhile. It also assumes you have enough time before you’ll need the money to allow your portfolio to rebound from any significant downturns.
If you’re in the distribution phase of life and are taking funds out of that mutual fund, what you run up against is the phenomenon of “reverse dollar cost averaging.” If you are taking out $3,000 a month to help cover your retirement expenses, and you have to sell shares at the lower $15 apiece price, you’ll need to sell more of them, which means you won’t be holding them when they recover. And sales like that can cause you to run out of money quicker.
Enter the Retirement Danger Zone
The retirement danger zone begins when you get within 10 years of your scheduled retirement date, and lasts for the remainder of your life. Any losses you take during this phase can dramatically affect the quality of your later years. Many older people who experienced such pains to their portfolios in 2007 and 2008 found that they couldn’t afford to retire on schedule, or had to go back to work to supplement their income. According to the Federal Reserve, the median net worth for Americans ages 55 to 64 went down approximately 33 percent from 2007 to 2010.
Stock indexes are hitting records again now, and enthusiasm may be causing some people to forget just how fast the market can turn. It is critical for those in the retirement danger zone to begin to reallocate more of their retirement funds toward rock-solid products that remove any risk of market loss. Below are some places you could reallocate money from stock and bond mutual funds to places with much less volatility. The old rule of thumb is that you will sacrifice decent growth to preserve your principal. In many cases, that is true.
- Savings accounts have a pitiful rate of growth and should be used strictly for a liquid emergency fund. The principal is protected and FDIC-insured.
- Money market accounts are usually very safe and offer a higher — but still low — growth rate than savings accounts. They are very liquid.
- Fixed annuities offer better rates than above but are not liquid. Annuities come built in with an early withdrawal penalty that can wipe out modest gains if funds are needed sooner than expected. Don’t confuse a fixed annuity with a variable annuity that tracks the markets and hence are subject to large losses. Variable annuities are not a place for retirement danger zone money.
- Certificates of deposit offer more interest than savings accounts but take away liquidity. CDs are for defined periods from 30 days to a number of years. The longer you agree to not touch the money, the more interest the bank will pay.
- Fixed indexed annuities are a hybrid of fixed and variable annuities that will protect your principal in down markets but allow you to participate in a portion of the gains in up markets. You can also buy a lifetime income rider that will assure a certain income for you and your spouse’s lifetime. They are illiquid for the first seven to 10 years, depending on the product. They could be a great place for IRA funds to grow safely.
- Cash accounts allow people to deposit funds with some life insurance companies on a fixed rate of return that is usually more attractive than what banks offers. When banks are paying 0.5 percent, some of these accounts pay 3 percent. These accounts are generally liquid — but if you withdraw from the account, you must withdraw the entire balance.
There’s no getting around it: Too many older Americans just haven’t saved enough for the retirement lifestyle they hope to enjoy. They add up their anticipated Social Security payments, their investment income, pensions and other sources, compare that sum to their expected expenses and — there’s a gap.
You can fill that gap by continuing to work, of course, but retirement isn’t really “retirement” if you’re still cranking away for a hovering boss. But there are alternatives, and one that is gaining popularity among those looking to pad their retirements is joining a direct sales enterprise. These businesses are also called network marketing, multilevel marketing, networking, direct sales and the not-so-flattering pyramid scheme.
In essence, you sell a product line or group of services to your “affinity groups” — in other words friends, friends of friends, family, and colleagues, past or present. You get a straightforward commission on your sales, and you can also invite people you know to sell the products as well — and you earn commissions on their sales. These sales structures can — and often do — go on for quite a few levels. Hence, the name multilevel marketing.
“In the United States, approximately 16 million people are involved in direct selling, accounting for almost $30 billion in annual sales,” the Direct Selling Association says. That averages out to $1,875 per person a year.
How It Works
Some people believe that since the people at the top of the distribution chain make the bulk of the money, that the term “pyramid” is appropriate. I’d respond to that by encouraging you to look at any large corporation; they all pay their top people significantly more money than their lower-level employees. Yes, it’s true: The company you work for is probably also one of those dreaded “pyramids.”
Multilevel marketing is merely a different way to promote and distribute products and services. Instead of spending large amounts of money on traditional marketing and advertising, it uses that money to pay commissions to its distributors or agents.
Distributors get to tie into an existing product line, and it takes minimal capital to get started. The key is to represent a product or service that you believe in, and one that has a good, true story of how it is helping people. Let’s say a certain brand of weight management products has been a huge help to you. Why not tell other people who have similar goals and earn a commission if they try the product?
Before You Get Involved
Here are seven tips to a successful network marketing experience.
- Make sure you love the products and that there is a true story you can to tell to your prospects about what the products have done for you or someone you know. Don’t get involved with any company just because of a compensation plan and its promises of riches. Passion is important to be successful selling anything.
- Understand how much you can make if you just sell the product and don’t recruit new sellers below you. Members of the association are required to give out “fact-based information about the company’s compensation structure and earning potential.”
- Look for a company that has been around for at least five years — and 10 would be better. Launches and failures of networking companies are common. Don’t worry about getting in on the ground floor — focus on dealing with a solid company with a track record.
- Investigate marketing support. You will most likely get a replicated website that you can use. How else does the company bring help distributors?
- Be wary of seminar companies in network marketing clothing. If you are forced or strongly encouraged to buy the CD of the month and a ticket to any and all events, that is the best sign that more money is being made on those items than on the actual product. Gatherings are a good thing in moderation. There has to be more than just hype and training materials.
- Be patient. It might take you a year or two to achieve that income goal — or more if you have bigger goals. Steady, persistent action is the key.
- Ask about if there are monthly minimums for personal production to qualify for commissions and if there are monthly personal points to be maintained.
Don’t judge direct selling by just the numbers. Judge by how it would work for you, with your own solid plan of action. One of my business ventures is a real estate brokerage, working with out-of-area investors. Realtors average a little over $14,000 a year. This encompasses everyone with a license — even if they don’t sell anything. Many friends and colleagues — and I — make many multiples of that amount. So don’t let an average scare you.
Do your homework, and look before you leap. Then be patient, persistent and refine your marketing campaign and sales skills. If you succeed, it could be just the boost your retirement needs. I will share more information on this subject in my new book, Wealth Without Stocks or Mutual Funds, releasing this year.
Many Americans have traditional Individual Retirement Accounts, where your annual contributions are reduced from your taxable income, yielding a tax deduction now, but your withdrawals are taxed. And many also have Roth IRAs, where the money you invest is taxed normally in the year you deposit it, but the profits grow tax-deferred and can be withdrawn tax-free after you retire.
The two options raise the obvious question: Would you rather pay tax on the seed money now or the crop of money later? This point has been debated for years, but for this post we are going to assume you would rather pay the known tax now vs. an unknown tax later.
Many people with traditional IRAs also open and fund a Roth IRA. But, if you’d like, you can convert a traditional IRA into a Roth account. Taxes are due on any amount you convert. The benefits of conversion:
- Tax-free qualified distributions.
- Tax-free growth of earnings.
- Uncertainty of future tax rates eliminated.
- Lower taxes owed on retirement benefits, such as Social Security
- No required minimum distributions.
- Possible larger estate to leave behind for heirs.
As great at these benefits are, a conversion may not be for everyone. The longer you have until the money is needed, the better a move conversion can be. Get advice from a professional, input your data into one of the many software programs designed to calculate the costs and benefits, or email me for a free customized analysis.
Partial Conversions Can Be Powerful
Many people don’t realize that they can convert just a portion of a traditional IRA. If you combine the partial conversion with certain financial products, your tax burden can be lessened dramatically.
Let’s assume you have $400,000 in a traditional IRA and your effective tax rate is 20 percent.
You initiate a partial conversion of $130,841, which would mean you have to pay $26,168 in taxes. This gives you $104,673 for your Roth account and leaves you $269,157 in your traditional IRA.
You could elect to combine the conversion with a rollover into a solid fixed indexed annuity that offered a initial premium bonus. If you roll over your $269,159 traditional IRA into a product that gave you a 7 percent premium bonus and did the same thing with your new Roth account with a balance of $104,673 after taxes, then you would receive a $26,168 bonus that would put your starting balance of your combined IRA accounts back to the original $400,000 before the conversion.
The difference is that now $104,673 is now tax-free and not just tax-deferred. Assuming a modest 5 percent growth rate inside of both accounts, after just 10 years, you would be $43,785 ahead with this strategy than if you just let your traditional IRA stand. In 20 years, you will have over $83,000 more in your combined accounts (even after factoring in the taxes on your traditional IRA) than you would have had without the conversion.
Creating and preserving wealth is much like any other endeavor in which you would like to have success. A good system plus discipline equals more success than just “winging” it in life. This one simple strategy can create tens and even hundreds of thousands of extra dollars in your later years or to leave behind for those you love. If you would like more information on this strategy visit us and request your free report.
In last week’s article we gave you an introduction to the United States Tax code and why you need to take control of how much you pay to the government. This week we will give you the most powerful strategy to legally and dramatically reduce the amount you pay in taxes.
The #1 Tax Strategy in America – Do something with the INTENT to make a profit from your home!
The “Business” tax breaks were passed by Congress for 2 reasons:
1) To stimulate the economy by creating more businesses and more jobs.
2) Encourage people to have additional sources of income to pay off their debt and contribute to their retirement.
An activity with the INTENT to make a PROFIT, can be considered a “Business” and qualify for “Business” tax deductions. You can do this as a sole proprietor (in your own name) or as an entity (corporation, LLC, etc…) either way works. In order for a business to be able to deduct all ordinary and necessary business expenses it must be able to show that the business is being run with the reasonable intent of making a profit. You do not need to actually make a profit as long as you intend to make a profit.
So here are the requirements set forth by Congress
- Have the intent to make a profit
- Work your business on a regular & consistent basis
- Treat it like a business – Keep good records
Meet these 3 requirements and you can qualify for $1,000’s in new Tax Deductions.
So let me share with you just 4 of the many Tax Deductions you will qualify for when you take the time to meet the above 3 requirements.
TAX DEDUCTION 1 You cannot deduct expenses for attending a convention, seminar, or similar meeting held outside the North American area unless:
- The meeting is directly related to your trade or business, and
- It is reasonable to hold the meeting outside the North American area.
It is considered “REASONABLE” to have a business meeting in any of these countries! (See chapter 1 of IRS Publication 463)
TAX DEDUCTION 2 – Travel Rule Basics:
Basic Rule: For each business day of travel, you can deduct 100% of your lodging and 50 percent of your meals and entertainment.
Workdays: You can count a business day as any day during which your principal activity during normal business hours is the pursuit of business. You must work more than half of the workday.
Tried-to-work days: You count a business day as any day you intended to work but circumstances beyond your control prevented you from actively pursuing your business objective.
Weekends, holidays: If a weekend or holiday falls between two business days, the weekend or holiday is considered to be a business day and is tax deductible. This applies only when it is not be practical to return home for the weekend because of time required or expense involved.
Saturday night travel: Airlines sometimes charge you less if you stay over a Saturday night. If you can save money by staying over Saturday night, you count the stay-over as a business days.
Travel days: Travel days are business days.
TAX DEDUCTION 3 – Meals & Entertainment
The IRS considers “entertainment” to be any activity that provides “entertainment, amusement, or recreation, and includes meals provided to a customer or client.”
You are permitted to deduct 50% of all of your ordinary and necessary meals and entertainment costs for your business.
The 50% limitation applies to all meals (whether local or in travel status) and entertainment expenses.
In order to qualify for the deduction, you must discuss business during the entertainment (directly related entertainment) or immediately before or after the entertaining – within 24 hours (associated test for entertainment expenses).
You must be able to document Who, Where, When, What & Why. Most receipts have the Where & When printed on them – you just have to document the Who, What, & Why
- The Tax Code does not provide any guidance as to what constitutes a “substantial and bona fide” business discussion for purposes of meals and/or entertainment.
- There are no rules that specify how long the discussion must be before it will constitute a business discussion for deducting your meal or entertainment expenses.
- Your business discussion does not need to take a greater amount of time than your non-business discussions for the meal or entertainment expenses to become deductible.
- As long as a business discussion is the primary purpose of the entertaining, the expenses will qualify for a deduction.
TAX DEDUCTION 4 – Dutch Treat
DEDUCTING “DUTCH-TREAT” BUSINESS ENTERTAINMENT
Many business expenses do not involve paying the expenses of clients or prospects. They are Dutch-treat. Everyone pays for himself or herself.
But how do you handle Dutch-treat expenses? How do you know if they’re deductible?
General Dutch-Treat rule: IRS regulations state that the taxpayer may deduct entertainment “even though the expenditure relates to the taxpayer alone.” The IRS says its objective test precludes arguments that “entertainment” means only entertainment of others. Further, the IRS acknowledges that business entertainment may include an activity that satisfies a personal, family, or living expense. The IRS notes that an individual in business may deduct the entertainment cost, including his personal benefit, as a business expense.
Translation: Business entertainment deductions aren’t limited to the costs of treating others; you’re also allowed to deduct your own costs if you “go Dutch.”
Tune in next week when we will give you more strategies to reduce your income taxes thereby giving yourself a raise!
For at least the last few years, the Internet has been abuzz about the “secret 770 account” that you simply must make a part of your investing strategy. Well, it’s not a secret — but it should be in your portfolio.
In this case, “770” refers to the section of the tax code covering funds inside a life insurance policy. Using the tax code to name a type of account is common: Think of the 401(k), 403(b) and the 1031 exchange.
Whole life insurance has been used for generations by corporations and dynasties to grow money safely, securely and in a tax-favored environment.
I was taught by financial gurus 25 years ago that you never put any money into a whole life insurance policy, and that theory is still being taught by some big names today. So when a friend whom I respect showed me how to use a life policy to grow and protect wealth, I spent three weeks trying to poke holes in his presentation — and I failed. Apparently, what I “knew” previously about whole life insurance was wrong.
If you are buying life insurance strictly for the protection, many advisers will recommend you buy term because it is much cheaper than whole life in the early years of the policy for the same death benefit. For example, if a 40-year-old man in good health wants $500,000 of coverage for his family, he can buy a straight term policy for 20 years for around $500 per year. The same coverage in a whole life policy might be $3,500 a year.
Financially Astute People Count on Many Benefits
If your main reason for setting up a whole life insurance policy is for the death benefit, that policy will differ from a policy whose main goal is to grow cash. Banks and Fortune 400 corporations have hundreds of billions of dollars in whole life. There are many benefits to purchasing a well-done life insurance contract. In fact, you will not find all these benefits in any other financial product.
- Your cash value balance is guaranteed by the insurance carrier to not go backward, assuming all premiums are paid.
- You will have guaranteed growth every year no matter how the stock market performs.
- All growth and dividends grow tax-deferred inside the policy.
- You have tax- and penalty-free access to your cash through policy loans at any age.
- There are no restrictions on when loans have to be paid back.
- Cash value may still increase even on borrowed funds, depending on the carrier.
- There are no restrictions — personal, business or investment — on using your cash value.
- There are very high limits on how much money can be put inside the policy (though avoid becoming a Modified Endowment Contract).
- It is possible to overcome the cost of insurance in the first few years and have the policy “self-complete” thereafter by paying remaining base premiums out of cash value — with cash value still growing larger
- You can borrow funds out of the policy and pay those funds back with much of the interest getting credited to your cash value, more quickly driving up the cash value.
- You maintain total control of your funds and cash flow.
- Access to the cash value is tax-free for the rest of your life.
- Since all this is done inside a life insurance contract, when you pass from this world, you will leave a large tax-free benefit to your estate (some limits apply).
If you say, “How much is the premium?” I know you are not grasping this concept. I know you understand if you ask, “How much money can I get in the policy?”
Traditional life policies are usually based on the income replacement needs of the insured. Properly designed life policies (or 770 accounts) are built more for the living benefits and less for the death benefit. The more financially astute understand the many other benefits and put as much cash in the policy as possible. The death benefit is the icing on an already fantastic cake.
There are many myths about life insurance that most people unfortunately consider as facts. Most of these myths are perpetrated by Wall Street and people who want every nickel of your money in the market under their management. The first huge myth is “buy term and invest the difference” and this one is so big it required its own article to debunk.
Life insurance is a lousy place to put money
What I described in previous articles about designing policies is very true but there are also some other facts that blow this myth away. Simply ask yourself this question, if putting money into life insurance contracts is such a lousy place to put money, why do the biggest and most wealthy institutions put loads of their own money into life insurance products? Major Banks, large corporations, and family dynasties have been putting boat loads of money inside these kinds of policies for generations. Are they that stupid about money? Not hardly. They are very savvy with money which is why they use life insurance contracts and other products to grow and protect their wealth.
Major Banks High Cash Value Life Insurance
As of 12/31/2014, Federal Financial Institutions Examinations Council Call Reports
|JPMorgan Chase||10.6 Billion Dollars|
|Wells Fargo Bank||17.995 Billion Dollars|
|Bank of America||20.794 Billion Dollars|
|PNC Bank||7.699 Billion Dollars|
Whole life insurance is too expensive
When someone tells me that I will simply say “in relationship to what?” If you are just comparing it to premiums for a term policy on the same coverage amount you are correct. However, because of the tax free guaranteed compounding of a proper life policy many of my clients will overcome the actual cost of the insurance in the first few years of the policy. These policies will get to the point where they self complete which means the insurance company owes you more than you owe them in minimum premiums. So if you decided to, you could have the basic premium paid out of cash value and your cash value will still grow and move forward. So when 20 years from now you still want coverage and go to extend your old term insurance policy or buy another one, get ready for the shock of the new premium based on your attained age. If you had strongly funded a life policy 20 years before, that policy’s death benefit would have been growing these last 20 years (all part of proper design of the policy with a proper carrier) and no more funds would be required to maintain the policy due to the huge cash values you have accrued. You would have also have had access to large cash values to use for other wealth strategies.
Universal life or Indexed Universal life does the same thing as Whole Life
This is such a myth that I will need more than the space allotted to let you know how these policies really work over time and why the cost of insurance will skyrocket over the life of the policy. Please download my free report at my website and find the indexed universal life report under the video. Don’t you dare buy one of these policies until you read this free report. If you already have one of these policies get the report and be thankful there is probably something we can do for you to help. Ask us about a 1035 exchange of that kind of a policy to one that is better suited for long term and being your own bank.
I am too old or in too bad of health to obtain a life insurance policy
I have clients all over the country who once believed this to be true but now own life insurance policies. If you like the concepts of self banking and insurance policies don’t assume you can’t qualify for one of these policies. You may be able to qualify and the numbers will still make sense. If you indeed can’t qualify yourself there are other options.
Many of my clients take out policies on their children or grandchildren which mean the younger, healthier person qualifies for the insurance but my client owns the policy with all the benefits. I have clients in their 70’s who took out new policies but put the policy on their adult children. They then went on to use the funds in the policy as their own bank. Contact us to see if this might be an option for your situation as well.
When I am speaking to a crowd on this topic I often call a properly designed whole life policy as the “one account” because it is so truly unique and powerful. It is the only account that I am aware of that can function with many different uses that all work together. This is the only account that can be:
Savings Account– When you are not using your money it is sitting inside of the life insurance contract collecting much more in interest than it would if it was sitting in a bank. As of this writing most savings accounts are paying 0.5% or less and some life carriers dividend scale is almost 6.5% on life policies. Even after you take out the cost of insurance in the early years of the policy your money still does far better than dying a slow death in a traditional bank. You have easy access to your funds just like a savings account so why keep most of your money in the bank doing nothing for you or your family?
Your Personal Bank– Just as described in the last chapter you can put these funds to use to plug up your 4 massive wealth drains and help you grow wealth as the bank. Because you are doing this inside of your life insurance contract your earnings are tax deferred inside the policy and when properly done can be accessed tax free. Also with some policies and carriers the money you borrow out will still be credited with growth and dividends. This is not common but there are carriers that allow this and we can help you determining which carrier is best for your needs
Retirement Account- There will come a time when you desire to pull an income stream out of your policy. You will be able to either withdraw the money as you see fit (not optimal most of the time) or take policy loans that you will not pay back. In most cases policy loans are optimal because you don’t have to pay taxes on policy loans. If you choose, you don’t have to pay the policy loans back during your lifetime. The loans can be paid back out of the death benefit after you pass away. For instance you have a $1,000,000 death benefit but have borrowed out $250,000 in policy loans and deferred interest and you pass away, your family will receive the $1,000,000 death benefit less any outstanding policy loans which in this case are $250,000. This will produce $750,000 tax free to your estate after you pass away.
Rainy Day Fund- You should never borrow all the cash value out of your policy but rather keep a chunk of money in the policy in case of emergency. This is a rainy day fund that produces solid interest rates and return.
Estate Creator- Let’s not forget you are creating all this wealth inside of a life insurance contract which will automatically leave behind money for your family and/or anyone else you choose after you pass away. My mom, as she aged, started to worry more about leaving money behind for her family instead of living as abundant of a life as she should have lead. This is the only kind of program where you can spend every nickel during your lifetime and still leave behind extra for your family. Wherever you have your money saved or invested currently, ask yourself if the account you have it in has all of the benefits listed below. These are all benefits of a properly designed life insurance contract. Please feel free to contact us if you need more information.
When you set up an individual retirement account, you’re usually given a list of investment choices — mostly stock-based funds, and some bond funds. Many financial professionals call this a self-directed IRA, but it’s really just a multiple-choice IRA: “You can invest in anything you like, as long as we approve it and control the funds.”
However, a real self-directed IRA can be set up with an administrator who is approved to handle nontraditional investments, such as real estate, private loans, tax liens, limited liability corporations, options and other non-stock and non-bond investments. These IRA are for the active and educated investor, not for the investor who just wants to put money away and turn the management over to brokers or financial advisers. It’s more work, but the potential with this type of account is tremendous.
Let’s consider a few hypothetical investments.
- If you bought a home for $50,000 using funds from your self-directed IRA and leased the property out for $900 a month, your net cash flow wouldn’t be taxable. If your net monthly positive cash flow was $550 (a reasonable figure), your $6,600 would either be tax-deferred or tax-free depending on the type of IRA you had used (traditional or Roth) to purchase the property. If you leased it for five years, that would mean $33,000 of positive cash flow would be in your IRA tax-free — plus, you still own the home. If you sold the home for $80,000, your net profit would be tax-deferred as well. In five years, you would have made $33,000 in cash flow plus $30,000 in appreciation, for a total of $63,000 of nontaxable profit in your IRA. And, yes, you can still take advantage of these types of deals.
- You could buy a fixer upper for $50,000 and put $25,000 in repairs for a total investment of $75,000. If you flipped that property for $110,000 and netted $105,000 after sale expenses, that would be a $30,000 profit. That profit will be tax-deferred — and you can repeat the process. If you had flipped the property outside of your IRA, you would be subject to short-term capital gains taxes, payable at your ordinary income level. You would have had to give $10,000 to Uncle Sam, and you’d have been left with just $20,000 after tax profit.
A More Complicated Scenario
You could buy a property and sell it with a wraparound mortgage. Let’s say you find a fixer-upper where the seller is willing to take a small down payment and carry the balance of his equity in a note and mortgage. The seller will take a payment for his equity for a number of years. Say the purchase price is $100,000, and your down payment (from your IRA) is $10,000. You have a $90,000 mortgage payable to the seller with a 30-year amortization at 5 percent, with a five-year balloon payment, giving you a principle and interest payment of $483.
You later sell with these terms:
- $125,000 purchase price.
- $20,000 down payment (giving your IRA the $10,000 investment back plus a $10,000 profit).
- $105,000 wraparound mortgage payable to you with a 30-year amortization at 7 percent, with a four-year balloon payment, giving you a $699 payment coming in every month.
- You are responsible for the underlying payment of $483, giving you a positive cash flow of $216 per month or $2,592 per year. This will be a four-year net cash flow of $10,368, plus the $10,000 profit up front.
- Also in four years, you will still be owed $100,000 but will only owe the underlying seller $84,000, giving you another profit on the back side of the sale of $16,000.
Let’s do a little back-of-the-envelope calculating to see if it’s worth your time to get educated on the ins and outs of this type of transaction. The profit over four years is $10,000 up front (the difference between the down payment you made and the down payment collected upon sale), $10,368 of positive cash flow and $16,000 of back end profit when loans are paid off for a $36,368 net profit for our IRA on a $10,000 investment that we received back in the first 90 days.
The Dodd-Frank Act mandates certain disclosure and actions be taken if you deal with private mortgages and financing. Get qualified help. Balloon mortgages are not acceptable anymore when selling to an ordinary buyer, but could be fine if you are selling to another investor.
In a transaction like this one, you would use borrowed money in the form of a seller-held mortgage. This would make some of your profit taxable out of the IRA, but the rest of the money would get to stay there tax-deferred. Your IRA can borrow money, but it has to be non-recourse debt, which means there are no personal guarantees on the money you borrow. If you don’t pay the seller, his or her only recourse is to foreclose on the house; he can’t come after the IRA or you personally for any deficiencies. Consult a highly knowledgeable real estate professional and an attorney to help you set this up properly. You should do research and get more training on these types of deals as well.
Some Limits Apply
There are some things you are not allowed to do with your IRA. Among them:
- You can’t invest in collectibles such as stamps, coins, comics or baseball cards.
- You can’t self-deal, which means no loaning money to yourself.
- You can’t loan money nor do business with IRA money with anyone in your direct linear family chain, such as your spouse, children, grandchildren and parents. Your IRA may do business with family members not in your direct lineage, such as siblings, aunts and uncles).
Several companies offer self-directed IRAs; two of the bigger ones are Equity Trust and Entrust. Before you go this route, it is important to do your homework on which is a good fit for you and what you are trying to accomplish. But if you’re up for the challenge of nontraditional investments, you should take a close look at this fantastic opportunity to be fully in control of your IRA.