The Hidden Secrets of a 401k

I want to share with you items to consider before investing in a 401k.  Some of those items are the tax ramifications and the control over your money you will be forfeiting.  Uncle Sam makes the decisions on when you can access your money without penalty, what the penalty is for early withdrawals, the taxes you pay, the required minimum distribution (RMD) amount, when you must begin to take the RMD and more… Watch my short presentation below for more information and view a full expo by both Frontline and 60 Minutes.

IRA’s – What you need to know

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Many have heard of an IRA but do they really know what it is or how the different types work?  An IRA is an Individual Retirement Account.  IRA’s are a way for you to save for retirement; something like a savings account but with limits on deposits, tax deferral, and restrictions & penalties on accessing the funds. Also, an IRA is an account and not an investment. The money is in the account and applied to different investments depending upon your choice of investment. Typical investments are stocks, bonds, mutual funds and/or other assets depending upon the type of IRA you opened.

Here is a breakdown of different IRA’s:

  • Traditional IRA – Generally, you pay taxes on the money (what you put in) when you begin your withdrawals; the money you initially put in is therefore tax deferred. The thought process on this is when you begin your withdrawals (currently mandatory at age 70-1/2 but can start as early as age 59-1/2 penalty free) your income will be less so your tax bracket is lower therefore you will owe less in taxes than if you paid them as you earned the money. With the advent of the 401k many people that leave their employer with a 401k then move the money into a Traditional IRA account.

There are annual limits on how much money you can contribute to a Traditional IRA based upon your income and age. As an example, currently in 2016, if you are under age 50 you contribute $5,500 annually. If you currently contribute through an employer plan consult a tax advisor before contributing to your IRA as it many impact your tax deductions allowed.

You can request an early withdrawal from your account however it will be taxed and you will pay a penalty (currently 10%) if it is requested before age 59-1/2.

  •  Roth IRA – With a Roth IRA you pay the taxes on the money going into the account and then your future withdrawals, including earnings, are tax free. However, the account must be open for at least five (5) years and the distributions begin after age 59-1/2. There are allowances for penalty free withdrawals such as for a first time home buyer.  Also, other withdrawals can be made tax-free; however, you might still have to pay a penalty. Always consult a tax advisor before making a withdrawal.
  • SEP IRA – Generally just referred to as a SEP this is a Simplified Employee Pension IRA. The SEP IRA is used by business owners with one or more employee’s, those that are self-employed or have freelance income for a simplified method to save and contribute to the employee’s and their own retirement. A SEP IRA is opened for each individual and contributions are made to the IRA by the employer. The SEP IRA follows the same rules as a Traditional IRA.
  • SIMPLE IRA – This is also for small business owners/employers and provides a simplified method for them to contribute to their and their employee’s retirement. SIMPLE stands for Savings Incentive Match Plan for Employees. This differs from the SEP IRA. Here employees may chose to make salary reduction contributions and the employer then makes matching or non-elective contributions. Each employee has their own SIMPLE IRA set up and contributions are made directly to that account.
  • Self-Directed IRA – This is similar to the Traditional IRA. However, the big difference is that you have control of the investments.  To open a Self-Directed IRA you must contact one of several companies out there that act as the custodian for your account.  You work through the custodian on where you want the money invested.  There are many more options for investing using this type of IRA.  Some options are real estate, tax lien certificates, precious metals and so much more.  However, there are strict rules on the self-directed IRA so be sure to do your research. For example: No loaning of money to yourself, your spouse or any family member in your direct linear family chain.

If you are interested in knowing more about IRA options you can check out information available on Roth Conversions and a Perpetual Pension that I have available for you.  Also, there are two great videos from Frontline and 60 minutes for you to watch.

Why lose a dime in the stock market again?

Did you know it’s not preordained that you must lose money in the stock market?  If you use the strategies of indexing and resetting you can grow your money without the risk of stock market losses. Enjoy this quick video explaining these two powerful yet little used strategies and let us know if we can help further.

Video – How to Avoid the Next Stock Market Crash

The Secret IRA

Types of IRA's

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).
  • Partnerships.

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.

Rental Income

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.

Profiting from an IRA Conversion?

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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:

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.

An IRA Option Your Financial Advisor Won’t Tell You About

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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.

Guaranteed Income (Part 3)

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Last week, we talked about investing, the second circle of wealth in my series of “Six Absolute Necessities for Acquiring Long-Term Wealth.” The third is guaranteed income. When I study people with successful retirements, filled with abundance and options, almost all have things in common:

  • They carry very little, if any, personal debt.
  • They have stable, secure income from multiple sources that they can set their watch by every month
  • Starting about 10 years before they retire, they begin shifting their assets from riskier investments to low- or no-risk income assets.

A mortgage is generally the biggest debt most of us have. Many argue that you should never pay off your house because the equity you put into it is tied up and not making you money. They might recommend borrowing as much as you can now because interest rates are low.

I say you can have the best of both worlds. First, pay off your mortgage before you retire. By adding small amounts directed to your principle every month, you will take months, even years off your payoff date. When your house is paid off, get the biggest equity line of credit you can. This way, if you see an attractive investment opportunity, you can put your equity to use, and if you don’t, you have removed the pressure of a big mortgage payment in retirement.

If you can pay off your mortgage while you are working, why not now shift that payment over to a solid savings or income product? This could work out to tens of thousands of extra dollars producing monthly income for when you retire.

An abundant retirement is about strong positive cash flow that you can count on for years to come. Do you have any idea how much money you need to retire every month? Do you know where you can get that income from? Do you have enough money for home health care or long-term care? Are you protected from big market downturns during your retirement years? How much will inflation eat into that monthly income needed?

Can You Answer These Questions?question mark

All these questions must be part of an income plan. We calculate these for clients all over the country. First, know how much income you and your spouse will receive from Social Security when you retire. You can get an estimate from the Social Security Administration. If you believe that number is at risk because of issues with Social Security, you better start putting more away and growing it safely.

If you need $5,000 per month to retire and the Social Security for you and your spouse is only $3,500, then you have a $1,500 shortfall. Do you have a pension? How much will that be when you begin to draw it? Do you have a 401(k) or Individual Retirement Account? How long could that account last if you need to draw $1,500 a month — $18,000 in a year? Will you have to pay taxes on what you take out? If you have a 401(k) or traditional IRA, the answer is yes. If you lose 50 percent of your capital to a bear market, how long will you be able to get $18,000 per year?

As you get to be in what we call the “retirement danger zone,” which is 10 years before your projected retirement, you need to start shifting assets away from market risk and over to guaranteed products. A solid fixed indexed annuity with a long-term income rider might be a very good call. I wrote an article about the different types of annuities and how to purchase one that fits your needs.

A lifetime income rider (state and product variations exist) will guarantee that you have a certain amount of income (depending on how much you have in your annuity and at what age you start withdrawing) for you and your spouse’s life. If you live to be very old, your normal retirement funds might run out, but a lifetime income rider guarantees that income stream regardless of what happens to the underlying cash in the account. Also if you have five to 10 years, you have time for that income rider to grow. Many income riders offer 6 percent and more guaranteed growth every year.

When you purchase a $200,000 annuity, many companies might offer a 10 percent bonus on your initial purchase price so your starting amount would be $220,000. When you add compound growth at 6 percent over 10 years, your income rider would top $400,000. Then you would start to draw your lifetime income at 6 percent of the $400,000, giving you $24,000 a year income for you and your spouse’s life. Presto! You have filled your income gap. If you have the resources to purchase another annuity, you might get one with a cost of living clause to hedge against inflation.

John Jamieson is the best-selling author of “The Perpetual Wealth System.” Check out this week’s featured video.

Do you review your beneficiary forms?

The importance of an annual review of your beneficiary forms on your different accounts and/or policies is often overlooked. Think of your smoke alarm; most people have an annual schedule to change their battery. Your beneficiary forms on your IRA, 401k, annuity or life insurance policies, etc… are important too and should be added to your schedule. At a minimum they should be reviewed by you annually and/or after a life-changing event such as death of a loved one, divorce Calendar 300x301or birth of a child.

Just think how upset you would be if the government took more taxes on your monies because you didn’t name the beneficiary correctly on one of your accounts. Maybe you forgot to change the beneficiary from your ex-spouse to your new spouse on your life insurance policy. Or you just named your estate as the beneficiary and therefore your estate goes to Probate Court. The probate process could take a year or more to get finalized; delaying your beneficiaries from getting the monies. This could have large ramifications for your loved one’s after you have passed away when you wanted to bring them peace of mind.

Did you know that your beneficiary form will override your will on your IRA accounts? Say you remembered to update your will after you remarried but didn’t update your beneficiary form on your IRA account. This means the monies in that account might not be going to the person or persons you wanted.

There could be tax ramifications for those named as your beneficiary on your different accounts and/or policies. For example; naming a person or trust as a beneficiary will usually help those monies avoid going to probate court. This could also keep the monies away from your estate and available to creditors. We recommend you speak with your tax advisor to determine the best way to list your beneficiary to avoid the common pitfalls that beneficiaries deal with after the death of their loved one.