Articles on Self-Directed IRAs, 401(k)s and Other Qualified Accounts

Transcription

1 Articles on Self-Directed IRAs, 401(k)s and Other Qualified Accounts H. Quincy Long, Certified IRA Services Phone: Professional (CISP), Attorney and President of Fax: Entrust Retirement Services, Inc. Toll-Free: Park Row, Suite Houston, Texas Title Page 1) The Truth About Self-Directed IRAs and Other Accounts 1 By H. Quincy Long 2) How the Richer Family Grows Richer 6 By H. Quincy Long 3) Using Self-Directed IRAs and 401(k)s to Make More 10 Money Now and to Build Your Retirement Wealth for the Future By H. Quincy Long 4) The Saver s Tax Credit How to Get $2,000 FREE 12 From the U.S. Government By H. Quincy Long 5) What s in a Name? Why It s Important to Name 14 A Beneficiary for Your IRA By H. Quincy Long 6) Can I Have a Roth Too, Please? Yes, You Can! 16 By H. Quincy Long 7) Do Roth Conversions Make Sense? 19 By H. Quincy Long and Carol A. Cantrell 8) Self-Directed Health Savings Accounts Building 34 Wealth Through Health By H. Quincy Long 9) The Amazing Health Savings Account The Best of Both Worlds 36 By Nathan W. Long i

2 10) How to Pay for Education Expenses With 38 Tax-Free Dollars By H. Quincy Long 11) To Pay or Not to Pay? That is the Question 41 Why Your IRA May Owe Taxes By H. Quincy Long 12) Frequently Asked Questions About Buying 50 Debt-Financed Real Estate in an IRA By H. Quincy Long 13) Prohibited Transactions and Other Restrictions on 54 IRAs and Other Plans By H. Quincy Long 14) Buying Real Estate in Your IRA 60 By H. Quincy Long 15) Either a Lender or a Borrower Be 67 By H. Quincy Long 16) Wealth Building Option Strategies for Your IRA 70 By H. Quincy Long 17) Entity Investments in Your IRA 75 Advantages, Cautions and Legal Considerations By H. Quincy Long 18) Entity Investments in Your IRA 78 Is Your Investment Income Taxable to the IRA? By H. Quincy Long 19) Entity Investments in Your IRA 81 Prohibited Transactions and Disqualified Persons By H. Quincy Long 20) Entity Investments in Your IRA 84 Who Cares About the Plan Asset Regulations? By H. Quincy Long ii

3 21) Entity Investments in Your IRA 87 Swanson v. Commissioner and the Checkbook Control IRA-Owned LLC By H. Quincy Long 22) How to Stretch a Roth IRA to Last More Than 150 years 90 By H. Quincy Long 23) Do Roth Conversion Make Sense? 93 How to Analyze the Roth Conversion Opportunity in 2010 By H. Quincy Long 24) 10 Things You Need To Know About Self-Directed IRAs 96 By: H. Quincy Long 25) 10 Things Your Need To Know When Investing in Real Estate Notes 100 By: H. Quincy Long iii

4 The Truth About Self-Directed IRAs and Other Accounts By H. Quincy Long There is a lot of confusion over self-directed IRAs and what is and is not possible. In this article we will disprove some of the more common self-directed IRA myths. Myth #1 Purchasing anything other than CDs, stocks, mutual funds or annuities is illegal in an IRA. Truth: The only prohibitions contained in the Internal Revenue Code for IRAs are investments in life insurance contracts and in collectibles, which are defined to include any work of art, any rug or antique, any metal or gem (with certain exceptions for gold, silver, platinum or palladium bullion), any stamp or coin (with certain exceptions for gold, silver, or platinum coins issued by the United States or under the laws of any State), any alcoholic beverage, or any other tangible personal property specified by the Secretary of the Treasury (no other property has been specified as of this date). Since there are so few restrictions contained in the law, almost anything else which can be documented can be purchased in your IRA. A self-directed IRA allows any investment not expressly prohibited by law. Common investment choices include real estate, both domestic and foreign, options, secured and unsecured notes, including first and second liens against real estate, C corporation stock, limited liability companies, limited partnerships, trusts and a whole lot more. Myth #2 Only Roth IRAs can be self-directed. Truth: Because of the power of tax free wealth accumulation in a self-directed Roth IRA, many articles are written on how to use a Roth IRA to invest in non-traditional investments. As a result, it is a surprisingly common misconception that a Roth IRA is the only account which can be self-directed. In fact, there are seven different types of accounts which can be self-directed. They are the 1) Roth IRA, 2) the Traditional IRA, 3) the SEP IRA, 4) the SIMPLE IRA, 5) the Individual 401(k), including the Roth 401(k), 6) the Coverdell Education Savings Account (ESA, formerly known as the Education IRA), and 7) the Health Savings Account (HSA). Not only can all of these accounts invest in non-traditional investments as indicated in Myth #1, but they can be combined together to purchase a single investment. 1

5 Myth #3 I don t qualify for a self-directed Roth or Traditional IRA because I am covered by a retirement plan at work or because I make too much money. Truth: Almost anyone can have a self-directed account of some type. Although there are income limits for contributing to a Roth IRA (in 2008 the income limits are $169,000 for a married couple filing jointly and $116,000 for a single person or head of household), having a plan at work does not affect your ability to contribute to a Roth IRA, and there is no age limit either. With a Traditional IRA, you or your spouse having a retirement plan at work does affect the deductibility of your contribution, but anyone with earned income who is under age 70 1/2 can contribute to a Traditional IRA. There are no upper income limits for contributing to a Traditional IRA. Also, a Traditional IRA can receive funds from a prior employer s 401(k) or other qualified plan. Additionally, you may be able to contribute to a Coverdell ESA for your children or grandchildren, nieces, nephews or even my children, if you are so inclined. If you have the right type of health insurance, called a High Deductible Health Plan, you can contribute to an HSA regardless of your income level. With an HSA, you may deduct your contributions to the account and qualified distributions are tax free forever! It s the best of both worlds. All of this is in addition to any retirement plan you have at your job or for your self-employed business. Myth #4 I can t have a self-directed 401(k) plan for my business because I am selfemployed and file a Schedule C for my income. Truth: You can have a self-directed SEP IRA, a SIMPLE IRA or a 401(k) plan even if you are self-employed and file your income on Schedule C of your personal tax return. With a SEP IRA, you can contribute up to 20% of your net earnings from self-employment (calculated by deducting one-half of your self-employment tax from your net profits as shown on Schedule C) or 25% of your wages from an employer, up to a maximum of $46,000 for With the SIMPLE IRA, you can defer up to the first $10,500 of your net earnings from self-employment (calculated by multiplying your net Schedule C income by % for SIMPLE IRA purposes), plus an additional $2,500 of your net earnings if you are age 50 by the end of the year, plus you can contribute an additional 3% of your net earnings as an employer contribution. Beginning in 2002 even self-employed persons are entitled to have their own 401(k) plan. Better yet, in 2006 the Roth 401(k) was added, allowing even high income earners to contribute after tax dollars into an account where qualified distributions are tax free forever! With an Individual 401(k) you can defer up to $15,500 (for 2007 and 2008) of your net earnings from self-employment (calculated by deducting one-half of your self-employment tax from your net profits as shown on Schedule C), plus an additional $5,000 of your net earnings if you reach age 50 by the end of the year, plus you can contribute as much as an additional $30,500 based on up to 20% of your net earnings for 2008 (or 25% of your wages from an employer). This means that a 50 plus year old selfemployed person can contribute up to $51,000 for 2008! 2

6 Myth #5 Because I have a small IRA and can only contribute $5,000, it s not worth having a self-directed IRA. Truth: Even small balance accounts can participate in non-traditional investing. Small balance accounts can be co-invested with larger accounts owned by you or even other people. For example, one recent hard money loan we funded had 10 different accounts participating. The smallest account to participate was for only $1,827.00! There are at least 4 ways you can participate in real estate investment even with a small IRA. First, you can wholesale property. You simply put the contract in the name of your IRA instead of your name. The earnest money comes from the IRA. When you assign the contract, the assignment fee goes back into your IRA. If using a Roth IRA, this profit is tax-free forever! Second, you can purchase an option on real estate, which then can be either exercised, assigned to a third party, or canceled for a fee. Third, you can purchase property in your IRA subject to existing financing or with a nonrecourse loan from a bank, a hard money lender, a financial friend or a motivated seller. Profits from debt-financed property in your IRA may incur unrelated business income tax (UBIT), however. Finally, as mentioned above, your IRA can be a partner with other IRA or non-ira investors. Myth # 6 If I want to purchase non-traditional investments in an IRA, I must first establish an LLC which will be owned by my IRA. Truth: A very popular idea in the marketplace right now is that you can invest your IRA in an LLC where you (the IRA owner) are the manager of the LLC. Effectively you have checkbook control of your IRA funds. Providers generally charge thousands of dollars to set up these LLCs and sometimes mislead people into thinking that this is necessary to invest in real estate or other non-traditional investments. This is simply not true. Not only can an IRA hold title to real estate and other non-traditional investments directly with companies such as Entrust Retirement Services, Inc., but having checkbook control of your IRA funds through an LLC can lead to many traps for the unwary. Far from protecting your IRA from the prohibited transaction rules, these setups may in fact lead to an inadvertent prohibited transaction, which may cause your IRA to be distributed to you, sometimes with substantial penalties. This is not to say that there are not times when having your IRA make an investment through an LLC is a good idea, especially for asset protection purposes. Nonetheless, you must educate yourself completely as to the rules before deciding on this route. Having a checkbook control IRA owned LLC is kind of like skydiving without a parachute it may be fun on the way down, but eventually you are likely to go SPLAT! 3

7 Myth #7 I can borrow money from my IRA to purchase a vacation home for myself. Truth: Although the Internal Revenue Code lists very few investment restrictions, certain transactions (as opposed to investments) are considered to be prohibited. If your IRA enters into a prohibited transaction, there are severe consequences, so it is important to understand what constitutes a prohibited transaction. Essentially, the prohibited transaction rules were made to discourage disqualified persons from dealing with the assets of the plan in a self-dealing manner, either directly or indirectly. The assets of a plan are to be invested in a manner which benefits the plan itself and not the IRA owner (other than as a beneficiary of the IRA) or any other disqualified person. Investment transactions are supposed to be on an arms length basis. As a result of these legal restrictions, a loan from your IRA or staying at a vacation home owned by your IRA, even if fair market rates are paid for interest or rent, would be prohibited. Myth #8 With a self-directed IRA, I can borrow my IRA funds to purchase real estate and then put all the profits back into the IRA. Truth: When real estate or any other asset is purchased within a self-directed IRA, the money never leaves the IRA at all. Instead, the IRA exchanges cash for the asset, in the same way that an IRA at a brokerage house exchanges cash for shares of stock or a mutual fund. Therefore, the asset must be held in the name of the IRA. For example, if Max N. Vestor were to purchase an investment house in his self-directed IRA, the title would be held as Entrust Retirement Services, Inc. FBO Max N. Vestor IRA # Since the IRA owns the asset, all expenses associated with the asset must be paid by the IRA and all profit resulting from that investment belongs to the IRA, including rents received and gains from the sale of the asset. Myth #9 If my IRA buys real estate, it must pay all cash for the property. An IRA cannot buy real estate with debt. Truth: An IRA can own debt-financed property, either directly or indirectly through a non-taxed entity such as an LLC or partnership. Any debt must be non-recourse to the IRA and to any disqualified person. An IRA may have to pay Unrelated Debt Financed Income Tax (UDFIT) on its profits from debt-financed property. In general, taxes must be paid on profits from an IRAowned property that is debt-financed, including profits from the sale or disposition of the property, in the same proportion that it had debt. For a simplified example, if the IRA puts 50% down, then 50% of its profits above $1,000 will be taxable. Although at first this sounds terrible, 4

8 in fact leverage can be an extremely powerful tool in building your retirement wealth. The same leverage principle applies inside or outside of your IRA you can do more with debt-financing than you can without it. One client was able to build her Roth IRA from $3,000 to over $33,000 in less than 4 months even after paying the taxes due by taking over a property subject to a debt and selling the property to another investor! Myth #10 An IRA cannot own a business. Truth: A self-directed IRA is an amazingly flexible wealth building tool and can own almost anything, including a business. However, due to the conflict of interest rules you cannot work for a business owned by your IRA and get paid. Some companies have a plan to start a C corporation, adopt a 401(k) plan, roll an IRA into the 401(k) plan and purchase employer securities to effectively start a new business, but this is not a direct investment by the IRA in the business and is fairly expensive to set up. Also, if your IRA owns an interest in a business, either directly or indirectly through a non-taxed entity such as an LLC or partnership, the IRA may owe Unrelated Business Income Tax (UBIT) on its profits from the business. A solution to this problem may be to have the business owned by a C corporation or another taxable entity. 5

9 How the Richer Family Grows Richer By H. Quincy Long Ira N. Richer, a 56 year old self-employed consultant, his wife, Hope Tobe Richer, Ira s 51 year old stay at home wife, and their 17 year old son, Will B. Richer are interested in saving money in self-directed accounts at Entrust. How much money can they contribute based on Ira s $30,000 net earnings from his consulting practice? Roth and Traditional IRAs Roth IRA Anytime from January 1, 2008 through April 15, 2009, Ira and Hope can both contribute to a Roth IRA for Even though Hope does not earn wages, she can still contribute to a Roth IRA based on Ira s income, assuming they are married filing jointly for federal tax purposes. Even if he doesn t claim net earnings from self-employment of over $30,000, Ira can contribute $6,000 into each Roth for 2008 ($5,000 base contribution plus a $1,000 catch up contribution since they were both at least 50 years of age by December 31, 2008). Assuming their son Will has compensation of at least the amount of his contribution, he may also contribute $5,000 to his own Roth IRA for Traditional IRA Ira and Hope could have contributed the amounts described under the Roth IRA into Traditional IRAs, but their total contributions to both their Traditional IRAs and their Roth IRAs cannot exceed the annual contribution limit of $6,000 per person over the age of 50. In this case they elected to put the entire contribution into their Roth IRAs. If neither Ira nor Hope were covered by a retirement plan at work, their contributions to a Traditional IRA would be fully deductible, no matter how much income they earned. Roth Conversion If Ira or Hope has money in a Traditional IRA (including a SEP IRA), that money can be converted into a Roth IRA provided that their Modified Adjusted Gross Income (MAGI) is $100,000 or less in the year they do the conversion. Any amount they convert is added to their taxable income for the year, but no penalties are assessed for doing a Roth conversion. Important Note: in 2010 the amount of modified adjusted gross income made by Ira and Hope will not affect their ability to do a Roth conversion. Also, they may split the taxes from the 2010 conversion and pay 50% in 2011 and 50% in For conversions in 2011 and after, taxes must be paid on the conversion income in the year the Traditional IRA was converted to the Roth. Work Plans Ira can also have an employer plan based on his self-employment consulting income. With any of the work plans discussed below, Ira must also cover any other employees under the 6

10 plan. This may affect which of the plans he chooses for his business. We will assume that Ira has no employees. Having any of the work plans discussed below does not affect Ira s or Hope s ability to contribute to a Traditional or Roth IRA, but above certain income levels it will affect the deductibility of a Traditional IRA contribution. SEP IRA Ira can choose to have a SEP IRA plan into which he can contribute up to a maximum of 20% of his net earnings from self-employment, or 25% of his W-2 wages if he is paid through a company. Net earnings from self-employment are calculated for SEP IRA purposes by deducting one-half of his self-employment tax from his net profits as shown on Schedule C. The plan can be set up and funded at any time prior to Ira s tax filing deadline, including extensions (ie. October 15, 2009 if Ira files for an extension). Since Ira s net earnings from self-employment were $30,000 in our scenario, he can contribute up to $6,000 into his SEP IRA at Entrust (the contribution limit would be $7,500 if Ira were paid W-2 wages from a company instead of reporting his income on Schedule C as self-employment income). If he wants to, in January of 2009 Ira can begin making contributions for 2009 to his SEP IRA. SIMPLE IRA - Another alternative is for Ira to have a SIMPLE IRA for his consulting business. This type of plan is appropriate for those with lower income levels or for those who have employees and who don t want to contribute an equal percent into their employees retirement plans as they do for themselves. Assuming he had the plan set up by October 1, 2008, Ira can contribute $10,500 of his net earnings from self-employment for 2008, plus an additional $2,500 catch up because he is over age 50 by December 31, The $13,000 is considered salary deferral and must be contributed by January 30, Ira can also contribute an additional $900 as an employer contribution by his tax filing deadline, including extensions (ie. October 15, 2009). For SIMPLE IRA purposes, net earnings from self-employment are calculated based on 92.35% of Ira s net Schedule C income. Ira is considered both the employer and the employee since he is self-employed. The total 2008 SIMPLE IRA contribution is $13,000 in salary deferral and $900 in employer contribution for a total of $13,900. This is an improvement over what he can contribute to a SEP IRA at his income level, but at income levels above around $60,000 (or around $48,000 if under age 50) the SEP is more advantageous, absent other factors. Profit Sharing/401(k) Plan The plan into which Ira can put the most money is an Individual 401(k)/Profit Sharing plan. An Individual 401(k)/Profit Sharing plan must be set up by December 31, 2008 if Ira wants to contribute or defer compensation for In this plan Ira can defer $15,500 plus $5,000 catch up for 2008 out of his $30,000 net earnings from selfemployment. Net earnings from self-employment is calculated for Individual 401(k)/Profit Sharing plan purposes by deducting one-half of his self-employment tax from his net profits as shown on Schedule C. In addition, Ira can contribute up to 20% of Ira s net earnings or 25% of his wages if he is paid by a company into the plan, or $6,000. These contributions must be made by Ira s tax filing deadline, including extensions. This means that for 2008, Ira can contribute $26,500 into his Individual 401(k) plan with only $30,000 in earned income! 7

11 Even better, starting in 2006, Ira s salary deferral can be a Roth 401(k), which means that he will pay taxes on his salary deferral when he contributes, but will pay NO TAXES when the funds are distributed to him, provided they are qualified distributions. What an opportunity! Although Ira qualifies for a Roth IRA because of his income level, even if he makes too much money to qualify for a Roth IRA he can defer salary into a Roth 401(k). The employer contribution ($6,000 in Ira s case) is pre-tax, so part of Ira s withdrawals from the plan will be taxable and the portion relating to the Roth 401(k) will be tax free. Additional Choices Besides Traditional or Roth IRAs and an Individual 401(k) plan, SEP IRA or SIMPLE IRA for Ira s consulting business, the Richer family can also have two other types of accounts. These are the Health Savings Account (HSA) and the Coverdell Education Savings Account (ESA). Like the other accounts they have at Entrust, the HSA and the ESA can be self-directed. Neither of these types of accounts is directly related to how much money Ira earns, although above certain income levels Ira and Hope could not contribute to Will s Coverdell Education Savings Account. Health Savings Accounts Ira and Hope can save on taxes for 2008 by opening a Health Savings Account, or HSA. In order to do this, they have to have a special type of insurance plan, called a High Deductible Health Plan, or HDHP. Just having a plan with a high deductible does not necessarily qualify you for an HSA. Assuming Ira and Hope have a family plan, they can contribute up to $5,800 for 2008 up until April 15, Because Ira is over 55 years old, he can add a $900 catch up contribution for 2008 in addition to the regular contribution. Ira and Hope can split the contribution into 2 separate accounts or put all of it into one account. Starting in 2007 contributions are no longer limited by the deductible amount, as they were in years past. Even if Ira and Hope have the minimum deductible of $2,200 for a family plan, they can contribute the maximum of $5,800 for the year plus the catch up contribution. Contributions to HSA accounts are tax deductible, and there is no tax on the distributions if the money is used for qualified medical expenses. This truly is the best of both worlds! Coverdell Education Savings Accounts (formerly Education IRA) Since Will is under age 18, Ira can put up to $2,000 into a Coverdell ESA for Ira will receive no deduction for the contribution, but any earnings which are withdrawn for qualified education expenses are tax free. Qualified education expenses include certain expenses for grade school and high school as well as for college. 8

12 Summary For the tax year of 2008, here is the maximum amount of money that the Richer family can put into self-directed accounts at Entrust: Maximum Contribution For Richer Family Ira s Roth IRA $ 6,000 Hope s Roth IRA $ 6,000 Will s Roth IRA $ 5,000 Ira s Individual (k) $26,500 Ira s HSA $ 6,700 Will s ESA $ 2,000 Total $52,200 Assuming all distributions are qualified distributions, the earnings from the Roth IRAs, the Roth 401(k), the HSA and the ESA are tax free forever! This means that the Richers can get richer by investing as much as $46,200 tax free and the balance on a tax deferred basis. All of these accounts can invest in real estate, real estate options, promissory notes, both secured and unsecured, LLCs, limited partnerships, private stock and much more. They can invest individually or in combination with each other. To find out more about these accounts, contact your local Entrust office today! 9

13 Using Self-Directed IRAs and 401(k)s to Make More Money Now and to Build Your Retirement Wealth for the Future By H. Quincy Long Self-directed IRAs and 401(k) plans have been around for more than 25 years, but many people are just now becoming aware of how powerful this idea can be. There are currently trillions of dollars in retirement plans. Do you know how to unlock your own retirement funds as well as the retirement funds of those within your circle of influence for real estate related and other non-traditional investments? Your knowledge of self-directed retirement plans can help make you money now as well as ensuring that you retire in style. Plans available for self-direction. A lot of retirement wealth is in traditional IRAs and employer sponsored plans. If you leave an employer, the funds in the employer plan can be moved into a self-directed traditional IRA. This includes money rolled over from 401(k) plans, 403(b) plans, 457 deferred compensation plans, and the federal thrift savings plan. Selfemployed people may have their own Individual 401(k) plan, which may even include the new Roth 401(k), no matter what their income level. Other employer sponsored plans which can be self-directed are SEP IRAs and SIMPLE IRAs. The king of all IRAs when it comes to building tax free wealth is the Roth IRA. Even if you do not qualify for a Roth IRA due to income limitations currently, in 2010 the income limitation for conversions from a traditional IRA to a Roth IRA will be eliminated. At that point even the very wealthy will be entitled to have a Roth IRA. This is a great planning opportunity! How does paying for your child s education or your health care expenses with tax free income sound? You can even self-direct a Coverdell Education Savings Account (ESA) or a Health Savings Account (HSA), and as long as distributions are for qualified education or health care expenses they are TAX FREE FOREVER. With an HSA you even get a tax deduction for putting the money in! Perhaps the best news of all is that you may combine your IRAs and other self-directed plans to make non-traditional investments. Even better, you can invest your IRAs with other people s IRAs or even non-ira money of people you know. The key element is that you must have your plans administered at a self-directed IRA company like Entrust Retirement Services, Inc. Make money now. We have all heard that knowledge is power. Your knowledge of self-directed retirement plans can translate into money in your pocket today. How? It s easy! While it is true that you may not derive a current benefit from your own IRA s investments, this does not mean that you cannot benefit right now from Other People s IRAs (OPI). Simply 10

14 become knowledgeable about self-directed plans by reading books and attending seminars or workshops, then spread the good news! Entrust has many seminars and workshops to help you and those whose IRAs you want to use to make money for yourself. There are also numerous books on the market explaining the power of self-directed retirement plans, such as Hubert Bromma s Investing in Real Estate With Your IRA and 401(k) which are selling quickly. For more information on seminars and workshops in your area, visit the Entrust website at Even if you don t have a dime of retirement funds yourself, you can use your knowledge to: * Borrow other people s IRA money to do your deals today * Sell real estate, notes or other non-traditional assets to people s IRAs * Make others aware of an opportunity to invest in your business (always be aware of securities laws when raising money) Anytime you go to a gathering of people, there are most likely millions of dollars available for non-traditional investments in their retirement plans. It is up to you to let people know about this powerful tool, and how they can take some or all of that anemic money and put it to work in a way that benefits both you and them. You will look highly intelligent and will inspire confidence with your advanced knowledge. You owe it to yourself to learn more today. Entrust can help. Invest your own IRA in what you know best. With all your knowledge of self-directed IRAs, you will most likely want to invest your own retirement funds in non-traditional investments as well. What investments do you know the most about? Almost without exception, you can invest in what you know best with your own IRA. The law contains very few investment restrictions for retirement plans, but most custodians refuse to allow IRAs to invest in non-traditional investments such as real estate simply because they are not set up to handle them. Not true with Entrust! Entrust self-directed retirement plans are under the same laws as plans at any other custodian or administrator. We are simply more flexible when it comes to administering nontraditional investments in your IRA or other self-directed plan. Entrust clients have used their retirement plans to purchase all of the following and much more: real estate, both foreign and domestic, including debt leveraged real estate, real estate options, loans secured by real estate, unsecured loans, limited partnership interests, limited liability company shares, stock in nonpublicly traded corporations, land trusts, factored invoices (including factored real estate commissions), tax lien certificates, foreclosure property, joint ventures, oil and gas interests and even race horse colts! You are limited only by your imagination. Ignorance may be bliss, but it will not make you wealthy. Use your knowledge of self-directed IRAs to make money now, to help others build their retirement wealth as well as your own, and to retire in the style and comfort in which you would like to become accustomed. Contact Entrust today! 11

15 By H. Quincy Long The Saver s Tax Credit How to get up to $2,000 FREE from the U.S. Government Tax time is coming, and many of you are considering whether or not to make a 2007 contribution to your Traditional or Roth IRA. I have good news! If you are at least 18 years old, you are not a full-time student, you are not claimed as a dependent on another person s tax return and you meet the income requirements listed below, you are entitled to a tax credit of up to 50% of your contribution to almost any type of retirement plan, including a Roth IRA! If you then take your refund from the government and put it back into your IRA, your retirement savings will increase by as much as 50%! Begun in 2002 as a temporary provision, the saver s credit was made a permanent part of the tax code as part of the Pension Protection Act of To help preserve the value of the credit, income limits are now adjusted annually to keep pace with inflation. To qualify for the Saver s Tax Credit, you must have Modified Adjusted Gross Income (MAGI) within the following limits for 2007: Credit Income for Married Income for Head of Income for Rate Filing Jointly Household Others 50% up to $31,000 up to $23,250 up to $15,500 20% $31,001 to $34,000 $23,251 to $25,500 $15,501 to $17,000 10% $34,001 to $52,000 $25,501 to $39,000 $17,001 to $26,000 The maximum tax credit allowed for 2007 is $1,000 (with a $2,000 contribution), or up to $2,000 if married filing jointly and each spouse makes a contribution. Simply attach Form 8880, Credit for Qualified Retirement Savings Contributions, to your income tax return, and you will receive up to a $2,000 tax credit. A tax credit is a dollar for dollar reduction in your tax bill, as opposed to a tax deduction, which only reduces the amount of money on which you pay income taxes. You may get more information on this credit from IRS Publication 590. To prevent abuse, the IRS has rules which will reduce the amount of contribution which qualifies for the saver s tax credit if the IRA owner has taken distributions from any eligible employer plan or IRA during a specified testing period. The testing period includes the two taxable years prior to the year the credit is claimed, plus the taxable year the credit is claimed and the following year up until the tax filing deadline for the year the credit is taken, including extensions. For example, if Josh contributes $2,000 to his Roth IRA for 2007 but had previously removed $500 from his IRA in 2006 and removes an additional $500 in 2008 before 12

16 October 15, only $1,000 of his $2,000 Roth IRA contribution for 2007 may be used toward the saver s tax credit on his 2007 tax return. Let me give you an example. Lucky Larry, a married man, was downsized from his job in the corporate world in December, Larry decided that he wanted to be a real estate investor instead of looking for another j-o-b. Things went fine in 2007, but Larry s modified adjusted gross income after all of his expenses will be $30,000 due to his various write-offs, and his taxable income after the standard deduction and 2 exemptions will be $13,500. Therefore his taxes before the tax credit will be $1,353 (see instructions for Form 1040, page 65). He and his wife contribute $1,353 each to a self-directed Roth IRA at Entrust, which they can use to purchase real estate options, debt-leveraged real estate, and many other things. Larry and his wife will receive a tax credit of $1,353 (50% of each of their contributions). Although the maximum contribution for purposes of the tax credit is $2,000 each, the tax credit is non-refundable. This means that the maximum tax credit Larry and his wife can receive is equal to the taxes they would otherwise pay. With the tax credit, Larry s income tax for 2007 is ZERO! Larry and his wife wisely decide to contribute the tax refund back into their Entrust self-directed Roth IRAs. Each Roth IRA grows by 50% to $2, absolutely FREE, courtesy of the United States government! 13

17 By H. Quincy Long What s in a Name? Why It s Important to Name a Beneficiary for Your IRA Many people probably don t think too much about how important it is to name a beneficiary for their IRAs. However, as my family recently found out, ignoring this important detail when setting up your IRA can be costly from a tax perspective. I recently received a distribution check from an IRA of my father, who passed away last year. My father was a very careful planner, so I was quite shocked at his lack of tax planning with his IRA. When setting up his IRA he named his estate as the beneficiary of the IRA (this is equivalent to not naming a beneficiary at all). This meant that when he passed away the estate had to be probated, even though the IRAs were the only assets requiring probate in his estate. IRAs that have named beneficiaries are generally non-probate assets, meaning that they pass directly to the beneficiaries instead of passing through a will. That was the first problem. The larger problem came because of the lack of choices he left us by naming his estate as beneficiary. In a Traditional IRA, required minimum distributions must begin no later than April 1 of the year after the IRA owner turns age 70 ½. This is known as the required beginning date. My father died before his required beginning date. Since his estate is a non-individual beneficiary, the IRA had to be distributed within 5 years, or by December 31, If my father had died after his required beginning date without having a named individual beneficiary, the yearly required minimum distributions would have been based on his remaining life expectancy in the year of his death reduced by one for each year following the year of his death. In contrast, the choices available to our family had my father simply named beneficiaries would have been much more favorable. Assuming my father wanted his wife and 3 sons to split the IRA in the same percentages he listed in the will, he could have named us specifically instead of requiring the distribution to be made through his estate. If the IRA was not split into separate IRAs by September 30 of the year following the year of his death, then required minimum distributions would have been based on the remaining life expectancy of the oldest beneficiary, which was of course his wife. As his wife is a few years younger than he was, this certainly would have been a large improvement over taking the entire IRA over the next 5 years. Had my father named the 4 of us as beneficiaries specifically, an even better plan would have been to separate the IRAs into 4 beneficiary IRAs with each of us as the sole beneficiary prior to September 30 of 2007 (the year following his death). In his wife s case this would mean that she could choose to take all the money out within 5 tax years, leave the IRA as a beneficiary IRA, thereby allowing her to take distributions without penalty even if she was under age 59 1/2, or she could have elected to treat the IRA as her own. In the case of his sons, we could have 14

18 taken the IRA over 5 years or we could have stretched the distributions over our life expectancy. For example, in my case I could have elected to take the distributions over the next 39 years instead of all at once! Since I expected nothing from my father s estate and have no critical need for the funds, I would have taken the longer distribution period. Instead I must add the distribution check to my taxable income for this year, which in my tax bracket means a substantial bite out of the money for taxes. Since I am reasonably good at investing in my self-directed IRAs, having the ability to stretch the distributions out over 39 years would have meant an inheritance of many times what I will end up with after taxes because I had to take it all within 5 years. The problem is even worse for my father s wife, who will have an extraordinarily large tax burden this year, since she chose to take her share of the IRA out all at once instead of over a 5 year period. While I am certainly grateful that my father thought of me in his will, simply naming specific beneficiaries would have made his legacy worth so much more to his family. Don t let it happen to your family! Review your IRA beneficiary designations, and if you haven t already done so, name your beneficiaries. Your family will be glad you did. 15

19 Can I Have a Roth Too, Please? Yes, You Can! By H. Quincy Long Most people want a Roth IRA once they understand the tremendous tax benefits. You do not receive a tax deduction for contributing money to a Roth IRA, but qualified distributions are TAX FREE FOREVER. Essentially the concept of a Roth IRA is that you pay taxes on the acorn (the initial contribution) instead of the oak tree (the potentially large amount in the Roth IRA after many years of tax deferred accumulation). This is especially beneficial in a truly self-directed IRA, which can invest in real estate, notes, options, private company stock, LLCs, limited partnerships and other non-traditional assets. Unfortunately, there are income limits for contributing to a Roth IRA or converting money from a Traditional IRA to a Roth IRA. For contributions, a married couple filing jointly may not contribute if they have Modified Adjusted Gross Income (MAGI) of more than $169,000 for For single individuals the MAGI limit is no more than $116,000 for 2008 to be able to contribute to a Roth IRA. The news is even worse if you want to convert assets from a Traditional IRA to a Roth IRA. Whether married or single, you are not eligible to do a Roth conversion if your MAGI is more than $100,000. For people who exceed these income limits, it might at first appear that they are left out in the cold when it comes to Roth IRAs. Fortunately, this is not actually true. There are at least 3 ways in which a person who exceeds the income limits may end up with a Roth IRA. The key phrase is end up with in the preceding statement. The first method of acquiring a Roth IRA if you exceed the income limits is to inherit one. There is no age discrimination for contributing to a Roth IRA, unlike the Traditional IRA. Anyone with earned income within the limits can contribute. Earned income is generally income on which you must pay Social Security and Medicare taxes. Passive or investment income, including rents, interest and dividends do not count as earned income, but it is not that hard to create earned income. An elderly relative or friend may be able to help in your business in some way, for example, and your payment to them for their assistance would be earned income. They may even be predisposed to name you as their beneficiary in the event of their death. When a Roth IRA is inherited, the new account owner must take required minimum distributions from the IRA, unless the inheritor is a spouse. Required minimum distributions are not required for the original account owner. However, this does not mean that the balance in the account cannot be invested, and it is easy, at least with a self-directed IRA, to create income which exceeds the yearly required minimum distributions. Even better, if the person who died had a Roth IRA for at least 5 tax years, distributions from the account are tax free, even if the 16

20 inheritor is under age 59 ½. There is never a 10% premature distribution penalty either, since the distribution is due to death. A second method to acquire a Roth IRA has to do with excess contributions. Many people do not really know whether their income will exceed the limits when they make their Roth IRA contribution, especially if they contribute early in the year. This is certainly true of self-employed persons. So what happens if you make a mistake by contributing early and it turns out your income exceeded the MAGI limit for the year? If you take action before your tax filing deadline, including extensions (generally October 15), you can recharacterize the contribution to a traditional IRA as long as you are under age 70 1/2, along with all of the net income attributable (NIA) to the contribution. You may also remove the contribution from the Roth IRA, along with any net income attributable. In this case the only penalty which you might have to pay is on the income attributed to the contribution, not on the contribution itself. If you remove the contribution after your tax filing deadline plus extensions, it is unclear from the regulations whether you must also remove the net income attributable from the Roth IRA. A third choice is to leave the contribution in the Roth IRA and pay a penalty on the excess contribution. In many circumstances this may be the wisest choice. If you leave the money in your Roth IRA, you are required to pay a penalty of 6% of the amount of the excess contribution for each year that the excess remains in the Roth IRA. For example, if you make an excess contribution $4,000 to a Roth IRA and your MAGI exceeds the limit, your penalty is only $240 for each year the excess remains in the account. This is the penalty regardless of how much money you make in the Roth! Since the penalty only applies for as long as the excess contribution remains in the Roth IRA, you will no longer have to pay the penalty if you qualify for a Roth in a future year and do not contribute or if you remove the contribution. Once you have a Roth IRA, the account may continue to be invested regardless of your current year income. Finally, in 2010 the $100,000 MAGI limit for converting assets from a Traditional IRA to a Roth IRA is eliminated. Although a person who exceeds the MAGI limit will still not be able to contribute to a Roth IRA, in 2010 and future years anyone may convert assets in a Traditional IRA to a Roth IRA, no matter what their income level. The amount converted is generally added to your taxable income for the year of conversion to extent it exceeds any non-deductible contributions in the account. For conversions in the year 2010 only, however, the person converting has the choice of paying 50% of the taxes on the conversion in 2011 and the other 50% in You have 3 years to pay taxes on Roth conversions done in 2010! As I always say, there are worse things than not qualifying for a Roth IRA, such as qualifying for a Roth IRA! Whether by inheriting a Roth IRA, through an inadvertent excess contribution, or by conversion in 2010, even those who are fortunate enough not to qualify for a 17

21 Roth IRA due to income exceeding the MAGI limit may end up with a Roth IRA. Even a small Roth IRA can be built into a large IRA with careful investing, which means that even the wealthy can have a substantial amount of tax free retirement income. 18

22 By H. Quincy Long and Carol A. Cantrell I. Background Do Roth Conversions Make Sense? A. Taxpayer Relief Act of 1997 The Taxpayer Relief Act of 1997 enacted the original Roth IRA to stimulate national savings, which was at an all time low. Congress felt more people would be inclined to save if they could look forward to tax free income coming out the other end. The Joint Conference Report added the income limits for annual Roth contributions and the $100,000 income limit for conversions. IRC 408A(c)(3)(B). The Act allowed a 4-year spread on conversion from a regular to a Roth IRA if the conversion occurred in Very few taxpayers took advantage of this generous offer. According to the latest IRS statistics, only about 3 percent of the current $2.5 trillion invested in IRAs is in Roth IRA plans. B. Tax Increase Prevention and Reconciliation Act of 2005 Under the Senate's budget rules, The Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) had to reduce federal tax revenues by no more than $ 70 billion for it to be protected from a point of order or filibuster that would require 60 votes to override. To meet that revenue target while still including all of the tax cuts that Congressional leaders wanted, TIPRA contained several tax increase provisions. One of the largest of these is Section 512 of the Act, which removes the $100,000 income limits for taxpayers to convert IRA balances into Roth IRAs. 1. Revenue Effect The Roth conversion would increase federal tax receipts by $6.5 billion in the budget window ( ), However, it loses revenue in the first 5 years of that window because some high-income taxpayers will transfer savings into nondeductible IRAs getting ready for the conversion in The IRS loses the tax that would otherwise have been paid on the taxable accounts. In calendar years 2011 and 2012, the Treasury gains the tax due on all of the rollovers. But the Treasury starts losing revenue again in fiscal year 2014, stemming from several sources. First, the taxable withdrawals from the traditional accounts that would have occurred disappear. Second, to the extent that taxpayers cashed in taxable investments to pay the rollover tax in 2011 and 2012, the tax base is reduced for a very long time. The Tax Policy Center estimates that the revenue loss grows in nominal terms until The 19

23 bottom line in present value is that the government loses over $ 4 billion due to the conversions from existing IRAs, even though the provision appears to raise $6.5 billion in the budget window. The losses from contributions through nondeductible IRAs are even more substantial. Effectively eliminating the income limits for Roth IRA contributions results in a present value revenue loss of over $ 10 billion through 2049 (and more thereafter). The revenue losses would be significantly greater if the high IRA contribution limits, enacted as part of the 2001 tax cut package, are made permanent as the President has proposed. On balance, this "revenue raiser" actually reduces tax revenues by over $ 14 billion over the long term. The revenue losses, which grow until 2046, reduce federal revenues at the same time that the baby boomers are aging, placing greater and greater demands on the federal government. 2. Criticism of the Roth Conversion Legislation "The Roth IRA is the antithesis of sensible tax and budget policy. Congress talked of simplification and a balanced budget but gave us both numbing complexity for ordinary citizens and budget busting, without any policy justification." Daniel Halperin, Professor of Law at Harvard Law School, "I Want a Roth IRA for Xmas" (Tax Notes, Dec. 21, 1998, p. 1567). "I think Congress is on to something. When you overspend, say on a vacation, what you need to do is buy a very expensive automobile,... with a large dealer 'cash back' and a deferral of loan payments. The cash back pays for the vacation, enabling you to ignore what the vacation cost. While you do have to pay for the car eventually, that is outside the 'budget window.'" Id. this specific gimmick (TIPRA Roth Conversion) is particularly insidious. It would have large and damaging effects on the federal budget for decades to come. Leonard E. Burman, Tax Policy Center Director, Smoke and Mirrors (Tax Notes, May 11, 2006). C. Pension Protection Act of 2006 Section 824 of the Pension Protection Act permits rollovers of amounts in retirement plans directly to Roth IRAs. This means that an individual will no longer need to do to rollovers in order to get money from a retirement plan into a Roth IRA. Instead, the rollover to a Roth IRA will be able to be accomplished in one step. This provision is effective for distributions after December 31,

24 II. Basics of Roth IRAs A. Definition of a Roth IRA 1 A Roth IRA is an individual retirement plan that, except as explained below, is subject to the same rules that apply to a traditional IRA.2 To be a Roth IRA, the account must be designated as a Roth IRA when it is set up. Neither a SEP IRA nor a SIMPLE IRA can be designated as a Roth IRA. B. Contribution Rules for Roth IRAs 1) Deductibility of Contributions. Unlike a traditional IRA, you cannot deduct contributions to a Roth IRA. But, if you satisfy the requirements, qualified distributions are tax free. 2) Income Limits. Generally, you can contribute to a Roth IRA if you have taxable compensation 3 and your modified AGI is less than: $160,000 for married filing jointly or qualifying widow(er), $10,000 for married filing separately and you lived with your spouse at any time during the year, and $110,000 for single, head of household, or married filing separately and you did not live with your spouse at any time during the year. 3) Age Limits. Contributions can be made to your Roth IRA regardless of your age. With a traditional IRA, you cannot make contributions after age 70 1/2. 4) Contribution Limits. If contributions are made only to Roth IRAs, your contribution limit generally is the lesser of: for 2006, $4,000 ($5,000, if you are age 50 or older), or Your taxable compensation. 1 Roth IRAs are discussed in IRS Publication 590. The basic IRA statute is Internal Revenue Code (IRC) Section 408, and the special rules for Roth IRA s are in IRC Section 408A. 2 See Appendix A for a chart showing the differences between a traditional IRA and a Roth IRA. 3 Generally, taxable compensation is what you earn from working. Compensation for purposes of an IRA includes wages, salaries, commissions, self-employment income, alimony and separate maintenance. Compensation does not include earnings and profits from property, interest and dividend income, pension or annuity income, deferred compensation, income from partnerships for which you do not provide services which are a material income producing factor, and any amounts you exclude from income. 21