“tax advantaged savings plan and that an IRA is a trust that is established in the US for the benefit of the account holder.”

Well, a Roth IRA (largely in effect as a result of Senator Bill Roth) is still an IRA, it simply does not have the tax advantages of an IRA. Instead of deducting such contributions to an IRA on your annual 1040 taxes, you simply are making the contributions (e.g., like a savings account) and paying taxes on the income that went in as a contribution.

You may say…..”well, that’s not good….
BUT remember this…

While you receive no tax-advantage to your ROTH contributions, you DO receive a significant benefit…whatever your Roth contributions grow to, you will never pay taxes to Uncle Sam again on the growth of your investments.

Might a ROTH IRA be best for you…that’s for you to decide.

As it relates to a checkbook controlled, self-directed Roth IRA vs. a “typical” Roth IRA is that your Roth IRA custodian (not the IRS) will limit what you can invest in with your Roth IRA funds. A true self-directed Roth IRA will not only provide you the retirement “checkbook”, but will allow you to invest in any permissible asset under IRS regulations.

1) The obvious, by having a checkbook-controlled ROTH 401K plan, you will have full freedom and flexibility to invest in any asset class permitted under IRS regulations. As long as you do not invest into a Disqualified Asset,(Item 1) the IRS does not preclude your from investing in assets more than stocks, bonds and mutual funds.

2) In your newly-established, self-directed ROTH 401K, you can make much larger contributions to the 401K than you can with any IRA. Compared to your standard IRA plans (Traditional or ROTH IRAs), you can make elective employee deferral contributions of up to $17,000 (under the age of 50) or $22,500 (over the age of 50) on your first 100% of self-employment income. Yes, in general terms, if you were under the age of 50 and wanted to contribute all $17,000 of your self-employment income to your 401K, you could do this. Further, through profit-share arrangements, profit share contributions (based on percentage of profit/income) can take the total amount contributed to the self-directed ROTH 401K up to $50,000 (under the age of 50) or $55,500 (over the age of 50). Oh, did we forget to say that your standard IRAs will allow you to contribute up to $5,000 (under the age of 50) or $6,000 (over the age of 50).

3) Roth 401K contributions are NOT subject to Modified Gross Income limitations imposed by the IRS. Where you may not be able to fully contribute to an IRA based upon the MGI limitations, a 401K has not such limitations. The contribution limits are placed based on earned income. So, where the MGI stops some from making full IRA contributions, that is not the case with a self-directed ROTH 401K.

4) The ability to make BOTH Traditional (pre-tax) and Roth (after-tax) contributions into one plan. Now, the contributions have to be segregated into separate accounts (Roth and Traditional) within the 401K, but this is a relatively easy process. Plus, you would always want the funds segregated…even if not required…to protect the value of your ROTH funds. The point is, however, is that you can have both Traditional and ROTH funds in the 401K and use both funds for investment purposes. You cannot do this with your father’s IRA.

Are there additional benefits associated with the ROTH 401K vs. an IRA…absolutely. However, these four benefits sufficiently define why one might want to consider establishing a self-directed ROTH 401K account. Remember, it’s not IF it is better, but rather do you qualify.

What Are You Telling Me?!?!

Many a blogs and articles have been written from this author and others about the benefits associated with a self-directed IRA and 401K. So, that being said, why would this post/article even begin to state that establishing a self-directed IRA might be the worst mistake you ever made?! Why would the ability to self-direct one’s own retirement assets be a bad thing…let alone the worst mistake an individual may have made?

First, let’s break this down a bit. In general, the title of this article reflects an opinion that most do not hold. The benefits of a well-structured, self-directed IRA account are many. However, here is the rub:

Do you really know what you are doing with your self-directed IRA? Have you, and how do you know, that your investment choices fit the stringent IRS rules regarding prohibited transactions?

As a result of this past tax season, we have seen more than a 100% increase in the number of errors committed by self-directed IRA owners. As one should and most likely be aware, even one small mistake can cost a self-directed account owner thousands of dollars in possible taxes and penalties.

But wait….can it get worse (you know if the question is asked, the answer has to be yes!)? Acutally, much worse. If an individual has a Roth IRA, and that Roth IRA engages in a prohibited transaction, no matter the value of the Roth, the self-directed account could be easily liable for mandatory fines of $200,000. And these fines are not waivable. Yikes.

Why address this? What can be done about it? Well, first and foremost, education, education and, oh lastly, education. Many people believe that in retaining the services of a self-directed administrator, custodian or facilitator, that these entities or individuals will keep them from harms way. In reality think again. In many cases, administrators and custodians are prohibited from providing advice on an investment. So, ultimately, the responsibility of knowing that the investment does not trigger a prohibited transaction lies with the IRA account holder.

In addition, most people do not realize that there are public databases which not only identifies that an individual has a self-directed IRA but what their IRA holds in assets. In many cases these databases can show if the IRA account entered into a prohibited transaction by the asset held in the IRA.

Individuals should not only become more knowledgeable about what they can and cannot invest in, but understanding that there are individuals who can assist them with these decisions….so they do not inadvertently violate IRS prohibited transactions regulations.

Just remember that, unfortunately, in the case of self-directed IRA’s, what you don’t know can hurt you…a lot!

Your Broker Might Not Know Everything

I remember as a young man that my dad asked me if the family should buy a Pontiac TransAm…I was floored! To this day, many moons later, I can still see the 2″ X 2″ advertisement in the local paper showing “my” car on sale for $3,596 (yes, I still remember!!). Whether wishful thinking or just playing with his son, my dad never did purchase MY car and instead bought a baby blue VW Beetle. I was crushed.

So, what it the heck does this have to do with a blog post on self-directed retirement accounts, you may ask? Well, hopefully not, you probably have an experience as a child that may be similar.

Wait, you are still saying…what does THAT have to do with retirement plans?! Well, it is like many individuals who are interested in the prospect of taking control of their retirement funds to then be bluntly told by their broker that they cannot do it.

Why? Well, instead of possibly having an educated decision with their client about the pros and cons of “non-traditional” asset investing, many brokers have taken the path of least resistance and just said, “you can’t do that…it’s illegal.”

Unfortunately, whether out of greed or ignorance, many individuals when first approaching their brokers, cpa’s, financial planners or accountants are often told that it is either “illegal”, “or too complicated”. I don’t fault ignorance as much as intent….individuals who won’t entertain the conversation with their clients may just be too interested in the commissions they receive off of selling their financial products.

As long as legally established, the IRS Code does not stipulate that you cannot invest in “non-traditional” assets (e.g., real estate). Better yet….find out for yourself by going to the Internal Revenue Service’s website www.IRS.gov. Request Publication 590. On pages 40-41 you will see what investments are not allowed (i.e., collectibles, life insurance, s-corporation stock). Real Estate is NOT mentioned as a disallowed investment just like stocks, bonds, mutual funds are not mentioned as a disallowed investment.

In the blog post titled: “Can an IRA be Co-Jointly Owned (Remember the “I”)” (July 6, 2012), we spoke of Jim and Susie’s question about whether they could co-jointly own each other’s IRA accounts. We spoke of both of their IRAs having values of $60,000 (Jim) and $40,000, respectively. Jim and Susie inquired about establishing self-directed IRAs so that they would have checkbook control of their retirement assets. They learned about how both of their IRAs could fund (or purchase the assets of) one LLC that could hold their IRA assets. Ownership of each IRA into the LLC would be directly proportional to the amount of funding into the LLC from each IRA.

Okay, that was that conversation….Jim and Susie well all set…or were they?!

Jim mentioned in the conversation that he was self-employed while his wife was a W-2 employee. With Jim’s business, he had no employees other than himself. And, to answer your next question….Susie was not employed by or with Jim’s business.

What occurred next was a spirited conversation on the merits of Jim having established for his business a self-directed 401K plan. It wasn’t a matter of qualifying for the plan…Jim did qualify. But, why should he consider the 401K vs. the IRA? Further, Jim’s primary interest was the ability to use both he and his wife’s IRA funds from one IRA LLC account, where each IRA had proportional ownership interests. Wasn’t talking about a 401K messing this whole thing up? Needless to say, he was perplexed.

Jim’s eyes grew large (metaphorically speaking….I couldn’t tell as I was on a call with him), when he was informed that by having a 401K, he cold see the following benefits:

1) Both Jim and Susie being able to “rollover” their Traditional IRAs into one 401K plan of which they would both serve as co-trustees.

2) To further benefit Jim and Susie, while they would have all $100,000 ($60,000 for Jim, $40,000 for Susie) in the 401K plan and available for investing purposes, both Jim and Susie’s respective funds would be segregated into 401K sub-accounts in each of their respective names.

3) While they could also have an LLC established for their 401K, they had “checkbook control” of their 401K plan without the LLC…..and, immediate access to their funds for investment purposes. And, since they ended up electing NOT to have an LLC, they would save that expense (where they would need the LLC for the IRA), which in their case totaled about $750.00.

4) Finally, since they were not establishing IRAs (two total, one for Jim and one for Susie), they would save almost $250 per year in IRA custodian fees. Jim was even amazed how PGI could possibly establish the 401K with no annual fees….and, remember, the 401K does not require a custodian when there are appointed Trustees for the plan.

5) As both Jim and Susie were co-trustees of the plan (by virtue of being married), Susie was permitted to rollover her funds into the 401K plan even though Susie was not an employee of Jim’s.

6) Finally, in the case of death of either Trustee, the other Trustee can carry on the plan even after death.

Guess what?………Jim and Susie established the 401K!