February 09, 2008
The Great 401(k) Escape - If the offerings in your employer's plan aren't so great, put your money elsewhere.
Retirement Guide
02.25.08,
12:00 AM ET
Ritch S. Wright, now 60, doesn't plan to retire from his job as a
Boeing
finance director until 2014, when his youngest daughter should be finishing college. Yet earlier this year the Huntington Beach, Calif. resident rolled nearly $1 million, a big chunk of his Boeing 401(k), into an individual retirement account, using a little-known maneuver: an "in-service" distribution.
Employers and 401(k) plan administrators don't advertise this fact, but most workers 591TK2 and older, and even some younger ones, can roll over 401(k) funds while they're still working and contributing to the plan. This option isn't right for everyone. But in some cases it can provide more attractive investment choices, a better way to leave money to your kids or even a chance (new in 2008) to move 401(k) dollars directly into a Roth IRA.
The law allows workers to empty their 401(k) accounts once they hit 591TK2. They can roll all the money into an IRA without paying tax now. Or they can take cash out, pay any ordinary income taxes due and spend what's left. The same goes for participants in government and not-for-profit savings plans similar to 401(k)s.
The law permits this, but employers don't have to permit it. Still, 70% of companies--and 89% of those with 5,000 or more employees--allow these in-service withdrawals, the Profit Sharing/401k Council of America found in a 2006 survey of 1,000 firms. So do some public sector employers; the federal government, for example, allows older workers to withdraw funds, but only once.
As for younger folks, the law permits them to get in-service distributions of money rolled over from previous 401(k)s; of employer (but not employee) pretax contributions; of employee aftertax contributions; and of account earnings. Here companies are less accommodating--only 16% allow this option, the 2006 survey found. Note that if a younger worker spends the cash, instead of rolling it over, he'll owe an extra 10% penalty on the taxable amount, just as he would if he got a "hardship" distribution from his 401(k) or took a loan from his 401(k) and switched jobs without repaying the loan.
One obvious reason to consider an in-service rollover is to escape a bum plan that has expensive or mediocre funds. Some small plans have annual fees on domestic equity mutual funds that top 2% a year. Outrageous. If you're stuck in one of those, you can chop your costs by rolling your 401(k) money into an IRA at a no-load fund company such as Vanguard, Fidelity or T. Rowe Price.
Even workers with reasonable 401(k) fund offerings, however, may want more choices. Only 14% of company 401(k)s offer a brokerage window that gives you access to a broad array of stocks, bonds and funds. A route around this blockade is to yank the money and send it into an IRA.
Another strategy: roll over part of your money. Jeffrey Bryant, a 56-year-old senior business analyst at PG&E in San Francisco, rolled part of his 401(k) into an IRA so he could invest in seven funds from Dimensional Fund Advisors, including small-capitalization and value funds; there were no comparable offerings in his company plan. He left the rest in his 401(k)'s bond and index funds, one with a rock-bottom expense of only 0.01%. a year--just one basis point. Bryant is buying the DFA funds through a fee-only financial planner at Merriman Berkman Next. So he's raising his total investment costs, even though the DFA funds are less expensive--at 0.29% to 0.74% a year--than the funds he sold off in his 401(k). Bryant is betting that with better funds and professional asset allocation and other advice, he'll come out ahead.
Not surprisingly, outside financial planners and brokers push rollovers, since it gives them more money to manage and collect fees for. Fifty-year-olds, as they near retirement and their 401(k) balances grow, want and are willing to pay for such help.
Wright will continue to invest the smaller amount he left in his Boeing 401(k) himself--he calls it his "play money." But he's handing management of his rolled-over funds to William Jordan, a financial planner at Sentinel Group in Laguna Hills, Calif. "I've reached that time in my life I need to become more conservative," says Wright, who has favored growth and international funds. His new objective: "Making sure I can eat all the way through retirement and making sure there is something left over for the kids."
Jordan plans to increase Wright's fixed-income allocation and construct a ladder of individual bonds with different maturity dates. In his 401(k), which doesn't let him buy individual securities, Wright's only choice would be a bond fund, whose maturity structure cannot be customized.
There are a few other reasons to consider an in-service rollover. One is a provision, new this year, that allows you to roll 401(k) money directly into a Roth IRA, where future earnings will be tax free. If your plan administrator is ready to cut a separate check with just your aftertax contributions, it appears (although the Internal Revenue Service hasn't issued rules on this) that you can roll that money directly into a Roth IRA and pay no taxes on the conversion. For now Roth rollovers are allowed only for those with family incomes of $100,000 or less. That income restriction is due to end in 2010.
Another reason to do an in-service rollover pops up if you're leaving retirement money to your kids or grandkids instead of to a spouse. A spouse who inherits either a 401(k) or an IRA can roll it into his or her own IRA with all the flexibility that an IRA offers its original owner. Kids, grandkids or other nonspousal heirs who inherit an IRA can't do that, but they can keep the money in an "inherited" IRA, potentially stretching out withdrawals and tax deferral for decades. Under a 2006 law change, kids and other nonspousal heirs can roll 401(k)s into inherited IRAs--but only if the employer permits it, which not all do. If yours is balky, get the money out now and put it into an IRA that won't have any employer getting in the way of your family's needs. (A nonspousal heir can't Rothify an inherited IRA.)
Before you rush to roll, consider some advantages to a 401(k). In a good plan the fees, particularly for index funds, may be extremely low. If you retire early, you can make penalty-free withdrawals from a 401(k) at age 55; with an IRA, you generally have to wait until you're 591/2. In a pinch you can take a loan (of up to $50,000) from your 401(k) but not your IRA.
Plus, if you hold your employer's stock in your 401(k), you may be eligible for a tax break at retirement. If you transfer that stock to a taxable account, you'll pay ordinary income tax (at rates of up to 35%) only on what the stock was worth at the time it was put into your 401(k). Any further appreciation won't be taxed until you sell the stock and then only at the long-term capital gains rate--which now tops out at 15%. There are some really crazy rules here that determine whether you're eligible for this break. So if you've got your employer's stock in your 401(k), check with your plan administrator and your tax adviser.
January 17, 2008
Entity Investments in Your IRA: Advantages, Cautions and Legal Considerations
January 17, 2008
By H. Quincy Long
There are advantages, cautions, and legal considerations when investing in an entity within your IRA. Advantages of having your IRA own an entity include:
1. Your IRA's funds may be held in the entity's name at a local bank. This can be an advantage when getting cashier's checks for the foreclosure or tax lien auction, paying earnest money or option fees, or paying contractors who prefer local checks, among other things.
2. Certain types of investments, such as real estate closings or investments at foreclosure auctions, may in some circumstances be easier to facilitate through an entity.
3. Investing your IRA's funds through an entity may give your IRA some asset protection. Always check with local legal counsel!
4. In certain limited circumstances, you may be able to act as a manager, director or officer of your IRA-owned entity without compensation.
5. If the entity's shares are all that the IRA owns, administration fees may be lower.
6. If the director, officer or manager is a trusted friend, you may more easily control what happens with your IRA's funds.
Cautions when investing your IRA through an entity include:...
Continue reading "Entity Investments in Your IRA: Advantages, Cautions and Legal Considerations" »
January 07, 2008
Keeping up with the Jones - Sound Advice for Young People
By Henry K. (Bud) Hebeler
6/9/05
When I was young, I got some valuable financial tips from my father. One of these was to always save at least 10% of my income and then some. Another was to NOT try to keep up with the Jones. These two principles have helped make my current retirement life a lot easier.
Modern young people are severely tempted to keep up with the Jones. They see people of like age all around them with the latest electronic toys, large houses, new vehicles, etc. In order to get these things, they make lots of purchases with credit cards. Little do they realize what this is costing them, not only in the near term, but also the long term.
For example, let’s suppose that they want to buy something that now costs $1,000. If they saved $180 a year for five years before this, they would have invested only 5 x $180, or $900. At the end of five years these savings at 5% return on investments would have compounded to $1,000 so that they could then buy the item for cash.
But keeping up with the Jones requires that they use their credit card instead. Let’s assume that they pay off their credit card debt in five years of equal payments. That $1,000 item will cost them $1,250 at 8% interest, $1,400 at 12% interest, or $1,600 if borrow at 18%. Think of it. Every item that they buy on credit and pay for over five years is costing 39% more at 8% interest, 56% more at 12% interest, or 78% more at 18% interest. Ouch!!!
Next think about the future. The person paying 12% credit card interest paid $500 more than the person who saved the money in advance. Suppose that $500 was invested in a balanced fund that averaged about 8% return. That $500 would grow to over $5,000 in thirty years (perhaps when retire) or $23,000 in fifty years (perhaps in the middle of retirement) or $109,000 in seventy years (when nursing home care might be necessary). Investing in a stock index fund might give over $11,000 in thirty years, $92,000 in fifty years, or $744,000 in seventy years! All of this is lost because of trying to keep up with the Jones.
The flip side of the coin is that all of these savings won’t buy as much as you might imagine. With 3% inflation, every $1,000 would be worth approximately $400 in thirty years, $200 in fifty years, and $100 in seventy years. Inflation is everyone’s enemy and means that we have to save even more to compensate.
The current generation is saving very little for retirement. The average for the U.S. has come down from its historical 10% to about 2% of disposable income. Perhaps people are counting on Social Security and Medicare to provide most of their assistance. That’s unlikely unless they will be willing to live like paupers. Social Security was originally intended to provide about 40% of the retirement income for the average person. The rest was supposed to come from pensions and personal savings.
Pensions are rapidly disappearing for a number of reasons including lack of portability, employer costs, trust solvency, and the current trend to get people to save for themselves using plans such as a 401(k), 403(b), IRA, etc. However, it’s not easy to save enough for retirement with these plans. Any projection requires tortuous assumptions that are highly unlikely to be precise, but using the common assumptions of 8% pre retirement returns and 7% post retirement returns, we’ll try to find how much you would have to save in each of four decades to replace 60% of a young person’s income. To complete the projection we’ll assume 30 years of retirement and that both pre retirement wages and inflation grow at 4%. (It’s common to assume 3% inflation, but excluding the great depression, lengthy periods have had inflation above 4%.)
To replace 60% of current income, you would need to save 10% in years 1 – 10, 15% in years 11-20, 20% in years 21-30, and 25% in years 31-40. That would take a 25 year old up to age 65.
To illustrate, if a twenty five year old earned $30,000 and saved $3,000 and followed the savings percentages described, in the last year of work the wage would grow to $144,000 and the new amount to save would be 25% of that, or $36,000. At retirement, the accumulated savings would support an annual withdrawal of 60% of $144,000 or $86,400. However, because of inflation, that withdrawal would be worth only 60% of the current $30,000 income, that is, $18,000 in today’s dollar values.
Of course savings could be smaller percentages if wages grew much faster than inflation, but the problem here is that wage growth increases the expectation of what is needed for retirement. It’s the Jones again.
Saving is not for the weak. You must be able to say, "No" and mean it. Here are some possible No candidates:
Anything that comes into your house on a wire or with radiation.
Anything that has a battery, chips, or motor.
Anything that has fur or feathers.
Anything with a prominent label.
Anything you can borrow instead.
Anything that requires credit.
So you say, you’ve already cut these kind of things to the bone. Here are some other possibilities:
Minimize insurance costs.
Get a second (or third) job.
Reduce the number of wheels.
Share quarters or rent out a room.
Downsize or relocate.
The best way to save is with payroll deductions, especially if your employer has a savings plan with matching funds. (Next best are usually Roths and IRAs.) Anyone who turns down free matching money from an employer is making a huge mistake.
When you are young, you have a great advantage both with regard to reducing spending and increasing savings. But the greatest advantage of all is that you have years for those early savings to compound into the kind of savings that you’ll need for an attractive retirement—then you’re likely to do better than the Jones.
Are You Prepared to Retire?
By Henry K. Hebeler 10-2-00
There are a number of general areas people close to retirement must consider including the activities they will pursue, things they will have to do to stay in good shape both physically and mentally, and their financial situation. These are all inexorably intertwined, but this being a business publication, I'll focus on the money ingredient. When looking ahead to your future retirement, remember that no one can predict the future, and turns in the economy may convert a brilliant idea into an absolute disaster.
Those who retired a decade ago, as did I, have enjoyed financial benefits that were largely unknown to many of the generations that preceded us. This makes it a lot easier to be an apparent expert. As an example that's completely opposite, my father retired at age 70 in 1968 and lived until he was 96. He was about as sharp as they come, very energetic, and even golfed regularly until the year before he died. However, because he lived so long, he experienced the same bad financial times of those who started retirement during the period 1964 through 1974. Investments didn't do very well, and inflation took its toll. (To put a number on inflation, from the year he retired to the year he died, prices increased by over 340%.) Whereas he thought he was well prepared for the future (and by the standards of those days he was), it wasn't long before he found himself borrowing money and subsequently needing help from his children.
Having just come through this remarkable financial period where it was almost impossible to lose money coupled with low inflation, many people have only dim recollections of more troublesome times. Although history does not repeat itself reliably enough to make a prediction, the general problems associated with a couple of years of unrecoverable negative returns and high inflation will likely reoccur at some point.
Before anyone retires, I think they should take a look at what could happen on the dark-side and have some degree of preparedness. If they can't do this themselves, they should seek the help of someone with some analytical capability in this area. I've found that you must seek answers to questions about the negative things. Even most professional planners, in my view, are jaded about the future and see through rose colored glasses unless stimulated otherwise.
How do you get a view of the dark-side? Start by asking about really prudent reserves for emergencies, repair or replacement of costly things that may be needed for your health, transportation, and shelter. Then subtract those reserves from the savings that you would otherwise spend on more normal things for retirement. Think about uninsured medical, dental, and drug bills that will almost certainly escalate at a dizzy rate during your retirement. (This includes getting information on alternative insurance possibilities.) Consider how many times you may have to replace your automobile. Estimate costly home maintenance items such as replacing your roof. If you can't pay for these things from your savings, you'll pay a lot more if you borrow the money.
Although I don't like being in a position to borrow money for most things, a home mortgage is normally such a good deal, that I personally don't think people should accelerate payments just because they are going to retire. In fact, in my view, the firm that put up the money is at a disadvantage because it has a fixed income investment in an inflationary environment. Conversely, you enjoy a small tax benefit from the mortgage and can invest at least part of your money in things that will outpace inflation in the long run.
As contrasted with good investment real estate that produces positive cash flow, I don't think your home is a good investment unless you are one of those rare people in a community that will have incredible appreciation over a prolonged period. If you need to down-size for retirement, take the medicine quickly and get the surplus funds to work right away.
A house that has rooms that may be used only a couple of days a year by some grandchildren is certainly not a good investment. After our children flew the coup, we once bought a small house from a retired couple that took the position that they could do more for their children and grandchildren with a larger retirement income than they could with a few night's layover at their house. Not only did they save on the original cost, they saved more every year because their interest, property taxes, and maintenance were significantly lower. Their penalty was that the kids had to sleep on the couch or floor, or spend sleeping time elsewhere while in town. In fact, the money saved would actually have paid for some lavish hotel accommodations with a lot left over.
There are a couple of things that really bother me about many who try to put some financial numbers together for future planning.
- First is to neglect an emergency reserve.
- Next is the almost inevitable optimism about returns from their investments, investment costs, and future inflation.
- Last is the susceptibility to bad advice from people who have little knowledge or are eager to maximize the money they can siphon away from the retiree.
What seems to get people's ear is the braggart who had some success (or at least says so) with one thing or another. It might be a hot stock, a mutual fund, or some real estate. The value is about the same as a tip at a race track. What's better in my view, especially for a person with little spare time, is a mix of a few no-load mutual funds to give some diversity and perhaps some actual bonds. The only discipline required is to convert part of the more rapidly growing stock funds to some fixed income funds or bonds to keep a reasonable mix of stocks and bonds. A portfolio like this is unlikely to need changes but once a year at most. This rebalancing is easy in a 401(k) or IRA because there is no tax consequence. Balanced funds do this automatically. Except for possible sale of the family mansion, there should be no traumatic change near the time of retirement.
Another category of things that bother me is people who estimate future income by adding a fixed pension or annuity to Social Security. These are like apples and oranges and are as different as night and day. A fixed pension is worth only about two-thirds of Social Security. As a rough rule of thumb, a person should spend only the after-tax portion of the pension multiplied by the retiree's age divided by 100. For example, a 65 year old would spend only 65% of a fixed pension. The rest of the after-tax income should be saved.
That's right! Early in retirement, retirees still have to save money, just not as much as before retirement. This means that part of the money must be put aside from bonds as well as a pension, and certainly retirees should not spend capital gain distributions early in retirement. As another rough rule of thumb, retirees should probably not spend much more than their investment balance divided by the number of years they still might live. That amount also has to cover the associated taxes due. In fact, that's one of the things I like about the IRS's "recalculation" method used for post 70 ½ IRA required minimum distribution requirements. It's the same math.
Retirees are likely to see more doctors, dentists, pharmacies, and hospital interiors than they care to think about. Nevertheless, that's something that has to come out well (pun intended), and everything else is a refinement for planning on future retirement. As costly as insurance may be, the lack of it is almost certain to determine the course of your future years.
Of course all of the things I like pre-retirees to consider take time, and most people just don't do it. Even one hour a year would make a huge improvement for many people. The typical person decides on a retirement date without hardly any consideration of the gain from working another year or more for some additional savings. They flourish their intended retirement date to the world much too early and feel embarrassed to back off the "commitment". Too often I see people trying to retire at 55 or younger. Their image is four future decades of mindless recreation. The majority will end up back at work, often at a job with little retirement benefits and a lot less challenge.
My biggest financial mistakes were real estate partnerships.
Not one has turned out super, several have been marginal, and most turned out just plain bad. I'd like to blame it on the change in the tax law which really hurt partnerships, but in the same interval, many people built fortunes in real estate. To me this illustrates the uncertainty of our own performance in an unknown future environment.
No one can predict the future. But we can do some estimating and, with the proper humility, admit that we need investment diversity because we can't foresee the ultimate outcomes.
During the few years before retirement, it is imperative to try to wear the hat of the broad thinking wise man. Go to some planning seminars, the library, bookstore. Engage a professional in the finance field. You spent a good deal of your life getting prepared to be an adult and be productive. Now spend some time preparing yourself for what could easily be one-third of your life. You may not have any control over the length of your retirement nor how much the government will take or give you, but you do have control over your financial actions.
Finally, try the acid test: During your last few working years, spend only the amount you can afford in retirement.
Helpful Retirement Articles Index
These are articles that were written by Henry K. (Bud) Hebeler to help develop ideas for journalists that work for The Wall Street Journal, Business Week, Kiplinger’s, Smart Money, AARP, newspapers, financial web sites, etc.
They’ve been used as a source of quotes for these publications.
Helpful Retirement Articles Link:
www.jonathanclements.com. This site has a broad range of articles Mr.Clements has written about retirement in
The Wall Street Journal and has some very helpful links.
Retire Rich: Learn from someone who did
Retire Rich: Learn from someone who did
This former engineer and self-taught expert learned firsthand how to prosper after you leave your job.
NEW YORK (Money Magazine) -- When Henry "Bud" Hebeler was winding down his career at Boeing nearly 20 years ago, he was appalled at the advice he got from retirement planning software.
"The assumptions about returns, inflation, longevity and expenses were highly simplistic," says the 74-year-old Hebeler. With his engineering degrees from MIT and his experience - first as Boeing's chief forecaster and planner and later as president of Boeing Aerospace - Hebeler figured he could do better.
He has. His Web site, AnalyzeNow.com, is a compendium of advice and tools (mostly free) that can help you tackle topics ranging from how to create a retirement budget to whether to buy an annuity.
What distinguishes Hebeler from the typical retirement "expert" is that he combines a strong quantitative background with real-life retirement experience - his own and that of fellow retirees.
Hebeler took time out from his hectic schedule of skiing, golf, travel and running a site to share his thoughts.
Q. What's the most popular misconception about retirement planning?
A. That your spending will drop as you age and you become less active. My father played golf until he was 95. My wife and I are in our seventies and we ski the expert slopes at Park City, Utah.
My friends who have reduced their spending didn't do so because of lack of energy or physical ability. It doesn't take much effort to get into a taxi and go to the theater. They're cutting back because they know they're going to live longer than they thought they would. They spent too much too early and now they're worried about running out.
Q. So what can you do to assure that your money will last?
A. If you have enough savings to live on, consider delaying taking Social Security until full retirement age or even later. Holding off can be especially worthwhile if you have a spouse who didn't work or had a low income, since the higher payment you get by waiting can be passed on to your spouse when you die.
I also think retirees should consider putting some, but not all, of their money in an immediate annuity. Look at inflation-adjusted immediate annuities, since they provide a lifetime income that, like Social Security, goes up with inflation.
Q. How did your work at Boeing influence the advice you give?
A. It made me more conservative. In business you see how often things don't work out as you planned. Projects cost more to complete than you estimated.
The same is true of retirement, but retirement plans seldom call for setting aside reserves for unforeseen events. There are a lot of surprises, usually more bad ones than good.
Q. What kinds of surprises?
A. For one thing, your expenses are likely to be very different in retirement than during your career. Things that were probably covered by your company insurance - dental work, vision care, a variety of medical tests - typically aren't paid for by Medicare. My hearing aids alone cost $6,000, which wasn't covered at all.
People also don't anticipate the impact of inflation. In the first 10 years of my retirement, the purchasing power of my company pension declined by 30%. And then there are obligations people rarely plan for, such as having to help parents or adult children who are struggling financially.
Q. If you could advise people to do just one thing to improve their retirement prospects, what would it be?
A. People who aren't retired need to know how much to save. My father used to tell me that you should always save at least 10% of your income.
That's more like 15% to 20% today because you're less likely to have a pension. 
December 25, 2007
Yes, you can buy real estate with your IRA - MSNBC.com
All your IRA money is in mutual funds and you'd like to diversify. One way is to buy raw land, a house or a building -- even your retirement home.
By Adriane G. Berg
There it is, the retirement home of your dreams. The trouble is that
you're at least a dozen or more years from retirement and most of your
money is tied up in your IRA.
Too bad, because by the time you're ready to sell your current home, that oceanfront beauty could be way out of reach.
If
only you could access some of that IRA money without paying a penalty.
If only you could rent the space and sock away the income,
tax-deferred. Until you retire and enjoy it yourself.Start investing with $100.
Explore our
new ETF center.
Maybe it's commercial space or raw land
Or
how about this scenario: Your landlord has just raised the rent on your
office and a little building down the block has come up for sale.
What
a dandy idea it would be to grab it and have a building of your own.
Once again, your IRA is richer than you are. If only it could be your
landlord.
Or maybe: Mabel and Norman always get such good deals
on raw land, but this one is the best yet. An acre of waterfront
property in Nicaragua, with two sweet little cottages for $45,000. If
only that IRA could be tapped without all those penalties.
All your IRA money doesn't have to be in paper
Most investors believe they cannot use IRA money to buy real estate. Developed or undeveloped. They are wrong.
You
can invest IRA money in a wide range of investments, including stocks,
bonds, mutual funds, money market funds, saving certificates, U.S.
Treasury securities, promissory notes secured by mortgages or deeds of
trust, limited partnerships and real estate. That includes houses,
condos, office buildings -- even if located in another country.
You
cannot use IRA money to buy your own residence, or any other property
in which you live. It has to be investment property. But when you
retire, you can direct your IRA to turn it over to you as a
distribution, at the current market value. Let's take a look at one
example.
Out of the woods in Maine
Jack Wrigley found himself in a potentially disastrous position and was able to free himself using the real estate IRA.
Jack
took early retirement from his corporation at age 55 and rolled his
company pension plan money into an IRA worth nearly $250,000. The money
was invested in stocks and bonds. He then set out to find his dream
retirement home in Maine.
Within a few months, he found it. It
was a bargain price, too, because the owner was required to sell within
eight weeks. The contract Jack signed required a $25,000 down payment,
to be forfeited if the closing didn't take place as scheduled. The
balance of the purchase price was $150,000.
The problem hit. The
investment condo in Boston that Jack was going to sell to raise the
$150,000 fell victim to a soft market. No buyers. Jack was in danger
not only of losing the retirement home of his dreams but his $25,000
down payment as well.
The real estate IRA to the rescue
The
solution was the real estate IRA. Jack quickly opened a new
self-directed IRA, rolled over the entire amount of his old IRA into
it, then directed his trustee to make the purchase with the IRA
becoming owner.
The closing took place, but that was only the
beginning of Jack's IRA advantage. Since the closing, the IRA has made
wonderful capital improvements in the Maine property and rented it out
for a nice income, all tax-deferred. (It could even have been tax-free
if the Roth IRA had been in existence at the time.)
Jack
eventually sold his Boston condo and pocketed that profit. Now he is
looking forward to his retirement, at which time the IRA will turn the
property over to him as a distribution of the then market value.
How come no one knows?
Given
the real estate boom of the 1980s, and its current resurgence, it's
curious that so little is understood about the real estate IRA. Perhaps
it's simply a lack of advertising.
IRA accounts invested in
stocks, bonds and other financial paper are very lucrative for banks,
mutual funds, insurance companies and brokerage houses.
These
institutions will gladly act as your trustee (the middlemen in all
IRAs) and sell you their wares. But they won't act as your trustee if
you want to buy real estate with IRA money. Why? They're not in the
real estate business.
So you're pretty much on your own
investing in a real estate IRA. You have to find your own property,
trustee and perhaps a management company, to collect rents and maintain
the property.
House power' to the people
As
a practical matter, you'll find very few professionals who can guide
you through the entire process. Housepower has created a manual and
audiotapes (priced around $130), but there is no one-stop shopping
service you can use. Still, the do-it-yourself process is simple.
Contact
an independent trustee for a self-directed IRA. You must find an
institution that will open a self-directed IRA and follow your
"self-directed" instructions to the letter. It's not as hard as you may
think. Try Mid-Ohio Securities in Elyria, Ohio, or Sterling Trust in
Waco, Texas.
Sign broker-to-broker papers that will transfer designated portions of your existing IRA to your self-directed IRA.
Find
and buy the property using a real estate attorney to create the usual
documents. Remember, you most likely will have to explain IRA ownership
to him. The trustee will take title at your direction.
The rules governing real estate IRAs are strict:
You cannot mortgage your IRA
The
biggest drawback of the real estate IRA is that it may lack the funds
to make a substantial purchase. At present, it is controversial as to
whether your IRA can take a mortgage, or if this would violate several
IRS provisions and render all of your IRA assets taxable.
Our
advice right now: Don't use IRA money as a down payment and take a
mortgage for the balance due. You'll have trouble finding a lender who
would go along with such an arrangement, anyway.
As the
self-directed IRA becomes more popular, however, we hopefully will see
clarification of the borrowing rules, and perhaps more lenders willing
to make loans.
Meanwhile, a special technique allows you to
participate in real estate ownership through your IRA, even if there is
not enough in capital to pay for the entire parcel. That technique
consists of buying fractional shares of property through the use of a
general or limited partnership.
You can pool real estate IRAs for expensive properties
In
this way, folks can get together and even buy all kinds of properties.
Tenants in office buildings have pooled their IRAs to buy out their
landlords.
In fact, a husband and wife can consolidate their
IRAs to have more cash for a purchase, or leave them separate and form
a partnership.
Remember, you can always get out of your
investment. Just direct your trustee to sell your property or interest,
and have the funds reinvested elsewhere.
Use the Roth and pay no tax at all later
Or
if you are over 59 , you may withdraw any portion of the proceeds of
sale after they are deposited in the IRA. The receipts from the sale
must be returned to your IRA account if you are to escape taxation and
possible penalties.
The Roth IRA is an ideal vehicle for those
who are eligible. If the value of the real estate is expected to
appreciate, it would be best to opt for a self-directed Roth IRA and
pay the taxes over the next four years. In that way, so long as the
real estate is not distributed for five years, it will incur no tax
when the deed is transferred to you personally.
Assuming you and your spouse eventually live in it before selling, $500,000 of profit is completely tax-exempt.
December 19, 2007
The End of Retirement- TheMotleyFool.com
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http://www.fool.com/personal-finance/retirement/2007/12/19/the-end-of-retirement.aspx
Robert Brokamp
Tired of reading about America's retirement woes? Then I have an
alternative for you: Watch a TV show about them. Heck, you don't even
have to move to your TV -- you can watch it on your computer, from the
comfort of your own desk chair. The particular program I'm talking
about is an episode of the PBS series Frontline titled "Can You Afford to Retire?"
Of course, since you've clicked on this article, you can't be too
tired of reading about all of the impending retirement woes out there,
so let me sum up the program's main points and then explain how you can be an extraordinary American by actually being able to retire.
Goodbye, pensions ... unless you're the CEO
But the real shocker in the Frontline program was the
revelation of how such bankruptcies are becoming an acceptable way for
companies to get out of their pension obligations. Check out what
United Airlines' lead bankruptcy lawyer, James H.A. Sprayregen, told Frontline:
"I would say that Chapter 11 has become somewhat of a more accepted
strategic tool than just companies filing who are about to go out of
business or something like that. As a result, there's more use of
Chapter 11 now than probably 20 years ago."
So should you be worried if your pension is underfunded? Things have
looked better over the past year or so, due to larger contributions on
the part of companies and decent stock market returns. Each year,
actuarial consulting firm Milliman analyzes the pensions of 100 large
corporations. According to the most recent analysis, 40 of the 100 were
fully funded at the end of 2006, up from 20 in 2005. That, of course,
leaves 60 still lagging. According to the report, here are some of the
companies that are still wrestling with pension deficits:
It should be noted that the liabilities Milliman reports include
foreign obligations, so they're not necessarily a crystal ball for the
future of U.S. retirees. That said, bankruptcy might be the only way
for some companies to survive, and sometimes employees have to give up
something just to keep their jobs. United was certainly in dire
straits.
But I suspect that it's harder for the folks in the rank-and-file to accept their reduced pension benefits when, according to Frontline, executives were given $400 million in stock grants and
CEO Glenn Tilton's $4.5 million retirement package was put in a special
trust so that he'll still get his full benefit. Very nice.
Hello, 401(k)s ... unless you don't participate
Unfortunately, employees don't seem to be doing a good job of taking
the reins. After all, they have to answer several important questions:
One of the most interesting tidbits from the Frontline
episode came from benefits consultant Brooks Hamilton, who oversees 15
large 401(k) plans. At one point, he calculated the investment return
for each participant in each of the plans. Here's what he found: Say the bottom 20% had an investment return for the
year of 4%. The top 20% would be anywhere between five and seven times
that number. ... In every case, the 20% at the top not only had the
highest investment income, they also had the highest average annual
pay. Whereas the bottom 20% not only had the lowest investment income,
they had the lowest average annual pay.
Frontline characterized the situation this way: "The
richest people are getting richer, and the middle-class workers are
falling further behind." This is certainly true, but not in the same
way as Glenn Tilton getting to keep his pension while everyone else's
is reduced; the 401(k) system isn't rigged. We do have to recognize,
however, that the average American isn't prepared to be an investment
expert. Most schools don't teach personal finance, and neither do most
parents. And clearly, most Americans aren't doing enough to teach
themselves.
Now, we at The Motley Fool -- being the do-it-yourself,
control-your-own-destiny types -- are big fans of self-directed
retirement accounts. And believe me, traditional pensions aren't the
answer. They benefit people who stay with the same employer for
decades, not the typical job-hopping American. My wife and I worked a
combined 10 years at the same elementary school, and from those jobs
we'll receive a combined $108 a month in retirement -- not
adjusted for inflation. I would have gladly taken the 6% of my salary
that the school contributed to the pension fund in the form of matched
contributions to our 403(b) plans.
But the reality is that as retirement becomes the sole responsibility
of the individual, many people -- because of bad decisions, bad health,
bad education, or bad luck -- will have to work forever.
It's all up to you
For millions of Americans, Ghilarducci is absolutely right. But it doesn't have to be that way for you.
You don't have to be among the people who don't save enough, who don't
invest wisely, and who don't make smart decisions about 401(k)
withdrawals. If you need to learn the basics, read about the easiest retirement plan ever. For more detailed information, give our Rule Your Retirement
service a 30-day free trial. You'll get access to all of our past
issues and special reports, as well as our online financial-planning
tool and professionally staffed discussion boards.
But whatever you do, just promise me you'll do something. The choice between working and retiring is entirely up to you.
This article was originally published June 22, 2006. It has been updated.
Robert Brokamp is the advisor of
Motley Fool Rule Your Retirement. Robert will rule his retirement by not paying $800 a year for basic cable. And with shows like Frontline, who needs cable? Robert doesn't own shares of any companies mentioned in this article. PPG Industries is a Motley Fool Income Investor recommendation. The Motley Fool has a disclosure policy. | ||
December 15, 2007
Vacation Time: How About a Little Beach House As a Souvenir?
Monday, October 15th, 2007
More and more I’m hearing about interest in purchasing real estate offshore. Some people are looking to diversify their investments, but many are simply being seduced by those whose sole goal is to sell real estate—forget the business realities and practicalities. Sounds just like the U.S.!
There’s a lot of opportunity in other countries, including great growth potential, quiet beaches, affordable retirement options, tax advantages, and relaxing resort-like living. Yet buying offshore has its own set of considerations.
My recent book, “How to Invest in Offshore Real Estate and Pay Little or No Taxes,” includes a checklist of things to be aware of and to investigate when buying offshore. I wrote this book because I’ve seen the great pictures and the lure, and I’ve also seen how people have been disappointed with losses and the difficulty of being an absentee landlord.
The hazards of investing while on vacation
Many of the most fatal real estate decisions are made when people get enamored with a property while on vacation. Vacation is often an escape to idyllic locations, and everything looks great when you’re away from it all. I’ve met these unquestioning buyers in Tahiti, New Zealand, Costa Rica, Nicaragua, Romania, Spain, South Africa, and many other places. In the midst of those good vacation feelings, people don’t think about:
- local tax laws
- treatment of capital gains
- language and culture differences, and,
- exchange rates
This type of research takes time—more than a two-week vacation. I’ve also observed that many people don’t know that U.S. tax laws apply to worldwide income, or they figure that the IRS won’t know about it so why bother. Don’t kid yourself. I’ve been interviewed by the IRS regarding money laundering by one of my clients, an attorney no less, who got involved in the lure of offshore ownership thinking it was a way to avoid taxes.
So now that I’ve scared a lot of people from even trying, I can also tell you that when you do perform due diligence, offshore real estate can result in great gains and advantages. You can make investments in real estate that have a good cash flow and appreciate, and you can also make some real money on exchange rates. Bottom line: education goes a long way, so in addition to those travel guides, read up on where you’re considering investing.
Hugh Bromma, Founder, The Entrust Group
October 15, 2007
The Solo 401(k) Can be Your Best Method for Real Estate Investing
by Phoebe Chongchua
The Solo 401(k) is not the most common method for investing in real estate but it is perhaps the best kept secret.
"It is a powerful tool that most people don't know about but should. There are at least four distinct advantages over an IRA (Individual Retirement Account)," says Jeff Moormeier co-founder of IRA Association of America, an alternative investment educational institution.
Moormeier teaches a program to real estate agents, CPAs, and investors on investing using the Solo 401(k). He says the advantages make this method of investing superior to a standard IRA.
He lists the following as the top reasons to set up a Solo 401(k) plan.
September 13, 2007
Retirement Advice - Next Generation Retirement - Forbes
Next Generation Retirement
Edited by Matthew Schifrin and John Dobosz 09.12.07,
6:00 AM ET
We have all heard the mind-boggling stats before. There are more than
75 million baby boomers, and every seven seconds another one turns 50.
Surfing atop this huge demographic wave is some big money; in less than
50 years, Americans will transfer more than $40 trillion in wealth
between generations. The numbers make for great sound bites and even
better PowerPoint slides for planners and brokers. 
A 6% Solution To Retirement Worries
Retirement And Marriage
How Stable Is Your Core?
For Golden Years, Invest Abroad
Safety-First Money Market Funds
Burdening Your Retirement With A Mortgage
Think twice before you rid yourself of a mortgage at retirement age. Use the leverage to your benefit.
September 12, 2007
Burdening Your Retirement With A Mortgage-One of retirement's great promises is the thrill of kissing that monthly mortgage payment goodbye. But don't start puckering up just yet. Lately, there has been a shift in thinking
Investopedia
09.12.07,
6:00 AM ET
One of retirement's great promises is the thrill of kissing that monthly mortgage payment goodbye. But don't start puckering up just yet. Lately, there has been a shift in thinking that has seen many financial planners suggest that retirees continue to carry a mortgage into and throughout retirement. Reinvest the money from your home equity, and suddenly that new income is making your golden years a little more golden. This is a brilliant strategy, right?
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Well, there can be some drawbacks. Carrying a mortgage in retirement can be a good idea in certain situations, but it is certainly not a one-size-fits-all solution for increasing retirement income.
You Can't Eat Your Home
The basic concept behind this strategy is "you can't eat your home." In other words, your residence produces no income and home equity is useless unless you borrow against it. Historically, in the long term, homes provide rates of return below those of properly diversified investment portfolios. Because home equity typically makes up a substantial portion of a retiree's net worth, it can arguably serve as a drag on income, net worth growth and overall quality of life in retirement.
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So, logically, the next move is to shift your assets from your home
by taking out a mortgage and investing the money in a diversified
portfolio that should outperform the after-tax cost of the mortgage,
thereby enhancing net worth. Additionally, investments such as most mutual and exchange-traded funds
are easily liquidated and can be sold piecemeal to meet extra spending
needs. (To learn more about mutual funds and exchange-traded funds, see
"Introduction to Money Market Mutual Funds" and "Advantages Of Exchange-Traded Funds.")
This all sounds great, but it's not that simple, and anytime you introduce more leverage
(a mortgage) into your finances, there are a lot of things you need to
consider. So, what are the benefits and drawbacks of this strategy?
Pros
A properly diversified investment portfolio should outperform residential real estate
over the long term. Don't be fooled by real estate returns over the
last decade or so. Residential real estate historically provides
single-digit annual rates of return, whereas diversified portfolios
tend to do much better over the long term and should reasonably be
expected to continue to do so in the future. Secondly, interest on a
home loan is tax deductible, which can serve to minimize the cost of
using this form of leverage, making it easier for your investments to
outperform.
Finally, from an investment point of view, a single property could be
considered completely undiversified, which is bad news if it comprises
a substantial portion of your net worth. Diversification is essential to maintaining not only financial stability, but peace of mind as well. (To learn more about diversification, see "Introduction To Diversification" and "The Importance Of Diversification.")
Cons
Despite the potential benefits, this strategy can also have
some unpleasant side effects. As mentioned before, taking out a
mortgage is another form of leverage. By using this strategy, you
effectively increase your total asset exposure to include not only a
house but also the additional investments. Your total risk exposure is
increased and your financial life becomes much more complicated.
Furthermore, the income you get from your investment will fluctuate.
Prolonged downward fluctuations can be scary and hard to manage.
Investment Returns
Another important factor to keep in mind is that investment
returns can be highly variable in the short term, while mortgages tend
to be fixed in nature. It is reasonable to expect periods of time when
your portfolio substantially underperforms the mortgage cost. This
could notably erode your financial base and potentially jeopardize your
future ability to keep up with payments.
This variability could also compromise your peace of mind. If you
become frightened during a downturn in the market, you may react by
tapping into your portfolio in order to pay off the mortgage, thereby
denying yourself the benefits of a recovery in your investments. If
this happens, you would actually end up detracting from your net worth
instead of increasing it. Do not underestimate the unsettling
psychological influence of leverage, or the value of a good night's
sleep, in making rational investment decisions. (For further reading
into emotions and investing, see "When Fear And Greed Take Over" and "Master Your Trading Mindtraps.")
There are many objective financial factors you need to take into
consideration to determine the merit of this strategy in your given
financial situation. While some financial planners may issue the same
advice across the board, this strategy is by no means appropriate for
everyone.
The foremost consideration is determining what your total mortgage
interest cost will be, as this is the hurdle your investment portfolio
must overcome to be successful. The factors that affect this are very
simple and include your credit worthiness and tax bracket.
Of course, the better your credit, the lower your total interest cost
will be. Furthermore, the higher your tax bracket, the more tax benefit
you receive from the interest write-off. (To get started, check out "Understanding The Mortgage Payment Structure.")
Where to Begin
The first thing you need to do is talk to your loan officer
and accountant to determine your total interest cost, net of the tax
benefit, which will tell you how much your investment portfolio needs
to earn in order to pay off the interest-rate charges of your mortgage.
Next, you need to approach your investment advisor to discuss beating this investment hurdle, which leads to another set of considerations.
Knowing your desired rate of return is simple enough, but whether you
can reasonably achieve that rate of return or tolerate the necessary
risk is another story. Generally speaking, beating your mortgage cost
will require a larger allocation to equities, which can entail
substantial amounts of portfolio volatility. Frankly, most retirees are probably unwilling to accept such levels of volatility.
Another factor to consider is that most financial advisors rely on
historical averages to estimate a portfolio's future return. There are
several issues to consider with this approach:
--Long-term expectations and short-term returns are almost never the same.
--Historical returns are based on very, very long time periods. The average retiree's investment horizon is much less than the "long term."
--You can't expect steady annual returns that resemble historical averages.
In other words, do not totally rely on return expectations. They
simply serve as a guidepost for your likely returns in the future. It
is wise to anticipate and consider a range of potential investment
returns over various time horizons in your financial planning.
Finally, the last major consideration is determining the percentage of
total net worth your home represents. The larger the percentage of your
net worth your home represents, the more important this decision
becomes.
For example, if your net worth is $2 million and your home only
represents $200,000 of it, this discussion is hardly worth the effort,
as the net marginal gain from this strategy will minimally affect your
net worth. However, if your net worth is $400,000 and $200,000 of this
comes from your home, then this discussion takes on a profound meaning
in your financial planning. This strategy has less of an impact, and
probably less appeal, for someone who is rich than someone who is poor.
It's never a good idea to blindly accept a piece of advice,
even if it comes from the mouth of a financial planner. The safety of
carrying a mortgage into retirement depends on a variety of factors.
This strategy is not guaranteed to succeed and can substantially
complicate your financial life. Most importantly, leverage is a
double-edged sword and could have dire financial consequences for a
retiree.
Simply put, do not make this decision lightly and be very thoughtful
before committing to it. Also, keep in mind the motivations of
financial advisors--the more money you investment with them, the more
money they make.
For related reading, see "The Home-Equity Loan: What It Is And How It Works."
This article is from Investopedia.com, the Web's largest site dedicated to financial education. Click here for more educational articles from Investopedia.
August 12, 2007
More IRA investors are taking control of their retirement funds
From the Los Angeles Times
Banking on it
More IRA investors are taking control of their retirement funds -- and chasing their real estate dreams.
By Ann Brenoff
Times Staff Writer
June 24, 2007
IF your retirement garden — specifically your individual retirement account or IRA — hasn't been growing fast enough to meet your future retirement needs, you might want to join a club of contrarians: those who have decided to take matters into their own hands. Literally.
Self-directed IRAs are billed as "putting the 'I' back in IRA." They let individuals determine what, when and where to invest their retirement money. And they are catching on — in no small part thanks to the stock market's volatility and the real estate market's recent riches.
Real estate has always been permitted in IRAs, but few people know about this option. Financial institutions — mutual funds, stock brokerages, banks — are typically where IRAs are held. But investments in other things, most notably real estate, are fully permissible under the Employee Retirement Income Security Act of 1974. It prohibits retirement plans from investing in just two types of investments — life insurance contracts and collectibles. Everything else is fair game.
But ERISA or no, the other thing standing in your way may be your employer. If your IRA is held in a company plan through your job, the plan's guidelines may specify what type of investments can be made — and real estate is rarely among them. If this is the case, establishing a self-directed IRA isn't an option until you and your employer part ways. Once you leave, no matter the reason, you can roll over the funds in your IRA and 401(k) to a self-directed IRA.
It is estimated that only about 4% of America's retirement funds are held in nontraditional accounts, including IRAs invested in real estate. But the trend, experts agree, is toward more money being funneled into these little-known, little-used, self-directed IRAs.
Although investors use self-directed IRAs for a variety of investments, among nontraditional accounts, real estate is by far the most popular.
It certainly was the motivation for Anthony Moreno, 56, of Oceanside, Calif., to establish his self-directed IRA.
Moreno retired in July 2005 after working more than 24 years as a nuclear computer technician at San Onofre Nuclear Generating Station. When he left Southern California Edison's employment, he initially left his pension and 401(k) with the company — primarily because he didn't know what else to do with it, he said. But concerns about a low rate of return and a lifelong desire to own international real estate led him to research self-directed IRAs with the idea of putting his money into real estate. Opening one simply made sense for him, he said.
Now Moreno is in escrow on a pristine 68-acre private island 300 yards off of Roatán Island in the Caribbean Honduras. It was listed at $850,000, and he plans to develop a day resort on it, ferrying cruise-ship passengers by private speedboat to his island. Carnival Cruise Line is building a $50-million terminal at Roatán Island that will be able to accommodate two mega-ships and 7,000 passengers a day, and Moreno plans to tap into this burgeoning tourist market.
Moreno's self-directed IRA was set up by Guidant Financial Group, which specializes in facilitating real estate investments using an IRA.
"I don't see it as gambling," Moreno said of investing his retirement funds in this venture, although he acknowledges that "conventional thinking would probably view this as very risky for someone of my age" and that "there are many 'safer' investments which I could have chosen." But, he added, none of those other investments had "the potential for making my dreams come true."
"I don't know of anybody who ever realized a dream by allowing their fears to prevent them from giving it their best shot. Regardless of the outcome, I will never regret going for my dream. If I hadn't tried, I would have always wondered: What might have been?"
As romantic as the idea of buying your own island sounds, many caution that real estate purchases made through self-directed IRAs aren't the answer to everyone's investment goals. Experts, such as Jeff Nabler of the IRA Assn. of America, strongly urge people to consult a professional advisor before moving their money into one.
For one thing, the tax laws concerning self-directed IRAs are complicated — and likely beyond a layman's interpretation. Mistakes can be costly; early withdrawal penalties may be imposed if funds are misused.
The Internal Revenue Code 4975 defines what are prohibited transactions for IRAs, said David Nilssen, chief executive of Guidant Financial Group, a Washington-based company that he says is rolling over about 200 accounts each month. Basically, any investment the IRA participates in must be for the exclusive benefit of the IRA, Nilssen said.
For instance, you can't use your IRA to buy a home for your mother to rent because there might be a conflict of interest to act in the best interest of the IRA (eviction) should Mom fail to make the rent payments.
For the same "exclusive-benefit" reason, self-directed IRAs cannot be used to purchase a principal residence or a vacation home. They can be used to buy income property, such as land or an apartment building. The title to the property would be held by a custodian, who acts as a trustee for the account and does not offer investment advice but functions essentially as a conduit for your wishes as they relate to buying and selling. The custodian would collect rent checks, pay the mortgage and taxes and handle the other financial aspects of your ownership — for a fee.
The fees vary, and investors are advised to check them carefully and do some price-comparison shopping before moving IRA money from a traditional fund to a self-directed one.
In the last seven years, Guidant's Nilssen said, the self-directed IRA industry has "exploded." Before 2000, "investors couldn't justify leaving the stock market because it was performing too well," Nilssen said. "The industry has more than doubled since that time."
Self-directed IRAs can produce great returns, Nilssen said, but he too cautioned that there are specific guidelines an investor must adhere to. "This is why we recommend that people not try to structure these investments themselves without the help of a qualified professional."
--
ann.brenoff@latimes.com
--
Begin text of infobox
IRAs and real estate investing
Where to find more information online:
• Internal Revenue Service: http://www.irs.gov/retirement/article/0id11141300.html <252>• Guidant Financial Group: http://www.guidantfinancial.com <252>• Pensco Trust Co.: http://www.penscotrust.com/
• IRA Resource Associates Inc.: iraresource.com/<252>• SelfDirectedIRA.org: http://www.selfdirectedira.org/
• Bankrate.com: http://www.bankrate.com/brm/news/sav/20010213a.asp and http://www.bankrate.com/brm/news/ira/20070417_real_estate_self-directed_IRA_a1.asp <252>
April 17, 2007
Alternative Uses for IRAs
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Alternative Uses for IRAshttp://www.fool.com/personal-finance/general/2007/04/14/alternative-uses-for-iras.aspx
Elizabeth Brokamp
We all know that an IRA is meant to build a tidy little nest egg for retirement. After all, it's not called an "Individual Retirement Arrangement" for nothing. (Yes, the A stands for Arrangement, not Account -- ask the IRS.) And most of us also know that if we try to use that money before we
reach retirement age (59 1/2 in this case), then we might pay a 10%
penalty. That might scare some people away from IRAs, especially
younger investors who fear they might need the money some time during
the intervening decades. If that's you, then we have good news. In some cases, you can get
your hands on your IRA money before age 59 1/2 and not pay a penalty.
In fact, some financial planners actually recommend using an IRA for a
financial goal other than retirement. What are some of these
alternative uses for an IRA?
1. Pay for college.
IRA assets used to pay for qualified higher-education expenses --
such as tuition, fees, books, room, and board -- are exempt from the
10% penalty. However, the money may be subject to ordinary income
taxes. With a traditional IRA, tax-deductible contributions and any
earnings on those contributions will be taxed when withdrawn. If you made after-tax contributions to a traditional IRA (i.e., you
weren't able to take a deduction on your tax return in the year you
made the contribution), then that money will come out tax-free. In that
case, a formula is used to determine exactly how much of your
withdrawal is attributable to the after-tax contribution and how much
is due to earnings. It's no big deal if you drain the entire account.
But if you only spend part of it, then the IRS will consider it a
partial withdrawal of earnings and a partial withdrawl of the after-tax
contribution. Roth IRAs, which are always funded with after-tax money, are less
complicated. The first dollars that come out are attributable to
contributions. So if you contributed a total of $8,000 to a Roth IRA
that is now worth $14,000, the first $8,000 you take out is tax-free.
After that, you'll have to pay ordinary income tax. Again, you won't
have to pay the 10% penalty as long as the money is spent in the
pursuit of a post-secondary education.
2. Pay for a house.
You can use your IRA to help put a roof over your head, as long as
you're considered a first-time homebuyer, which according to the IRS,
includes anyone who hasn't owned a home in the past two years. Go
figure. There is a $10,000 lifetime limit on how much can be withdrawn
penalty-free, and, as in the case of college expenses above, the
withdrawals might still be taxable. There are a few other caveats, so
before you tap your next egg to feather your nest, read this article by Fool tax guru Roy Lewis.
3. A backup emergency fund.
As mentioned earlier, contributions to a Roth IRA can be
withdrawn tax- and penalty-free. It doesn't even matter how you use
that money -- college, a house, a hot tub, whatever. Therefore, as Rule Your Retirement editor Robert Brokamp explains,
a Roth IRA might make for a backup emergency fund in some cases. We say
"backup" because you should still have an emergency stash to cover
three to six months' worth of expenses in a safe place, such as a money
market. But if a really big-ticket emergency befalls you, know that
part of your Roth IRA is available without any consequences from Uncle
Sam.
4. An estate-planning tool.
Let's say you're still working, which means you can still contribute
to an IRA. (Folks who don't earn a paycheck can't contribute to an
IRA.) However, let's also say that you've already saved enough for your
own retirement, but you'd like to help your kids, grandkids, or
favorite Motley Fool writers. What should you do? Contribute to a Roth IRA and name your relative(s) as the
beneficiaries. When you retire from this world to the next, your heirs
will receive that money income tax-free (though it may be subject to
estate taxes). A Roth IRA is better than a traditional IRA for this purpose for a
few reasons. You can't contribute to a traditional IRA past age 70,
even if you're still working. In fact, at that point, you must begin
taking money out (known as required minimum distributions, or RMDs).
Not so with the Roth; there's no age limit, and no RMDs. Plus, heirs
must pay income taxes on inherited traditional IRAs. That said, not everyone is eligible for the Roth. Single taxpayers
with a modified adjusted gross income above $99,000 see their
contribution limits begin to decline to zero; that magic number is
$156,000 for married taxpayers. You should certainly do all you can to resist tapping your IRA until
you retire. But if an emergency arises, knowing that there are
circumstances in which you can access the money may set your mind at
ease.
This article is adapted from the
Motley Fool Green Light
"Money Answers" archive, which features more than 100 articles on
personal finance topics ranging from taxes to credit to beginning
investing, organized by subject and life stage. For access to this
content -- plus the current newsletter, back issues, members-only
discussion boards, and advisor blogs -- take a free 30-day trial today!
Fool contributor Elizabeth Brokamp is a licensed professional counselor with a special interest in Robert Brokamp, editor of The Motley Fool's Rule Your Retirement newsletter. |
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Legal Information. ©1995-2006 The Motley Fool. All rights reserved. | ||
April 11, 2007
Intimidated by Retirement Investing? Get Professional Help!
It might seem like something of a no-brainer to ask for professional investment advice, particularly about retirement. That said, there's still an astonishing number of people I know who don't. They either go it alone, wading through jargon that they don't understand and desperately trying to make numbers that don't mean anything to them mean something, or the guess and hope they get lucky, or they avoid the topic altogether.
Continue reading "Intimidated by Retirement Investing? Get Professional Help!" »
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