IRA Mistake #2 Know thy difference between fees and no fees!
If you missed IRA Mistake #1 CLICK HERE
In Part I we discussed how Wall Street has clearly dominated IRA funds for thirty years evidenced by its continued control over 97% of five trillion IRA dollars.
We also discovered that over 200 million dollars monthly flee Wall Street IRAs for Self-Directed IRAs because a growing contingency of IRA owners demand a wider selection of investment options, i.e. investment choices that are not offered by Wall Street. These maverick IRA owners most specifically want real estate in their IRA portfolios evidenced by the fact that real estate is the #1 choice for the 200 million dollars that flee Wall Street each month.
IRA Mistake #2
Not knowing the operational differences among the Self-Directed IRA, the Check Book Control Self-Directed IRA and the Individual 401(k), the benefits and burdens of each, and the bottom line cost to establish each.
The Self-Directed IRA
The Self-Directed IRA has been around longer than most people realize. It is only in the last decade that the Self-Directed IRA has forged its way into the consciousness of a few of the 45,000,000 IRA holders in America.
The Self-Directed IRA may have never made a debut in America if Wall Street hadn’t more than once vaporized trillions of IRA dollars precipitated by huge declines in the value of stocks and mutual funds.
After the first of many Street financial debacles a small minority if IRA owners sought more control over how their IRAs could invest and looked to Wall Street. Predictably Wall Street turned a deaf ear. Eventually a few enterprising entrepreneurs, many being prior Insurance and Bank executives, saw an incredible and obvious opportunity, i.e. give these disgruntled IRA owners what they want. And regarding compensation, well, after all Wall Street had been extracting lucrative fees off of five trillion IRA dollars for decades, who not this new breed of IRA Custodians?
The primary differences between an IRA (Wall Street type) and a Self-Directed IRA are control and product diversity.
The Self-Directed IRA allows you to step out of the limited Wall Street Menu box and purchase alternative investments like real estate, e.g. raw land, lots, houses, multi-unit rental properties and even vineyards, and also real estate related products: Tax Lien Certificates, Discounted Notes, Mortgages, Leases, Water Rights and more.
The Self-Directed IRA also grants you more control over your IRA; i.e. what to buy, how to buy, when to buy, when to sell, how to sell and more. An example would be, your Self-Directed IRA buys a single family rental property for $75,000 and sells it five years later for $125,000 with $75,000 down and a 1st mortgage of $50,000 at 8% interest. This could never be accomplished with a Wall Street IRA.
The Self-Directed IRA Cost
Many Self-Directed IRA Custodians offer Self-Directed IRA plans with a mere $50.00 sign up fee (usually can be completed on the internet) with a published schedule of fees.
IRA Custodial Fee Schedules (listed on the IRA Custodian’s Web Site) are imposed on each transaction, the number of assets, the value of assets etc.
However, the Self-Directed IRA also has two mandatory components that can place a damper on the supposed “control” over your newly created Self-Directed IRA.
The IRA Buy Direction Form (published on the IRA Custodian’s Web Site)
The IRA Buy Direction Form must be completed and submitted and approved by the Self-Directed IRA Custodian before your IRA transaction can move forward. Its purpose is to clearly identify what it is you want your IRA to purchase. This allows the IRA Custodian to cover its backside and scrutinize what it is you are directing the IRA Custodian to buy for your IRA. For example alcohol and antiques are not allowable for an IRA as mandated by the IRS. Thus if your IRA Buy Direction Form described “Ten cases of fine Malbec wine” and a “Louis XIV desk” your IRA Custodian would not approve this transaction.
The IRA Custodian approval process should require but a day or two but I have seen days turn into weeks and weeks into months while IRA paperwork, emails and phone calls ping ponging back and forth between the IRA Custodian and the IRA Owner.
The IRA Funding Form (published on the IRA Custodian’s Web Site)
The IRA Funding Form follows the IRA Buy Direction Form after it has been approved. The IRA Funding Form instructs the IRA Custodian how to fund the approved purchase, e.g. use IRA Money Market funds, sell 100 shares of IBM stock held in the IRA, a combination etc. This allows the IRA Custodian to cover its backside by not unilaterally using unauthorized funds or selling stock or mutual funds without your written direction.
Benefit of the Self-Directed IRA
It is inexpensive to set up, often only $50.00 and opens up a whole new world of investment products not offered by Wall Street. This allows you to truly hold Wall Street to its mantra of “Diversify”. How can your IRA be diversified if all of your IRA funds are in Wall Street financial products?
Burdens of the Self-Directed IRA
A major speed bump that comes along with a Self-Directed IRA is the fact that it does not offer “immediacy”.
With a Self-Directed IRA you cannot stand on Court House steps or sit across the desk from a REO Bank Rep and when a price is agreed upon write a check. Quite the converse is true, you’ll need a few days to … yep, complete, submit and get approved both the IRA Buy Direction Form and the IRA Funding Form?
However, in fairness “immediacy” may not be a big deal for every Self-Directed IRA Owner and whether it takes a few days or a few weeks to get the nod of approval from your Self-Directed IRA Custodian may not be a problem for you at all. If this is the case then a Self-Directed IRA may be just the right fit for your financial needs.
One quick note, many Self-Directed IRA Custodians use Fee Schedules that can frankly nickel and dime you to death. There are a few Self-Directed IRA Custodians who offer a “Flat Fee” imposed annually rather than a schedule of fees. You should check out both.
The Check Book Control Self-Directed IRA
The Check Book Control Self-Directed IRA is everything the Self-Directed IRA is minus having to comply with the IRA Buy Direction Form and the IRA Funding Form. That’s right, there is no requirement for you to complete, submit and wait for an approval for both the IRA Buy Direction Form and the IRA Funding Form. Voila, they are gone.
The Check Book Control Self-Directed IRA concept is simple. An LLC is created for the benefit of your IRA; you elect yourself manager of the IRA LLC and open a bank account for your IRA LLC which allows you to simply snap off a check. For those of you who have heard negative information about the Check Book Control Self-Directed IRA and perhaps doubt its authenticity, I suggest you study the Tax Court Case, Swanson v. Commissioner, 106 T.C. 76 (1996). If you like email me and I will send you a PDF of the case.
The Check Book Control Self-Directed IRA Cost
Ah, here’s where the tire meets the road. Setting up a Check Book Control Self-Directed IRA can cost $2,500 or more because an LLC with a “Special Operating Agreement” needs to be established.
Caveat. Before you run out and buy LLCs for Dummies or google some nebulous internet provider of Check Book Control Self-Directed IRAs, be sure the company you choose has done a lot of them. Ask for references, do your due diligence. A few dollars saved now in the formation period could cost your thousands later.
Benefits of the Check Book Control Self-Directed IRA
The first and primary benefit is “immediacy”. Imagine yourself on the Courthouse steps or sitting across from a REO rep and asking; “Who shall I make the check payable to?” You can’t get any more immediate than that which may result in your getting more deals than a competitor who is saddled with the IRA Buy Direction and IRA Funding Forms.
Burdens of the Check Book Control Self-Directed IRA
The most obvious is cost. If all you contemplate is making one deal at that’s it, and the Seller is patient and will wait for you to complete the IRA forms, why spend the extra money. But if you see yourself much more active and aggressively doing multiple deals then the Check Book Control Self-Directed IRA may be for you.
The Individual, Solo, or Entrepreneurial 401(k)
In 2001 the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) created the Individual, Solo, or Entrepreneurial 401(k) herein called the Individual 401(k).
With the Individual 401(k) you are allowed to make dual contributions:
a) As the Employer
b) As the Employee
- Presence of self employment activity
- Absence of Full Time Employees (may be 1099 workers but not W-2 workers)
The Individual 401(k) offers a wide Diversification of Investment Products not offered by Wall Street including real estate both foreign and domestic.
The Individual 401(k) Cost
Here is where all four tires meet the road; the Individual 401(k) can run from $2,500 to $4,000 and more depending on the complexity of the plan.
Benefits of the Individual 401(k)
The Individual 401(k) has many advantages over the Self-Directed IRA and the Check Book Control Self-Directed IRA.
The Individual 401(k) has much higher Contribution Limits. All IRAs have annual contribution limits of $5,000 + $1,000 Catch Up if over age 50.The Individual 401(k) annual contribution is $49,000 + $5,500 Catch Up if over age 50.
Many investors want to use leverage with their real estate purchases and seek mortgage money whether with a bank or perhaps Seller financing. Individual 401(k) owned and debt financed property is not subject to U.B.I.T (Unrelated Business Income Tax) tax on any net income from rental property. The U.B.I.T. tax rate is quite high and can be 37%.
U.B.I.T tax can be imposed on a Self-Directed IRA or Check Book Control Self-Directed IRA that employs debt financed property.
The Individual 401(k) can borrow up to 50% of IRA Account Value ($50,000 max) for any reason. Such loans may be amortized up to a maximum of sixty (60) months with payments made monthly or quarterly and the loan must earn a minimum of 1% over the Prime Rate established at the time the loan is made. Only one 401(k) loan at a time, i.e. you cannot have a series of Loans.
The Individual 401(k) can include you and your spouse under the same plan.
The Individual 401(k) can have two components, Traditional and ROTH. You can elect which plan to contribute to.
Burdens of the Individual 401(k)
A higher cost is a factor and whether or not you have employees which could disqualify you from such a plan.
As you can see there are multiple options for you if you make the decision to move away from your restrictive Wall Street IRA to gain true financial independence and product diversity.
Just as no two IRAs are alike, no two IRA Owners are alike. Each case should be studied on an individual basis and beware of those who tell you “One size IRA fits all”. This is not true.
In Part III we’ll explore IRA Mistake #3
Not knowing how to buy real estate with your IRA including debt financing.
We will delve in more detail the buying and selling of real estate with a:
- Self-Directed IRA (with and without financing)
- Check Book Control Self-Directed IRA (with and without financing)
- Individual 401(k) (with and without financing)
For a FREE copy of the tax court case Swanson v. Commissioner and a 30 minute no obligation phone consultation about your IRA please provide the information below and the court case will be sent to you immediately by email: