Tax Hacker Tuesday is back to teach you all the 401k and IRA stuff that no one else is telling you about! Learn about the huge differences between 401k plans and IRAs (and which one Tim recommends), how to protect your retirement fund from the IRS, who is eligible to sponsor a 401k plan, and more with Epic Real Estate and Tim Berry on Tax Hacker Tuesday!
What You Will Learn About 401k and IRA Stuff That No One is Telling You About:
- How to handle outstanding loans with old employers
- The shocking thing the IRS can take away from you (and what to do if you’re worried about it)
- The real reason why Tim is always “screaming from the rooftop” about using a 401k plan instead of an IRA
- Everything you need to know about the recent law Congress passed regarding Roth accounts
- Who is eligible to sponsor a 401k plan
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Speaker 1: This is Theriault Media.
Did you know that up to 50% of your lifetime income will be wiped out by taxes? What if you could stop this madness? Isn’t it about time you play on a level playing field with the wealthiest 1%?
Now, you can. Tim Berry, attorney-at-law, shares here each and every week current tactics and strategies that anyone can implement to hack the tax code. Protect your assets and keep what’s rightfully yours. It’s time for Tax Hacker Tuesday.
Tim Berry: So another day I was buying a car. As I was buying the car, I was talking to somebody at the car dealership, and they had a really interesting situation. What had happened is they had left their old employer, and they had moved to a new employer. But here’s the interesting situation: They had an outstanding loan with the old employer, and that loan was probably going to become a taxable event unless they paid off that loan, and they didn’t have the cash to pay off that loan of the old employer.
But here’s the really interesting dynamic. They had already moved an awful lot of money over into their new employer’s retirement plan. Now, under the terms of the new employer’s retirement plan, they were able to borrow out from that new employer’s retirement plan. Effectively, the best thing for them and their situation was to do this, borrow money from their current retirement plan, use that money to pay off their loan at the old retirement plan, and then – get this – then they’re going to transfer the proceeds, what they’ve paid off that loan with – they’re going to transfer it from the old retirement plan, into the new retirement plan.
If you run into a situation and you’re leaving an old employer and you have an outstanding loan, this is something that could really dramatically help you and save you a lot in taxes. It also answers a very simple, basic question: Can you take a loan from two different retirement plans? The answer is yes, so long as they’re separate entities, and they’re not… the ownership isn’t attributed to each other, you’re allowed to have a loan from two separate retirement plans.
You’re living your quiet life of desperation, you owe the IRS money. Now you’re terrified that they’re going take away everything – they’re going to take away the dog, the cat, the canary, everything. You’re absolutely afraid of this. Now, the big question we are constantly being hit with by people is, “Can they take away my 401(k) funds?” Simple answer is, yes. They are allowed to take away your 401(k) funds. In particular, the IRS has the exact same rights in property that you have. If currently you’re allowed to take a distribution from the 401(k), or cause a distribution to be made, and take that hard cold cash, the IRS has the exact same rights.
This is what you do if you’re worried about the IRS taking away your retirement plan funds: You make sure that you don’t have rights in your retirement funds currently. Simple way to do that is just make sure that any retirement plan that your money goes into, that that retirement plan’s kind of a Hotel California retirement plan. It goes in, but it can’t come out. How do you do that? You just make sure that there’s provisions saying you are not entitled to any distribution from your retirement plan until, gosh, age 65, age 70, for as long as you can make it. Now if the IRS comes in, knocks on your door, and says, “Hey Mr. Mrs. Jones, we’d like to take away your retirement plan money,” if you don’t have the rights to get that money, the IRS doesn’t have the rights to get that money either.
401(k) plans. Why am I always screaming from the rooftops about use a 401(k) plan instead of an IRA? Well, let me ask you a series of questions. What if Congress passed a new law and they said that they would pay you – they would give you money to open up a trust? Then, whenever you open up that trust, and you put money inside of that trust, as that trust earned income, you wouldn’t have to pay taxes on the earnings of the income inside the trust? Sound pretty cool? Oh, and by the way, under certain situations, Congress would say inside this new law, you got paid to open the trust, the trust didn’t have to pay taxes on the earnings inside of it, and under certain circumstances, whenever you take the money out, you wouldn’t have to pay taxes on that distribution. Does it sound pretty good so far?
Oh, but wait, there’s more. It gets better. It slices. It dices. Other great aspect of this, not only does the money grow tax-free, and in some situation the money comes out tax-free, but also the assets inside this trust are not subject to the claims of creditors. Does this sound great? What am I talking about? Well, in some people say, “Oh I know what you’re talking about. You’re talking about going offshore.” Au contraire. I’m not talking about going offshore. I’m talking about a 401(k) plan.
Let’s stop and analyze this. I said earlier that in some situations, the government is going to pay you to open the trust. Under some circumstances, the IRS will actually give you a tax credit just to establish a 401(k) plan. They will give you a credit equal to a percentage of the amount you spent to open the 401(k) plan. For just creating the 401(k) plan, you can get a credit, a tax credit, which is a dollar-for-dollar reduction on your taxes.
Then, whenever you start making contributions to the 401(k) plan, you’re going to get a tax deduction. If you start making contributions of profit sharing contributions, your business gets a tax deduction. So literally, you’re being paid to create this 401(k) plan, and to fund this 401(k) plan. Next, the trust wouldn’t have to pay taxes on the earnings. Distributions could come out tax-free. There’s a number of different flavors of 401(k) plan, and I don’t want to get too complicated with this, but recently, Congress passed a law saying that there can be designated Roth accounts. What that means is you don’t get the initial tax deduction putting the money into the Roth account, the Roth 401(k), but as long as the account’s open for five years and you’re over 59 and-a-half, whenever the distributions come out, they come out tax-free.
Finally, the creditors, including the IRS, couldn’t take the trust assets if you have to file bankruptcy. Your 401(k) isn’t even a part of your bankruptcy estate. States have laws saying that 401(k) plans are exempt from the claims of creditors. The IRS says they can’t go after assets inside a 401(k) plan unless the 401(k) plan is in something called pay status. So if the plan isn’t in pay status, the IRS doesn’t have the rights to go after those assets. Those are basically the reasons why I love talking about 401(k)s so much. They just got so many benefits. Once again, every now and again, I hear some yahoo talking about going offshore taking assets offshore, ’cause no one’s going to find out about them. They grow tax-free. They don’t. And no creditors are going to be able to get at them. That’s probably not true either.
They’re talking about offshore, and I’m thinking, “Why would you go offshore, when everything you need is located in a 401(k)? Now, let’s get to the basics of a 401(k). What do you have to do in order to create a 401(k) plan? ‘Cause a lot of people are under the mistaken concept that 401(k) plans are only for large corporations – they’re only for IBM, Motorola, Apple, Johnson & Johnson. Not true.
Tax code says that anybody with a valid business can sponsor a 401(k) plan. If you have a blog, and you make a few dollars a month from that blog, and you’re continually working that blog, that’s a business. If you have a multi-level marketing business, a network marketing business – I don’t know if I should say multi-level marketing business; some people take offense to that – but if you have a network marketing business, so long as you’re treating that as a business and you’re making a profit, you now have a business.
Just had a phone conference with a guy. He’s running in some issues right now with his regular company – fairly large company. I think he has 20 employees. But off on the side, he created a network marketing business. It’s already making $2500 a month for the guy. Well, he can establish a 401(k) for that network marketing business. Once again, you have to have a valid business in order to sponsor the plan. The assets grow in a tax-free environment… Now, here’s a really cool thing. If the only participants of the 401(k) are either the owners of the business sponsoring the 401(k) plan and the owners and their spouses, the 401(k) plan doesn’t even need to file a tax return unless the assets exceed $250,000.
These are the basics of the 401(k). You have to have a business to sponsor, grows in a tax-free environment, and the reporting of the 401(k) is fairly simple. Now, a lot of you are listening and thinking, well, gosh, Tim, I don’t know why I need a 401(k). I already have an IRA. Why would I want to use a 401(k) instead of an IRA? Well, number one, prohibited transaction issues. Most IRA custodians have screwed up the IRA paperwork, and just by agreeing to the terms of that IRA paperwork, you’ve probably engaged in a prohibited transaction that has caused your IRA to be considered fully distributed. With the 401(k) plan, if you had agreed to the terms of that paperwork, in most situations, there’d be absolutely no consequences.
Typically, the 401(k) plan, if it engages in a prohibited transaction, it’s hit with a 15% excise tax on the dollar amount involved. Well, if you signed a personal guarantee or an indemnity clause, and that’s never triggered, chances are, there’s no dollar amount involved, and so, therefore, you owe an excise tax of 15% of zero, which is equal to zero. That’s the first big reason as to why to use a 401(k) instead of an IRA. You have a fantastic safety net with the 401(k) that you don’t have with the IRA. Other big one: With the IRAs, you’re allowed to put in a whopping – what, $5, $6,000 a year? That’s not too exciting. With a 401(k) plan, we can put in $50,000 – maybe even $54,000. It just all depends upon the situation, but we’re talking $50,000, five zero thousand, as opposed to $5000. Big difference there.
Other one, with an IRA, you need a custodian. Just had a guy call me up today. He called one of these self-directed IRA custodians and he told them he wanted to set up a self-directed 401(k). They said, “No problem. You’re going to need to set up an account with a custodian. You’re going to need to set up an account with a 401(k) document provider, and you’re going to need to set up an account with a third party administrator.” These three different layers were all going to have fees involved, and all have their paperwork.
With a true self-directed 401(k), you can be your own trustee. You don’t need a custodian. You don’t need a third party administrator. You don’t need someone providing ongoing accounting for the 401(k), ’cause chances are, you’re going to make one, maybe two investments and just hang onto it, and it’s going to be very simple to account for, and you can do that on your own.
Why not with a IRA once again? Less flexibility. 401(k)s have a ton more flexibility of what you can and can’t do. You can make contributions of assets you already own to the qualified retirement plan. You can’t do that with an IRA. You can take loans out of the 401(k). You can’t do that out of the IRA. Why would you use an IRA instead of a 401(k)? The only time I can ever think of why you would ever use an IRA instead of a 401(k) is if you do not have a valid business, because you need that valid business to establish the 401(k). But once you have the valid business, it’s a no-brainer to use the 401(k) instead of the IRA.
Other big one – with a Roth IRA, if you want to establish a Roth IRA, there’s income limitations. You can’t make over $160,000 a year if you’re married filing jointly. With the Roth 401(k), there’s no income limitations. If you’re making $160,000,000 a year, you can still make contributions to the 401(k) and have them designated as Roth contributions. That’s just a no-brainer.
Let’s just keep a running tally of what’s better, the Roth IRA or the Roth 401(k). And I say Roth IRA – any IRA, for that matter. Are there income limitations to making a contribution to a Roth IRA? Yes, there are. Are there income limitations for making a contribution to a Roth 401(k)? No, there’s not. Contribution limits, with the Roth IRA, $5000 bucks. With a traditional IRA, $5000 bucks – $6000 if you’re fortunate enough to be over 50 years old. With the 401(k), with the Roth 401(k) – $50,000. If you’re over 50 years old, it’s $55,500.
Let’s talk about another great reason about why to use a 401(k) instead of an IRA. With a 401(k), there’s provisions where if you don’t make enough contributions from your salary, your wages, your profits, and if your business doesn’t make contributions, you can go ahead and take money out of your personal savings account and contribute it to the 401(k). Stop and think about how powerful this is. What we’re basically doing is we’re converting assets that you have in your personal name, that are subject to taxes, and that are subject to the claims of creditors, and we’re converting those assets over to assets that are not subject to taxes and that are not subject to the claims of creditors.
Let’s just walk through this example. Let’s say Mark makes $65,000 a year flipping houses, and he has $100,000 lying inside an account that inherited from his mother. He could take up $50,000 of that inheritance and he can put it inside of his 401(k). Now, guys, let me throw out the caveat here – it all depends upon the facts, and the situations et cetera so forth, but conceivably, if he did things right, he could take $50,000 of that inheritance in year one and put it inside a 401(k) plan.
Now, he took $50,000 from an account that was subject to taxes and subject to the claims of creditors, and he has now sheltered that $50,000 from taxes and from the claims of creditors. Can you do that with an IRA? Don’t think so. Another great aspect – a big difference between a 401(k) and an IRA – with an IRA, be it a Roth IRA or a traditional IRA, if that IRA borrows money and it makes a profit from that borrowed money, it has to pay taxes on the profits generated by the borrowed money. Whereas with a 401(k), if the 401(k) goes out and borrows money and it invests in real estate and it does things correctly, whenever it sells that real estate, there’s no taxes due on the profit. That debt financed income rule does not apply.
Let’s look at this running tally. Income limitations? Yes for the IRAs, no for the 401(k). Debt financed income. Are we hit with debt financed income? With the IRA? Yes. With the 401(k)? No. Guys, it’s just a no-brainer. Here’s an example again on the debt financed income. Let’s say that John’s IRA borrows $90,000 to buy a $100,000 property. Furthermore, the IRA makes a profit of $200,000 on the property because 90% of the purchase price was financed. 90% of the profits is subject to taxes. 90% times $200,000. $180,000 of the profit is subject to taxes if you did that investment inside of an IRA, and if you did that investment inside of a Roth IRA.
Let’s talk about our good buddy the Roth 401(k). John’s Roth 401(k) borrows $90,000 to buy a $100,000 property. Same fact pattern. The 401(k) makes $200,000 on it. Not a single dime of that profit is subject to taxes. Not a single dime of the profit is subject to taxes. Here’s the interesting thing. If you made a $180,000, and let’s just say the tax brackets – the average tax bracket of whatever, let’s say 20% – that means you’d had to pay – or, I’m sorry. Your IRA would have had to have paid $36,000 on this profit.
If we did this inside the 401(k)? Nothing is subject to taxes. Therefore, you just saved $36,000 just by having the knowledge of what structure to use to make the proper investment – which tax deferred account, what retirement account to use – you just saved $36,000, and that’s on top of all those other benefits that we’ve talked about with the 401(k) plan.
Here’s another great one: a loan. If I borrow money from my IRA or my Roth IRA, once I borrow that money out, it’s considered fully distributed and taxable. Da, da, da, da – if I borrow money from my Roth 401(k), guess what? You got to pay it back. You got to pay it back in level amortized quarterly payments, but so long as you do things right and you pay it back, that is not considered a taxable distribution. You can get up to $50,000 from your 401(k) tax-free in the form of a loan, where you can’t do that with an IRA.
Just had a guy call up. It’s tax season, as I’m recording this, so a lot of people are scrambling to pay their taxes. One guy called up said, “Hey, Tim, I’ve got $10,000 inside my 401(k). Can I borrow that money out of the 401(k) and use that to make a new contribution to my 401(k) to lower my taxes for this year?” Answer is yes, so long as you do things right. He can borrow money out of his 401(k) plan. He’s now got that money in his hands, and he can now use that money to be a new contribution into his 401(k) plan to lower his current income taxes. This is just fun stuff guys. You can’t do that with an IRA, but you can with a 401(k) plan.
Going through the dynamics again. Income limitations for the IRAs? Yes. Debt financed income? Yes. These yes’s are not good things, by the way. Where it’s a no, and a no, which are good things on the 401(k) side. Can you do a loan with the IRA? No. Can you do a loan with a 401(k)? Yes, you can. Asset protection, super biggie, especially in this day and age of so many real estate investors went out there, they got leveraged, and now they have deficiency judgements hanging over their heads. With an IRA, chances are, your IRA is considered fully distributed because you engaged in a prohibited transaction, and you don’t have an IRA anymore – you just have a regular savings account. If you just have a regular savings account, you have no asset protection. Let me say that again: You have no asset protection.
With a 401(k) plan, if it accidentally engages in a prohibited transaction… no big deal, no harm, no foul. Therefore, it is still a valid entity; therefore, it is still exempt from the claims of creditors. 401(k)s have a heck of a lot stronger asset protection than IRAs do. Once again, if you accidentally engage in a prohibited transaction, is that a full distribution of your IRA? Yes, it is. Is it a full distribution of your 401(k)? No, it’s not.
Reporting, do you have easy reporting with a 401(k)? Sure you do. Once again, so long as the assets are below $250,000, if the only participants in the plan are the business owner, and the business owner and their spouse, no need to even file with a tax return for the whole thing. Rollovers. Can we accept rollovers into a 401(k)? Sure you can. The only thing that can’t be rolled over into a 401(k) is Roth IRA money. We can’t roll Roth IRA money into a 401(k) or a Roth 401(k). That’s one limitation dealing with the 401(k)s, but that’s just a relatively minor limitation.
Minimum required distributions. Whenever you turn age 70 and-a-half, are you hit with minimum required distributions for a Roth IRA? For a Roth IRA, no; for a traditional IRA, yes, and for 401(k), yes. So if you turn 70 and-a-half, you are going to be hit with the required minimum distributions from a 401(k) and from a traditional IRA, but not the Roth IRA.
Long and short of it, guys – and this was just a quick little presentation to make you aware of like the possibilities. It’s an absolute no-brainer if you have a valid business. You want to establish your 401(k). You want to avoid the IRAs. You can do everything you can do with the IRA, but more with the 401(k). You want to go out and buy a Tax Lien Certificates? You can do it with a 401(k). You want to buy real estate? You can do it with a 401(k). You want to buy hard money loans or make hard money loans? You can do it with a 401(k). The 401(k) is just an absolute no-brainer if you have a valid business.
Speaker 1: That’s it for today, as we dream of a tax system that works just for you. But until then, you have Tim Berry. See you next Tuesday for another episode of Tax Hacker Tuesday.