2 More Questions to Ask Yourself About a 401(k) Plan
In yesterday’s blog entry we looked at the first three basic questions to ask before investing in a pre-tax 401(k) plan. Now, let’s look at the two advanced questions you should consider before making that kind of investment.
Do You Plan to Roll Your Nest Egg?
Would a 401(k) contribution get you out of AMT this year?
AMT (Alternative Minimum Tax) looks to be a serious issue for many Americans this year. I’ll be blogging about any updates on this on TaxLoopholes, so make a note to check often.
The problem with AMT is that it can be triggered by so many things: income over $100,000, long-term capital gains sales, and high state income tax are all things that can trigger the alternative tax. The problem is that many of the deductions you’re used to taking to reduce your taxes, simply don’t work with AMT. One strategy that does work this year if you own your own business (and otherwise qualify) is to put a Solo 401(k) plan in place. It can take you out of AMT harm’s way and create a perfect set-up for (5) below.
Will you roll in 2010?
There is a fantastic loophole for the rich occurring in 2010. In 2010, you’ll be able to roll all of your pension plans into Roth accounts, without limitations. Remember a Roth account allows you to grow your investments without paying tax, ever. If you’ve got a proven track record with investments and know you’re going to make money, wouldn’t you rather make that money in a Roth account? Currently, if you make too much money, you can’t do the roll over. That’s what has kept so many people out of these great wealth-building vehicles.
In 2010, for one year only, anyone can roll. There is no limit on how much you can move over either. You’ll have to pay tax on the amount that is rolled, but the government is even going to give you two years to pay it! It’s a great deal, for the right person, and the best way to optimize it is to put as much as possible away in 2007, 2008 and 2009.
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Diane,
Where are your thoughts on this for high income earners with high IRA balances? Is there a benefit to partial rollovers versus full rollovers in order to manage the taxes paid? Rolling over large sums will push some taxpayers into higher brackets than they are currently in, but for people who have more years before retirement, the benefits are huge.
As an example, Sam Smart earns $150k per year and in addition to his other investments, has traditional IRAs totalling $200k. If Sam rolls over all of the IRA money into a Roth IRA, his federal tax bracket on most of the $200k will increase from 28% to 33% on this IRA money. If Sam’s state tax is 7%, Sam would pay 40% to convert this. That would be $80k in extra taxes to rollover the full $200k IRA. If Sam starts saving for the extra taxes in 2007, then he’d need to save $20k per year for 4 years to foot the tax bill.
Do you think that Congress would reneg on Roth distributions being non-taxable for the wealthy in the future once the Roth account balances become larger and Congress sees it as another source of potential income?
You bring up some great points.
I think if someone is close to retirement and isn’t someone about to make a big gain on stock or real estate wouldn’t want to pay tax all at once and at their current working tax rate. BUT if they’re at the beginning of the wealth-building cycle, building up cash flow and appreciation tax free is really compelling.
You’ve also got a great quesion - will Congress honor their promise? All I can do is give it my best guess, based on what I’ve seen, I don’t think they’ll tax Roth. But, I think they are going to look hard at other sources of revenue. I think we might see a national sales tax at sometime in our lifetimes, or maybe in our children’s lifetime. That seems the best way to tax the retirees - catch them on what they spend because so much of their revenue will be tax free or partially tax free (like Social Security)
Just my two cents, though, I don’t have a crystal ball on this!
Can self-directed 401(k) plans invest in a Limited Partnership or hedge funds? What are the rules / restriction?
A solo 401(k) can invest in a Limited Partnership, real estate, stocks, bonds, funds….practically anything except for a few exceptions such as life insurance policies and collectibles.
But the “how” of you do the investment and whom you can do it with does have more rules and regs.
I really recommend that you check out my book, “The Insider’s Guide to Tax Free Real Estate Investing”. You’ll find all the rules in there plus step by step strategies to put your pension plans to work for you.
I just read your e-book “Less Tax With Real Estate IRA”. I thought it was very informative and well-written!
How can I apply the same concepts to investing my IRA into a LLC / LP used for trading derivaties (Section 1256 contracts)?
Specifically, my brokerage has several restrictions on trading in IRA accounts. For instance, IRA accounts are non-margin accounts. As a result, certain transactions, such as selling naked puts in a IRA, require significant margin requirements. In a non-IRA account, the margin requirements are much more favorable, less restrictive, and allow for greater leverage.
1) To get around the restrictive margin requirements of a traditional IRA account, could I open a separate margin account under a LP / LLC and use a self-directed IRA to invest into the LP / LLC?
2) Since margin requirements in options trading are more of a performance bond rather than borrowing cash, what would be the impact of UDFI? Is UDFI only a concern if you borrow more cash than the available funds of the IRA? Would UDFI be a concern if you leveraged your trades without borrowing any additional cash?
I’m glad you enjoyed the eBook.
Actually, an IRA can do trading. I think the key is finding a custodian who is set up to allow it. OR set up an IRA LLC and then take over check book control for the activities.
I think that might be where you are going with (1) (set up an LP/LLC and then let the IRA invest in it), but there are a little tougher guidelines. In a way, that makes it much easier because we know exactly what it takes to set up an IRA LLC and how to administer. My colleague, Megan Hughes, who blogs on this with me sets up IRA LLCs all the time. She is the only person that my company refers to for this type of work.
UDFI (the tax based on the leveraged portion) is going to come into play based on the percentage of leverage versus non leverage applied to the total gain.
Maybe we should do some more blogs on investing with your pension… Anyone else interested?
If I have a Solo 401(K) already, should I bother converting it into a Solo ROTH 401(k)? Or should I simply wait and then roll my existing Solo 401(K) into a Roth in 2010?
Good question. Ally, I think for you one thing to look at would be whether the tax deduction you get for the Solo 401(k) is more important now then it would be in the future. In other words, if your earned income is higher now than it will be in 2010, then max your deduction. If not, then you might want to have part of the Solo 401(k) ear-marked for Solo Roth 401(k).
You’ve got a really good point here. I’ve been considering that as well for my clients, on a case-by-case basis.