Which Individual Retirement Plan is Best for Me?

Patricia McCrystal
June 22, 2015

Here at New Direction IRA, one of the most frequently asked questions by prospective clients is which Individual Retirement Plan will suit them best. The fact of the matter is, there is no easy answer to this question. Our role at New Direction IRA is to be a trusted provider of administrative services for individual retirement plans and HSAs; we specialize in the bookkeeping and reporting for unique and alternative assets. As such, we do not provide investment advice or endorse any products. However, one of our primary functions is to provide educational services for our clients so they may be empowered to make educated decisions about which IRA they would like to self-direct.

Each retirement plan yields different benefits and involves different restrictions, and the equation for which arrangement is the most advantageous depends on many present and future factors in a client’s life. Below are highlights of the various features of each IRA to illustrate which arrangement could be the most beneficial to your individual investment goals.

Traditional IRA

A Traditional IRA may be opened by any individual who has earned income. With a Traditional IRA, cash is contributed "pre-tax", meaning the contribution is taken as a tax deduction from earned income for that tax year. This cash can then buys assets (stocks, real estate, gold, etc.) on a tax deferred basis. In general, assets can be bought, sold, or traded within the IRA without incurring capital gains tax, and without affecting the IRA holder's personal taxes. There are a few exceptions to this advantage, such as the occurrence of UBIT (Unrelated Business Income Tax), which can result when your self-directed IRA makes a debt-financed purchase, or when you operate a business with your IRA. 

The main incentive behind opening a Traditional IRA is the projection that you will be in a lower tax bracket when you retire, and that your initial contribution will have grown on a tax deferred basis. Most 401(k)s, 403(b)s, Thrift Savings plans, and 457s are within the same tax status as a Traditional IRA. The rollover from any of these accounts into a Traditional self-directed IRA incurs no penalty fees or taxes. When you reach 59.5 years of age, you can begin to withdraw from the account (take a distribution) without penalty. You then pay taxes on the amount withdrawn.

What Are The Benefits Of A Traditional IRA?

A Traditional IRA enables you to invest for retirement in an account that lets your investments compound each year without being hindered by taxes. By contributing to your Traditional IRA, you may lower your tax bracket.

By investing with a Traditional IRA, as opposed to outside of an IRA, you are able to invest more money because taxes have not been deducted. If you anticipate your tax rate at retirement to be lower than your current tax rate , your total tax burden may be less.
You can make contributions even if you are not eligible to make a Roth IRA contribution because your income is too high.

A Traditional IRA can be used to invest in a wide variety of assets including real estate, precious metals, public and private stock, notes, and more. Additionally, early distributions may be taken without penalties for unusual circumstances like a first home purchase, or certain medical expenses.

Roth IRA

The Roth IRA is a powerful way to save for retirement because earnings on your investments are free from federal income tax, providing certain conditions are met. With a Roth IRA, cash is contributed "post-tax", meaning the contribution is made with taxable earnings for that year. This cash then buys assets (stocks, real estate, gold, etc.) on a tax advantaged basis. In other words, assets can be bought, sold, or traded within the IRA without incurring capital gains tax, and without affecting the IRA holder's personal taxes.

Keep in mind, a Roth IRA holder may withdraw the principal amounts (i.e. your contributions) at any time without penalty or tax liability. Once you reach 59.5 years of age, you can begin to take a distribution of the earnings from the account without penalty and without taxes, as long as the account has been open for 5 years.

Unlike a Traditional IRA, contributions may be made into a Roth IRA even after you are 70½, and you are not required to take distributions at any age. The Roth IRA is popular with clients who anticipate a large return on their assets, or for clients who invest in real estate and may have taken a loss for that specific year.

What Are The Benefits Of A Roth IRA?

The qualified withdrawals (distributions) from a Roth IRA are tax free since you already paid taxes on the contributions. All earnings derived from your contributions can be distributed without incurring any tax. 

A Roth IRA enables you to invest for retirement in an account that allows your investments to compound each year without being chipped away by taxes. If you anticipate your tax rate at retirement to be the same or higher than your current tax rate , your total tax burden on distributions may be less.

A Roth IRA can be used to invest in a wide variety of assets including real estate, precious metals, public and private stock, notes, and more. Distributions up to the amount of your total contributions may be taken at any time without tax or penalties. With a Roth IRA, there are no Required Minimum Distributions (RMD).  

SEP IRA

Self employed? The Simplified Employee Pension (SEP) IRA is a popular employer plan for self-employed individuals. SEPs offer significantly higher contribution limits than individual plans such as Traditional and Roth IRAs. Any SEP IRA can acquire alternative assets, as long as the account is with a provider like New Direction IRA that services those assets. SEP IRAs accrue the same tax advantages as a Traditional IRA.
A SEP IRA account holder has the ability to fund a SEP IRA with annual contributions, transfers from other IRAs, and Employer Plan Rollovers. With a SEP IRA, you can choose the percentage of contribution for any given year (0-25% of earned income) for yourself and your staff. The only requirement is that the contribution percentage, in any year, must be the same for each employee.

NOTE: New Direction IRA provides SEP IRAs for any account holder that already has a SEP IRA, or self-employed persons who would like to establish a new SEP IRA.

Individual 401(K)

An Individual 401(k) plan is simply a 401(k) plan for companies with no employees. Individual 401(k) plans have the same options available to them as larger 401(k) plans. However, with an Individual 401(k), the employer, trustee, and participant are usually the same person.

For self-employed persons or companies with no qualifying employees, an Individual 401(k) plan allows the employer/participant high annual contribution limits as well as a high degree of flexibility and convenience when it comes to acquiring assets.

What Are The Benefits Of An Individual 401(K)?

A 401(k) plan provides employers flexibility and customization depending on the needs of the company and its employees.  It also provides higher contribution limits than individual accounts such as a Traditional IRA. 

There are tax benefits for the 401(k) participant and the employer. If you leave your employer, you are allowed to rollover a 401(k) into an IRA, tax and penalty free. Similarly, you are allowed an IRA to 401(k) rollover.

401(k)s can be used to invest in real estate, precious metals, private equity, publicly traded securities and more. You can make contributions to your 401(k) even if you are over 70.5, as long as you are still employed. 

Individual 401(K) Eligibility And Other Rules

To be eligible for an Individual 401(k), you must be the age required by the employer (or older), even if you are a full-time employee and receive other benefits. Eligibility rules change from company to company, as each employer is able to customize the 401(k) plan.
The Individual 401(k) is available for any sole proprietorship, partnership, limited liability corporation (LLC), or incorporated business, including sub-chapter "S" Corporation. The Individual 401(k) is used by owner-only and small businesses with no employees, or if the employees fall outside of certain guidelines. 

No savers are restricted to any just one of these individual retirement plans. You can manage any combination of these accounts to reap the full benefits of both pre-tax contributions and tax-free gains.

Any of these Individual Retirement Arrangements can be part of a generational wealth plan. Although NDIRA cannot provide investment or legal advice concerning which retirement plan will be the best fit for our clients, we hope you use this information to your advantage to make well-informed decisions about which IRA will be the best option for you. 

Top 7 Benefits of a Truly Self-Directed Solo(k) Plan

What is an Solo(k) anyways?

The Solo(k) also known as Individual(k), Individual 401(k), Uni(k), and One-Participant(k) operates in essentially the same way that a 401(k) retirement plan offered by a large employer does. In fact, the official IRS designation for this type of account is a One-Participant 401(k) plan. The Solo(k) is different than a major employer plan only in that it’s strictly for companies without employees other than the owner (although spouses may be eligible).

The Solo(k) has many features not offered under IRA structure and this blog will give you a better idea of the advantages and how they can dramatically benefit you and your real estate investing goals.

Please take the time to share, comment, and ask questions after reading this condensed overview.

There are many experienced professionals on BiggerPockets that have Solo(k) plans themselves, and I hope that this blog becomes a great starting place for beginners through your addition of comments and dialog. Thanks for reading!

#1: Large Contribution Limits

A Solo(k) provides you the opportunity to defer substantially more income when compared to an ordinary Traditional or Roth IRA. In 2014, the contribution limits for a Traditional and Roth IRA are only $5,500 (if you are under 50 years old). The contribution limits for a Solo(k) in 2014 however are as much as $52,000 ($57,000 if you’re over 50). You can clearly see the difference that these annual contributions limits can have when attempting to grow a nest over your lifetime.

Solo(k) contributions work differently than IRA contributions. They are broken into two categories: elective employee deferrals and employer contributions. Here is the breakdown as it’s described on the IRS website:

• Elective deferrals up to 100% of compensation (“earned income” in the case of a self-employed individual) up to the annual contribution limit:
• 2013 and 2014: $17,500, or $23,000* if age 50 or over; and
• Employer non-elective contributions up to
• 25% of compensation as defined by the plan, or
• for self-employed individuals, see discussion below

*Note that for those of age 50 or older, there is a $5,000 catch-up provision in addition to the elective deferrals.

Math Example: Nancy, age 48, earned $50,000 in W-2 wages from her C Corporation in 2014. She defers $17,500 in regular elective deferrals to the 401(k) plan. Her business contributes 25% of her compensation to the plan, $12,500. Total contributions to the plan for 2014 were $35,500. This is the maximum that can be contributed to the plan for Nancy for 2014.

Roth 401(k) Component

If making your employee deferrals to a post-tax (Roth) structure appeals to you, the Roth 401(k) component may be an attractive option for you. When adopting an Solo(k), you have the option to allow all or part of your elective employee deferrals to be made as a Roth, post-tax component. When compared to a Roth IRA, you can more than triple your annual contributions through an Individual(k).

#2: Tax-Deferred or Tax-Free Growth

One advantage to utilizing retirement account funds for real estate deals is receiving the benefit of tax-deferred growth. As plan funds are invested, they generally grow without taxes. When paying the full purchase price for real estate using IRA or 401(k) cash, there is no need to worry about depreciation or investment expenses because no taxes exist. Furthermore, when the plan sells the property at a later date, there are no concerns over capital gains or need for a 1031 exchange. The tax advantage that the plan enjoys can create a dramatic snowball effect of growth.

#3: Special Tax Treatment on UDFI (Unrelated Debt Financed Income)

An IRA or Solo(k) can seek out a non-recourse mortgage and increase the purchase power of the plan assets. For those of you that don’t know, a non-recourse mortgage does not have a personal guarantee, and only the property itself is held as collateral. Lenders will usually look for down payments between 30-40% depending on who your lender is.

Normally with an IRA, profits generated from debt-leveraged financing are subject to something called unrelated business income tax (UBIT). This special tax is the IRS’s way of leveling the playing field for tax-advantaged entities utilizing leverage and investing in ongoing business activities. Let’s look at a quick math example:

Assume I purchase a property with my IRA for $100,000 and finance 50% or $50,000. For simple math purposes, also assume that I generate net income of $10,000 after depreciation in year one. If my outstanding debt ratio is 50% then half ($5,000) of my net income is derived from non-IRA dollars. Therefore, I would have to file tax form 990-T for my IRA and calculate UBIT on the net profit of that 50% that is attributed to the debt leverage. This is a simplified explanation and other details go beyond this explanation but it serves as a good example. UDFI taxes follow the IRS tax rate schedule for Trusts and Estates.

So... How does this UBIT apply to 401k real estate investing?

UBIT associated with UDFI does not apply to 401(k)s. Self-employed real estate investors that have an Solo(k) can therefore benefit from some additional tax savings under the 401k structure when leveraging retirement dollars.

It’s important to note that the 401k structure is NOT exempt from UBIT when it comes to unrelated business taxable income (UBTI) derived from an operating business. Continuous fix-and-flips may constitute an operating business and may therefore be subject to UBIT as a result.

At this time, there are no IRS rulings that clarify whether a second, third or twentieth flip constitutes an operating business. It’s best that you consult an experienced ERISA attorney for advice.

#4: Fewer Investment Restrictions

Many brokerage houses offer Individual 401(k) plans for little to no cost. The pitfall of course is that your investment options are usually restricted to the offerings of the brokerage house; limiting you to traditional publicly traded securities. This means you’re unable to invest in real estate, private loans, private equity, and other allowable investments. Make sure to adopt plan documents that are written to give you the flexibility to invest in alternative assets.

If you already have an Solo(k) plan, check with your provider to learn about any investment limitations. You can always perform a ‘restatement’ of plan documents, which means you’ve decided to replace your existing 401k plan documents with new documents that allow you to invest in anything allowable by law.

#5: Ability to Borrow from Plan

Unlike an IRA, the 401k structure has language that allows plan participants to borrow against plan funds. The funds must be paid back to the plan and certain timelines are associated with each loan, based on the situation. There are also limitations to the amount you can borrow from the plan. In general, participants are able to borrow up to 50% of the plan balance or $50,000, whichever is less.

This option can offer you access to fast cash if you need it for your personal finances. Be aware, these funds will be deemed taxable if they aren’t repaid within the given time frame for your loan.

#6: Be your own Trustee with Checkbook Control

Possibly the most sought after feature of the Solo(k) is the power to self-trustee your own plan. Unlike the IRA, a 401K is a do-it-yourself dream come true for those that prefer to do all their own bookkeeping and plan administration. This option is a way to gain retirement plan flexibility.

Keep in mind that with power comes responsibility, and becoming the trustee for your own Solo(k) plan is not something to take lightly. There are many rules that must be followed and special reporting requirements also exist. It can be valuable to have professional tax and legal advisors available to answer questions as they come up.

#7: No-testing Advantage for Self-Employed

A self-employed business owner with no common-law employees can avoid having to perform regular nondiscrimination testing for the plan. Since the plan is only for an individual, the administrative burden and added cost is reduced.