by Mat Sorensen | Sep 21, 2022 | Investing
A SEP IRA is a powerful retirement account used by many self-employed persons and business owners. It is particularly attractive as you can contribute up to $61,000 into it annually. That’s in comparison to a Traditional IRA, where you can only contribute up to $6,000 a year. “But what if I have employees? If I have employees in my business do I need to offer then plan and contribute for them?” The answer is “yes” and “no,” as it depends on your employees. The devil’s – or perhaps we should say loopholes – in the details.
Employer Contribution
Keep in mind that the money contributed to a SEP IRA is an “employer contribution.” This means that the money comes from the company and is set at a maximum of 25% of the employee’s wage. So, if you are the only employee and you make $100,000 that year, the company can contribute $25,000 to the SEP IRA. For a business owner with no employees, it doesn’t really make a difference whether you pay into the SEP IRA from your company’s account or from your personal account as its all effectively your money in the end.
However, once you have employees, you are required to offer the same SEP IRA and same employer contribution to them that you offer to yourself. Now, you will likely care whether that money comes from the employee’s wages or from the company’s account. So, let’s say you had an S-Corporation and had a W-2 of $100,000, and you had one employee who had a W-2 of $40,000. The company would contribute $25,000 to your SEP IRA account (if doing the 25% max rate) and would also contribute $10,000 to the employee’s SEP IRA. While you, as the business owner, may be excited about contributing $25,000 into your own SEP IRA from the company’s funds, you may be less excited about contributing $10,000 to an employee’s SEP IRA account from the company’s funds. But, this is what’s required if the employee is eligible.
Employee Eligibility Loophole and Flexibility
The good news is that you only need to offer the SEP IRA to “eligible employees,” and you can make employees “ineligible” if they have not worked for you for 3 years out of the prior 5 years (see IRS SEP IRA FAQs). In other words, until someone has worked for the company for at least 3 years, you do not need to offer the SEP IRA to them. For many small businesses, self-employed persons and new companies, a SEP IRA can be an excellent choice for the business owner as they may be the only eligible person who has worked for the company for 3 years. You can also restrict eligibility if an employee has not yet turned 21. This 3 year employee eligibility rule under a SEP IRA is far superior to the 1 year employee eligibility rule that would apply when using a Solo K upon hiring employees.
Keep in mind that you are subject to the same eligibility rules. So, if this is a new company, then the strategy of offering the plan to yourself while restricting others doesn’t work so well. But, as is usually the case, if you have worked the business for years before having an employee, then you can set the work year requirement to make yourself eligible while setting it out up to 3 years for any employees.
If an employee has worked 3 out of the prior 5 years and is now eligible, the business owner can decide to cease the SEP IRA plan (and their own contributions), and can instead move to a 401(k) or other more common retirement plan structure where the company is not required to offer such a generous employer contribution.
A SEP IRA can be self-directed and invested into real estate, LLCs, private stock, notes, and precious metals. Directed IRA establishes SEP IRA accounts for self-directed investors and you can set-up an account entirely online. Learn more now at www.directedira.com.
Mat has been at the forefront of the self-directed IRA industry since 2006. He is the CEO of Directed IRA & Directed Trust Company where they handle all types of self-directed accounts (IRAs, Roth IRAs, HSAs, Coverdell ESA, Solo Ks, and Custodial Accounts) which are typically invested into real estate, private company/private equity, IRA/LLCs, notes, precious metals, and cryptocurrency. Mat is also a partner at KKOS Lawyers and serves clients nationwide from its Phoenix, AZ office.
He is published regularly on retirement, tax, and business topics, and is a VIP Contributor at Entrepreneur.com. Mat is the best-selling author of the most widely used book in the self-directed IRA industry, The Self-Directed IRA Handbook: An Authoritative Guide for Self-Directed Retirement Plan Investors and Their Advisors.
by Mat Sorensen | Aug 17, 2020 | Investing
Kids are going back to school and it’s a great time to think about college and to make financial plans for your children or grandchildren’s education. As you consider the different plan options, you’ll want to make sure you know the two most common tax favored college savings tools.
There are two types of accounts that you can establish to save for higher education expenses in a tax favorable manner. These two types of accounts are Coverdell Education Savings Accounts and 529 Plan accounts.
The first type of account is known as a Coverdell Education Savings Account. A Coverdell account is typically set up for the higher education expenses of a child. The contributed funds grow in the account tax deferred and the money comes out for education expenses tax free. There is no tax deduction for amounts contributed to a Coverdell but you do have significant investment options including self-directed investment options (similar to IRA rules). A Coverdell has the following rules and benefits.
COVERDELL RULES
- $2,000 annual contribution limit per beneficiary (e.g. child or grandchild).
- Parents (or grandparents) can contribute without limitations to a Coverdell until a beneficiary reaches age 18 if the contributor has income of less than $190k (married joint) or $110,000 (single). For high-income earners, keep in mind that the child can always contribute to their own account with gifted funds (no need to have earned income) so you can always get around the income limitation by having the child contribute themselves.
- Funds can be used for tuition, fees, books, and equipment for college as well as certain K-12 expenses too.
- There are zero federal or state income tax deductions on Coverdell accounts.
COVERDELL BENEFITS
- Accounts can be invested into stocks, mutual funds, and can even be self-directed. They operate similar to an IRA. Self-directed Coverdell accounts can be opened at Directed IRA, www.directedira.com.
- Contributions grow tax-free and can be withdrawn for education expenses until the account beneficiary reaches age 30. Unused amounts can be transferred to another family member beneficiary.
The second type of account is a 529 Plan account. Contributions to 529 Plan accounts can be eligible for a state income tax deduction (depending on the state). Money contributed to a 529 Plan account is invested into a state managed fund. A 529 has the following rules and benefits.
529 RULES
- Amounts are invested into a state run program.
- Amounts can be withdrawn for tuition, fees, books, supplies, equipment, special needs, room and board.
- Up to a few hundred thousand dollars can be invested per beneficiary by any person.
- There are no federal tax deductions or credits for contributions.
529 BENEFITS
- Many states offer tax deductions for contributions to 529 Plan accounts. For example, Arizona offers a $4,000 tax deduction for married tax filers and a $2,000 deduction for single filers. Thirty-five states offer some type of state income tax deduction for 529 Plan contributions. However, there are some states, like California, who offer no tax deduction for contributions to 529 Plan accounts. Click here to see a comprehensive list that outlines the different state funds and tax deductions (or credits for some states).
- Downside, invested amounts must be invested solely into state run programs. There are no other investment options.
In summary, Coverdell accounts have the benefit of allowing account owner’s to decide how the money will be invested with zero tax deductions available on contributions while 529 Plan accounts give you zero investment options (all funds go to state run fund) but offer state income tax deductions in most states.
If you live in a state that offers a tax deduction on contributions, such as Arizona or New York, then the 529 Plan account is a great option if you can stomach having the money go into a state run fund. On the other hand, if you live in a state with zero income tax (e.g. Texas or Florida) or if you live in state with zero 529 Plan deductions (e.g. California) then you might as well use a Coverdell account because you’re not trading any tax deductions for investment options. For those who can’t make up their mind and who have the funds, consider doing both but do the Coverdell first. There is no restriction against doing a Coverdell account (no tax deductions, but investment options) and a 529 Plan account (possible state tax deductions but no investment options). Follow this link to a YouTube video explaining the simple steps to opening these beneficial education investment accounts: Opening an Account with Directed IRA
Mat has been at the forefront of the self-directed IRA industry since 2006. He is the CEO of Directed IRA & Directed Trust Company where they handle all types of self-directed accounts (IRAs, Roth IRAs, HSAs, Coverdell ESA, Solo Ks, and Custodial Accounts) which are typically invested into real estate, private company/private equity, IRA/LLCs, notes, precious metals, and cryptocurrency. Mat is also a partner at KKOS Lawyers and serves clients nationwide from its Phoenix, AZ office.
He is published regularly on retirement, tax, and business topics, and is a VIP Contributor at Entrepreneur.com. Mat is the best-selling author of the most widely used book in the self-directed IRA industry, The Self-Directed IRA Handbook: An Authoritative Guide for Self-Directed Retirement Plan Investors and Their Advisors.
by Mat Sorensen | Jul 16, 2020 | News
From my article on Entrepreneur.com
The rules governing your retirement accounts have been loosened in the year 2020. You have more time to put money in, can take money out early without penalty, and the required minimum distribution rules (RMD) for those 72 and older have been removed entirely.
by Mat Sorensen | Jan 7, 2020 | News
The SECURE Act was signed into law by President Trump at the end of 2019, and makes sweeping changes to the laws affecting retirement plans, including IRAs. The law, known as the SECURE Act, is a mixed bag of good, bad, and ugly. This article breaks down the details that IRA owners need to know moving forward.
The Good
RMD Age Raised to 72
- Required Minimum Distributions (RMDs) are no longer required until the IRA owner reaches 72. Prior to the new law, RMDs were required once the account owner reached age 70½. By extending the RMD requirement to 72, IRA owners can delay taking distributions from the IRA by an additional 1½ years. This is a good thing as you can let more money grow tax-deferred. The 70½ year rule was also confusing, as it takes a while to do the math and figure out what year you turn 70½. It used to be the only half-birthday you had to keep track of. There is still no RMD requirement on Roth IRAs. If you already reached 70½ in 2019 or earlier, and haven taken out previous distributions, then you continue taking distributions as usual (even if you aren’t yet 72).
IRA Age Limit for Contributions Removed
- There is no longer an age restriction on when you can contribute to an IRA. Prior to the law, Traditional IRA contributions were restricted once you reached RMD age of 70½. Under the new law, there is no longer a restriction (even when you each 72). This means older IRA owners who are still working or have earned income can continue to contribute to a Traditional IRA.
Exception to 10% Early Withdrawal Penalty for Birth or Adoption
- A new exception to the 10% early withdrawal penalty was added in the case of the birth or adoption of a child. This is limited to $5,000, but will allow new parents to withdraw up to $5,000 from any IRA or other retirement account without having a 10% early withdrawal penalty apply. Taxes would still be due on Traditional (pre-tax) funds withdrawn, but the 10% penalty is waived.
The Bad
The Stretch IRA Has Been Gutted
- The Stretch IRA, whereby a non-spouse could inherit an IRA or Roth IRA and take distributions over their lifetime, has been gutted. While a non-spouse can still inherit an IRA or Roth IRA, the account (in most instances) must be distributed in 10 years. There are no annual distributions required under this new rule over the 10-year period. Instead, the total account balance just needs to be distributed in 10 years. So, if you inherit an IRA in 2020 or later, then you will have 10 years to continue investing the account and you can take distributions whenever you want (or just at the end) with the full amount being distributed within 10 years. There are some persons who can still use the old Stretch IRA rules, but these groups are limited and include: Disabled or chronically ill persons, minor children inheriting, and beneficiaries not more than 10 years younger than the IRA owner.
The Ugly
The elimination of the Stretch IRA was bad and ugly. What else can I say? The only good news is that those who have already inherited one in 2019 or earlier can still operate as usual. Everyone else who looked forward to one will have to take solace in the fact that they at least have 10 years of “stretching” to continue investing the funds in a tax-free (Roth) or tax-deferred (Traditional) manner. And, under the new rule, there is no RMD rule in effect each year. Instead, the total amount must be distributed at the end of 10 years. This makes things a little easier with self-directed assets and also helps any IRA owner – 10 years is still a good amount of time – get a little bit of additional tax-deferred (Traditional) or tax-free (Roth) growth.
At Directed IRA we are a custodian of inherited Traditional IRAs and inherited Roth IRAs, we are keenly aware of the changes and are helping our clients understand the new rules. Please reach out and gives us a call ((602) 899-9396) if you have questions on these new rules.
Mat has been at the forefront of the self-directed IRA industry since 2006. He is the CEO of Directed IRA & Directed Trust Company where they handle all types of self-directed accounts (IRAs, Roth IRAs, HSAs, Coverdell ESA, Solo Ks, and Custodial Accounts) which are typically invested into real estate, private company/private equity, IRA/LLCs, notes, precious metals, and cryptocurrency. Mat is also a partner at KKOS Lawyers and serves clients nationwide from its Phoenix, AZ office.
He is published regularly on retirement, tax, and business topics, as well as a VIP Contributor at Entrepreneur.com. Mat is the best-selling author of the most widely used book in the self-directed IRA industry, The Self-Directed IRA Handbook: An Authoritative Guide for Self-Directed Retirement Plan Investors and Their Advisors.
by Mat Sorensen | Aug 13, 2019 | Investing
If you’ve inherited an IRA from a parent or another loved one, it is likely that you have an Inherited IRA (aka, Beneficiary IRA). These can be powerful accounts, but you need to understand the Required Minimum Distribution (“RMD”) rules for your Inherited IRA to properly utilize it. The inherited IRA may be a Traditional or Roth IRA, and there are three different distribution options you may elect when you inherit the IRA. These distribution options dictate how you can invest the account. Please note that if you inherit an account from a spouse, you can just do a spousal rollover and consider the account as yours. This article is for those inheriting an IRA from a non-spouse.
Distribution Options
You will have three distribution options upon the death of your loved one to receive the funds from their IRA. In general, the best option is the “Life Expectancy Method” as it allows you to delay the withdrawal of funds from the IRA, and allows the money invested to grow tax-deferred (Traditional) or tax-free (Roth). The three options are outlined fully below:
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Lump Sum
The first option is to simply take a lump-sum and be taxed on the full distribution. There is no 10% early withdrawal penalty (regardless of your age or the deceased owner), but you are taxed on the amount distributed if it is a Traditional IRA. You’re also giving up the tax-deferred (Traditional) or tax-free (Roth) benefits of the account. Don’t take this option. It’s the worst tax and financial option available to you.
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Life Expectancy Method – Stretch IRA
The Life Expectancy Method is the best option. Under this option, you take distributions from the inherited IRA over your lifetime based on the value of the account. These distributions are required for Traditional IRAs and even for inherited Roth IRAs. For example, if you inherited a $100,000 IRA at age 50, you would have to take about $3,000 a year as a required minimum distribution each year and the rest can stay invested. The RMD amount changes each year as you age and as the account value grows or decreases. There is no 10% early withdrawal penalty when you pull money out of the account regardless of your age. Traditional Inherited IRA distributions are taxable to the Beneficiary while Roth IRA distributions are tax-free. And yes, Inherited Roth IRAs are subject to RMD even though there is no RMD for regular Roth IRAs.
There is pending legislation which the House has passed, but the Senate has sat on, which would limit the ability to stretch the IRA out to a maximum of 10 years. Even if that legislation passes, the Stretch IRA will be a good option to at least continue the tax benefits of the inherited IRA for 10 years.
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Five-Year Method
This option is available to all inherited Roth accounts, but is only available to inherited Traditional IRAs where the deceased account owner was under age 70 1/2 at the date of their death. Under this option, the Inherited IRA is not subject to RMD. However, it must be fully distributed by December 31st of the fifth year following the year of the account owner’s death. There is no 10% early withdrawal penalty, and distributions are subject to tax. Again, this option is only available to Traditional accounts.
Investing with a Self-Directed Inherited IRA
Yes, you can self-direct your Inherited IRA (aka, beneficiary IRA). Before you do, make sure you understand the amount of funds you’ll need to take as an RMD, and that you will have available cash in the account to cover those RMDs. As I described above, assume you are 50 and inherited an Inherited IRA for $100,000. You will need to take annual distributions of around $3,000. So, if you invest all of the $100,000 into an illiquid asset, then you will be unable to take RMDs and you will force the IRA account to pay stiff penalties. Consequently, when making a self-directed investment from an Inherited IRA, you must take into account the amount of the investment, the total value of the account, and the timeline of the investment (when will it generate cash back to the IRA). If you inherited the $100,000 account above, you may decide to only invest $70,000 of the Inherited IRA into an illiquid investment (e.g. real estate or private company), while leaving the other $30,000 to be invested into liquid investments like publicly-traded stocks, CDs, cash or mutual funds. This will leave funds available for RMD until such time as the illiquid investment generates income or is sold for profit.
Stretching out the benefits of an inherited IRA can be powerful, but make sure you plan for RMDs before you make any self-directed investments from your Inherited IRA.
Self-directed Inherited IRA accounts can be set-up at Directed IRA in as little as five minutes on-line at www.directedira.com.
Mat has been at the forefront of the self-directed IRA industry since 2006. He is the CEO of Directed IRA & Directed Trust Company where they handle all types of self-directed accounts (IRAs, Roth IRAs, HSAs, Coverdell ESA, Solo Ks, and Custodial Accounts) which are typically invested into real estate, private company/private equity, IRA/LLCs, notes, precious metals, and cryptocurrency. Mat is also a partner at KKOS Lawyers and serves clients nationwide from its Phoenix, AZ office.
He is published regularly on retirement, tax, and business topics, and is a VIP Contributor at Entrepreneur.com. Mat is the best-selling author of the most widely used book in the self-directed IRA industry, The Self-Directed IRA Handbook: An Authoritative Guide for Self-Directed Retirement Plan Investors and Their Advisors.
A SEP IRA is a powerful retirement account used by many self-employed persons and business owners. It is particularly attractive as you can contribute up to $61,000 into it annually. That’s in comparison to a Traditional IRA, where you can only contribute up to $6,000 a year. “But what if I have employees? If I have employees in my business do I need to offer then plan and contribute for them?” The answer is “yes” and “no,” as it depends on your employees. The devil’s – or perhaps we should say loopholes – in the details.
