Category Archives: Self-Directed IRA & Qualified Plan Information

Changes to Coverdell Education Savings Accounts (ESA) Starting January 1, 2011

Question:

From what I have read Coverdell Educational accounts will no longer be allowed to be established starting January 1, 2011. Does anybody know if you have already established one of these accounts before the end of this year if you can continue to make contributions to it or not?

Answer:

That is a great question!!! Thanks for sending it.  The answer is that unless Congress takes action, the rules for the Coverdell Education Savings Accounts will return to the rules as they were in 2001.  Essentially, the new/old rules will mean that the contribution limits will be reduced to $500 for 2011 and future years.  Worse, the extreme tax advantage of tax free distributions for qualified education expenses will be reverted to distributions being taxable but no penalty if used for qualified education expenses (although your contributions will not be taxed as they are returned on a pro rata basis).  Expenses will then be limited to college expenses, unlike the current rules where you can also fund primary and secondary education.  Contributions will not be able to be made to both a Coverdell ESA and a 529 plan in the same year. 

It’s very hard to say whether or not the government will reinstate the current rules, let the pre-2002 rules come back (thereby killing the effectiveness of ESAs) or if they will reach some middle ground.  I will keep watch over this issue and let you know if I find anything new out.

Can a 401K Pension Plan own 96% of a C-corporation that owns ones home in which one does business? & Can a 401K PP own an LLC that has collectibles like Ansel Adams photos and historic guns?

Quincy’s Response:

The answer to your first question is no!!! That one is easy.

The second question is more complex.  In answer to a similar question posed about a mutual fund which invested in collectibles, our consultants responded as follows:

“A good question and the answer is not entirely clear. Since the consequences of being wrong are significant (the investment is treated as a distribution), it would be a good idea to apply for a private letter ruling before proceeding.

“According to Regulation section 1.408-10, “The acquisition by an individually-directed account under a plan described in section 401(a) of any collectible shall be treated (for purposes of section 402 and 408) as a distribution from such account in an amount equal to the cost to such account of such collectible.

“For purposes of this section, the term acquisition includes purchase, exchange, contribution, or any method by which an individually-directed account may directly or indirectly acquire a collectible”.

“Needless to say, “indirectly” is not defined.”

I am assuming that the PP is an individually directed account.  Therefore, caution would be urged in making an investment through an LLC.

How does one take a property out of their IRA if they want to use it for personal use?

Another great question we answer frequently…

Question:  A few weeks ago I attended an IRA seminar that you presented in Amarillo.  Since that time a client has contacted us seeking to purchase a resort lot in their IRA.  If purchased in the IRA, does this prevent the beneficiary from purchasing the lot from the IRA in the future?  If not, can the beneficiary purchase the lot from the IRA under a note receivable purchase?

Answer:  While the IRA owner COULD NOT use the property while it was in his or her IRA, the property COULD be taken as a distribution when they were ready to retire (or ready to use the property personally before retirement). Or,  the only way to purchase the lot from the IRA in the future is to get special permission from the Department of Labor through a Prohibited Transaction Exemption.  I have heard of them approving such purchases under certain circumstances, but it may not be worth the time and expense of getting the exemption.  That is a judgment call your client would need to make. I suppose that after the property was taken as a distribution your bank could make them a loan to pay taxes on the distribution, but NO, there would be no way for the IRA to “seller finance” the acquisition of the property from the IRA to the IRA owner.

Entity Investments in Your IRA – Swanson v. Commissioner and the “Checkbook Control” IRA-Owned LLC

Quest IRA, Inc. has been receiving alot of these questions lately so I have decided to repost the original article Quincy wrote about this topic….

BY H. QUINCY LONG

One of the most popular ideas in the self-directed IRA industry today is the “checkbook control” IRA.  You may have wondered what exactly it means to have “checkbook control” over your IRA’s funds.  In this article we will examine the celebrated case of Swanson v. Commissioner, on which the idea of “checkbook control” is based.  The entire text of the Swanson case is available on our website at www.QuestIRA.com.

The essential facts of Swanson are as follows:

1) Mr. Swanson was the sole shareholder of H & S Swansons’ Tool Company (Swansons’ Tool).

2) Mr. Swanson arranged for the organization of Swansons’ Worldwide, Inc. (Worldwide). Mr. Swanson was named as president and director of Worldwide.  Mr. Swanson also arranged for the formation of an individual retirement account (IRA #1).

3) Mr. Swanson directed the custodian of his IRA to execute a subscription agreement for 2,500 shares of Worldwide original issue stock. The shares were subsequently issued to IRA #1, which became the sole shareholder of Worldwide.

4) Swansons’ Tool paid commissions to Worldwide with respect to the sale by Swansons’ Tool of export property. Mr. Swanson, who had been named president of Worldwide, directed, with the IRA custodian’s consent, that Worldwide pay dividends to IRA #1.

5) A similar arrangement was set up with regards to IRA #2 and a second corporation called Swansons’ Trading Company.

6) Mr. Swanson received no compensation for his services as president and director of Swansons’ Worldwide, Inc. and Swansons’ Trading Company.

The IRS attacked Mr. Swanson’s setup on two fronts.  First, the IRS argued that the payment of dividends from Worldwide to IRA #1 was a prohibited transaction within the meaning of Internal Revenue Code (IRC) Section 4975(c)(1)(E) as an act of self-dealing, where a disqualified person who is a fiduciary deals with the assets of the plan in his own interest.  Mr.

Swanson argued that he engaged in no activities on behalf of Worldwide which benefited him other than as a beneficiary of IRA #1.

The court agreed with Mr. Swanson, and found that the IRS was not substantially justified in its position.  The court said that section 4975(c)(1)(E) addresses itself only to acts of disqualified persons who, as fiduciaries, deal directly or indirectly with the income or assets of a plan for their own benefit or account.  In Mr. Swanson’s case the court found that there was no such direct or indirect dealing with the income or assets of the IRA.  The IRS never suggested that Mr. Swanson, acting as a “fiduciary” or otherwise, ever dealt with the corpus of IRA #1 for his own benefit.  According to the court, the only direct or indirect benefit that Mr. Swanson realized from the payments of dividends by Worldwide related solely to his status as a participant of IRA #1.  In this regard, Mr. Swanson benefited only insofar as IRA #1 accumulated assets for future distribution.

The second issue the IRS raised was that the sale of stock by Swansons’ Worldwide to Mr. Swanson’s IRA was a prohibited transaction within the meaning of section 4975(c)(1)(A) of the Code, which prohibits the direct or indirect sale or exchange, or leasing, of any property between an IRA and a disqualified person.  Mr. Swanson argued that at all pertinent times IRA #1 was the sole shareholder of Worldwide, and that since the 2,500 shares of Worldwide issued to IRA #1 were original issue, no sale or exchange of the stock occurred.

Once again, the court sided with Mr. Swanson.  The critical factor was that the stock acquired in that transaction was newly issued – prior to that point in time, Worldwide had no shares or shareholders.  The court found that a corporation without shares or shareholders does not fit within the definition of a disqualified person under section 4975(e)(2)(G).  It was only after Worldwide issued its stock to IRA #1 that petitioner held a beneficial interest in Worldwide’s stock, thereby causing Worldwide to become a disqualified person.  Accordingly, the issuance of stock to IRA #1 did not, within the plain meaning of section 4975(c)(1)(A), qualify as a “sale or exchange, or leasing, of any property between a plan and a disqualified person”.

On the surface it seems like the court endorsed the idea of an IRA holder being the sole director and officer of an entity owned by his IRA.  In other words, by having the IRA invested in an entity such as an LLC of which the IRA owner is the manager, the IRA owner gets to have “checkbook control” over his or her IRA’s funds.  This sounds like a great idea.  However, before jumping too fast into this area, there are some issues to consider.

One thing to remember is that the LLC does not insulate the IRA from the prohibited transaction rules.  Amazingly, the IRS and the court in Swanson v. Commissioner ignored completely the fact that Mr. Swanson’s non-IRA owned corporation, Swansons’ Tools, paid commissions to Worldwide, thereby reducing Swansons’ Tools’ taxable income and indirectly benefiting Mr. Swanson.  Especially after the recent case of Rollins v. Commissioner, it seems clear that this would be a prohibited transaction.  In the Rollins case, Mr. Rollins loaned money from his 401(k) plan to corporations in which he served as president but of which he owned only a minority interest.  The corporations were clearly not disqualified persons, but the court nonetheless held that there was an indirect benefit to Mr. Rollins, who was the largest shareholder and an officer of each corporation.

The IRS also might have argued that Mr. Swanson’s service as the president and sole director of Worldwide was a prohibited transaction as described in 4975(c)(1)(C), which prohibits the furnishing of goods, services or facilities between an IRA and a disqualified person.  Although Mr. Swanson stated that Worldwide had no “active” employees, one has to wonder at what point the services rendered to an IRA-owned entity become a problem.  Another question which was not raised in the Swanson case was whether or not an IRA owner having checkbook control over his IRA funds through a 100% IRA-owned entity violates IRC Section 408(a)(2), which requires that the custodian of an IRA be a bank or other qualified institution.  Why have that requirement at all if the IRA owner can get around it merely by having his or her IRA own 100% of an LLC managed by the IRA owner?

Although the Swanson case appears to be good case law, a great deal of care is merited when relying on this case.  Several questions which were not raised in the Swanson case remain unanswered.  As noted by the court, Mr. Swanson was “following the advice of experienced counsel.”  Even then, Mr. Swanson had to fight the IRS in tax court to win his case.  For most people, even getting into a battle with the IRS is a losing proposition.  Some people, perhaps through ignorance of the rules, appear to be abusing Swanson-type entities.  For example, in IRS Notice 2004-8 on abusive Roth transactions, the IRS states that it is aware of situations where taxpayers are using a Roth IRA-owned corporation which deals with a pre-existing business owned by the same taxpayer to shift otherwise taxable income into the Roth IRA.  If the IRS has become aware of the problem, there may come a day when they decide to go after these types of arrangements more actively.

When relying on the Swanson case to set up a checkbook control LLC or other entity, always use experienced legal counsel who is very familiar with how to set up this type of entity and who will be there to guide you on issues such as the prohibited transaction rules, the plan assets regulations, unrelated business income tax issues and the other rules and regulations which may apply.  What happens after the LLC is formed is just as important as the initial setup and can get you into just as much trouble.  To attempt a “checkbook control” entity without knowledge of all the rules and regulations or competent counsel to guide you is sort of like jumping out of an airplane without a parachute – it may be fun on the way down, but eventually you’re going to go SPLAT!

Can I invest my IRA into a company that my husband is the president and owns 23% of the stock?

This was a question that came in and I thought that the question was good enough to post on my blog as I get this question alot from my clients.

Question: I have an ira currently invested the stock market. My question is around self directed iras and disqualified persons. My husband is the president of a corporation, and owns approx 23% of the stock. What I would like to do is turn my ira into a self-directed ira and invest it in a deed of trust secured by the land the coporation owns (in other words, a mortgage loan). Would this be a disqualified transaction? I’ve found the rules on disqualified persons to be a bit confusing.

Answer:  Thank you for the excellent question.  You are correct when you state that the rules on disqualified persons (and prohibited transactions) are confusing.  Unfortunately, I DO believe that if your proposed transaction were looked at  it would be considered to be a prohibited transaction.  While it’s true that the corporation your husband is President and a 23% shareholder of is not a disqualified person as to your IRA (assuming that no other disqualified family members own more than 27% of the stock), your husband is a disqualified person to your IRA.  The prohibited transaction rules of Section 4975 say that there can be no direct or indirect benefit to any disqualified person from an investment in your IRA.  It is this indirect benefit rule that would most likely lead to problems for you because your husband would indirectly benefit from the private loan made by your IRA to a company he works for and owns a substantial interest in.  Another issue is that the corporation is an entity in which you have an interest in which would affect your best judgment as a fiduciary for your IRA.  A benefit to a person in whom you have an interest which would affect your best judgment as a fiduciary can be deemed to be an indirect benefit to you, and of course you are a disqualified person to your own IRA. 

I have attached a couple of legal opinions, one from the Department of Labor and one from tax court, which may help you or your legal counsel to decide what to do.  Unfortunately, I cannot give you tax, legal or investment advice.  Good luck with your investing, and thank you for contacting me.

Attachments: Rollins v. Commissioner & DOL Advisory Opinion 88-18A

Thanks again for you question. Anyone, please feel free to submit your questions to me on this blog. Who knows, your qusetion may be helpful to others that are thinking about investing with a Self-Directed IRA.

How to Pay for Education Expenses With Tax-Free Dollars

By H. Quincy Long

            Many people are under the mistaken impression that a Roth IRA is the only type of self-directed account from which tax free distributions can be taken.  However, distributions from Health Savings Accounts (HSAs) and Coverdell Education Savings Accounts (ESAs) can be tax free if they are for qualified expenses.  In this article we will discuss the benefits of the Coverdell Education Savings Account and, more importantly, what investments you can make with a self-directed ESA.

            Contributions.  Contributions to a Coverdell ESA may be made until the designated beneficiary reaches age 18, unless the beneficiary is a special needs beneficiary.  The maximum contribution is $2,000 per year per beneficiary (no matter how many different contributors or accounts) and may be made until the contributor’s tax filing deadline, not including extensions (for individuals, generally April 15 of the following year).  The contribution is not tax deductible, but distributions can be tax free, as discussed below.  Contributions may be made to both a Coverdell ESA and a Qualified Tuition Program (a 529 plan) in the same year for the same beneficiary without penalty.

          To make a full contribution to a Coverdell ESA, the contributor must have Modified Adjusted Gross Income (MAGI) of less than $95,000 for a single individual or $190,000 for a married couple filing jointly.  Partial contributions may be made with MAGI as high as $110,000 for an individual and $220,000 for a married couple filing jointly.  Since there is no limit on who can contribute to a Coverdell ESA, if your MAGI is too high consider making a gift to an individual whose income is less than the limits, and they can make the contribution.  Organizations can make contributions to a Coverdell ESA without any limitation on income. 

            Tax Free Distributions.  The good news is that distributions from a Coverdell ESA for “qualified education expenses” are tax free.  Qualified education expenses are broadly defined and include qualified elementary and secondary education expenses (K-12) as well as qualified higher education expenses. 

            Qualified elementary and secondary education expenses can include tuition, fees, books, supplies, equipment, academic tutoring and special needs services for special needs beneficiaries.  If required or provided by the school, it can also include room and board, uniforms, transportation and supplementary items and services, including extended day programs.  Even the purchase of computer technology, equipment or internet access and related services are included if they are to be used by the beneficiary and the beneficiary’s family during any of the years the beneficiary is in elementary or secondary school.

             Qualified higher education expenses include required expenses for tuition, fees, books, supplies and equipment and special needs services.  If the beneficiary is enrolled at least half-time, some room and board may qualify for tax free reimbursement.  Most interestingly, a Qualified Tuition Program (a 529 plan) can be considered a qualified education expense.  If you believe that contributing to a 529 plan is a good deal, then contributing that money with pre-tax dollars is a great deal! 

            One thing to be aware of is that the money must be distributed by the time the beneficiary reaches age 30.  If not previously distributed for qualified education expenses, distributions from the account may be both taxable and subject to a 10% additional tax.  Fortunately, if it looks like the money will not be used up or if the child does not attend an eligible educational institution, the money may be rolled over to a member of the beneficiary’s family who is under age 30.  For this purpose, the beneficiary’s family includes, among others, the beneficiary’s spouse, children, parents, brothers or sisters, aunts or uncles, and even first cousins. 

            Investment Opportunities.  Many people question why a Coverdell ESA is so beneficial when so little can be contributed to it.  For one thing, the gift of education is a major improvement over typical gifts given by relatives to children.  Over a long period of time, investing a Coverdell ESA in mutual funds or similar investments will certainly help towards paying for the beneficiary’s education.  However, clearly the best way to pay for your child’s education is through a self-directed Coverdell ESA. 

            With a self-directed Coverdell ESA, you choose your ESA’s investments.  Common investment choices for self-directed accounts of all types include real estate, both domestic and foreign, options, secured and unsecured notes, including first and second liens against real estate, C corporation stock, limited liability companies, limited partnerships, trusts and much more.   

            With the small contribution limits for Coverdell ESAs, you might wonder how these investments can be made.  Often these accounts are combined with other self-directed accounts, including Traditional, Roth, SEP and SIMPLE IRAs, Health Savings Accounts (HSAs) and Individual 401(k) plans, to make a single investment.  For example, I combined my daughters’ Coverdell ESAs with our Roth IRAs to fund a hard money loan with 2 points up front and 12% interest per year. 

            One client supercharged his daughter’s Coverdell ESA by placing a burned down house under contract in the ESA.  The contract price was for $5,500 and the earnest money deposit was $100.  Since the ESA was the buyer on the contract, the earnest money came from that account.  After depositing the contract with the title company, the client located another investor who specialized in rehabbing burned out houses.  The new investor agreed to pay $14,000 for the property.  At closing approximately one month later, the ESA received a check for $8,500 on its $100 investment.  That is an astounding 8,400% return in only one month!  How many people have done that well in the stock market or with a mutual fund? 

            But the story gets even better.  Shortly after closing, the client took a TAX FREE distribution of $3,315 to pay for his 10 year old daughter’s private school tuition.  Later that same year he took an additional $4,000 distribution.  Assuming a marginal tax rate of 28%, this means that the client saved more than $2,048 in taxes.  In effect, this is the same thing as achieving a 28% discount on his daughter’s private school tuition which he had to pay anyway! 

            The Coverdell ESA may be analogized to a Roth IRA, but for qualified education expenses only, in that you receive no tax deduction for contributing the money but qualified distributions are tax free forever.  Investing through a Coverdell ESA can significantly reduce the effective cost of your child or grandchild’s education.  As education costs continue to skyrocket, using the Coverdell ESA as part of your overall investment strategy can be a wise move.  With a self-directed ESA (or a self-directed IRA, 401(k) or HSA for that matter), you don’t have to “think outside the box” when it comes to your ESA’s investments.  You just have to realize that the investment box is much larger than you think!

The Amazing Health Savings Account – The Best of Both Worlds

By Nathan W. Long

By now most people have heard of using self-directed IRAs to make purchases other than stocks, bonds, and mutual funds.  Companies like Quest IRA, Inc., operating out of Houston and San Antonio, have been doing a good job, through a series of free education seminars, of teaching people about using self-directed IRAs to buy real estate, foreclosures, foreign property, invest in notes, deeds of trust, private stock, limited partnerships, LLCs, and other non-traditional assets.  In examining some of the other government sponsored savings vehicles available for investing in non-traditional assets I discovered the highly under-utilized Health Savings Account (HSA).  Before my recent employment with Quest IRA, Inc. I did not know that you could purchase non-traditional assets with a Health Savings Account (HSA).

A Health Savings Account is a powerful investing tool that many people overlook.  Because it is the only account where contributions are tax deductible and qualified distributions are tax free, it is the best of both worlds.  Furthermore, the definition of “qualified medical expenses” is fairly broad.  IRS Publication 502 has an available list of qualified medical expenses. These include a broad range of medical, dental and vision expenses, but generally do not include the cost of health insurance premiums.  You can, however, treat premiums for long-term care coverage, health care coverage while you receive unemployment benefits, or health care continuation coverage required under any federal law (COBRA) as qualified medical expenses for HSAs. If you are age 65 or older, you can treat insurance premiums (other than premiums for a Medicare supplemental policy, such as Medigap) as quailed medical expenses for HSAs.

In order to be an eligible individual and qualify for a Heath Savings Account you must have a High Deductible Health Plan (HDHP), you cannot be enrolled in Medicare, and you cannot be claimed as a dependent on someone else’s tax return.  Recent changes in HSA rules allow you to contribute the maximum amount to your HSA even if your deductible is less than that amount.  If you are an individual the amount you can contribute for the year 2007 is $2,850 and for a family it is $5,650.  In addition, if you are over the age of 55 you are allowed an $800 catch up contribution.  Unlike other plans you may have heard about, the amount you put into a Health Savings Account is allowed to rollover from year to year and the profits on any investments with the money are tax deferred.  When the money is used to pay or reimburse for qualified medical expenses the distributions are tax free.

The knowledge of how to invest with a self-directed Health Savings Account from Quest IRA, Inc. allowed me to do some amazing investments this year.  I have a High Deductible Health Plan (HDHP) for my family.  This health plan works well for me.  I personally like high deductible insurance policies. My family rarely turns in a claim on most of our insurance policies.  Because my family is financially stable, in the event of an accident or major illness paying a few thousand dollars would not be a problem. Over the years I have saved a lot of money by using high deductible insurance policies.  When I discovered that Quest IRA, Inc. offered self-directed Health Savings Accounts I saw a great opportunity.

This year my wife needed extensive dental procedures.  The cost went well over $5,650.  The insurance company did not pay because it was a dental procedure and I don’t carry any dental insurance.  I opened an HSA with Quest IRA, Inc. with a maximum deposit of $5,650. I could have immediately taken a distribution for my wife’s dental expenses, effectively negotiating a discount on the dental bill equal to my marginal tax rate.  Instead I chose to leave the money in the HSA and invest the money in partnership with my son’s Roth IRA and my wife’s Roth IRA to purchase a note secured by a first lien on real estate.  The note was for 12% with a 2% origination fee and all costs were paid by the borrower, including Quest IRA Inc., fees, with an 18 month balloon.

I can add $5,800 again to the HSA in January of 2008.  As the money grows I can take any amount of money out of the account as long as I have qualified medical expenses, including dental or vision expenses, to be reimbursed.  Since I already have a large amount of dental bills I just keep these bills along with any others in a file.  When I want to withdraw some money for any reason I just request a reimbursement for the expenses regardless of the year the expenses were incurred, as long as the expense was incurred after opening my HSA.  That being said, don’t make the same mistake I made.  I opened my HDHP at the first of the year but waited to fund my Quest IRA Inc. HSA until I could fund it fully.  My wife had some of the dental work done before I opened the HSA.  The work done before the HSA was opened will not qualify for a tax free reimbursement.  If I would have simply opened the account with a small amount then funded the rest later in the year I could have used those expenses as well.

If in the future we decide that a HDHP is not good for our family we can switch to another plan.  We will not be able to continue to contribute to the HSA, but we can keep the HSA open and withdraw the money out as needed tax free for qualified medical expenses.

If I had just paid for the dental expenses out of my pocket like I originally planned to, I would have lost the opportunity for a $5,650 deduction on my taxes and the opportunity to make a great investment. Remember, I can take the money out as my investments mature and gains on the investments can be withdrawn tax free. Like we always say here at Quest IRA, Inc., “You don’t have to think outside the box, just realize the box is bigger than you think!”

Self-Directed Health Savings Accounts – Building Wealth Through Health

By H. Quincy Long

By now you have probably heard of the Health Savings Account (HSA).  What you may not know is just how amazing this type of account actually is, in terms of premium savings, tax savings, and, most importantly, what you can invest in with your HSA.

Qualification Requirements.  In order to have a Health Savings Account, you must be an “eligible individual.”  To be an eligible individual, you must 1) have a High Deductible Health Plan (HDHP); 2) have no other health coverage, with certain exceptions; 3) not be enrolled in Medicare; and 4) not be claimed as a dependent on another person’s tax return.

While a full description of a HDHP is beyond the scope of this article, its key features are a higher deductible than many insurance policies and a maximum limit on the out-of-pocket expenses (including the deductible and co-payments, but excluding the premium payments).  For 2008, the minimum deductible is $1,100 for self-only coverage and $2,200 for family coverage, and the maximum out-of-pocket expense is $5,600 for self-only coverage and $11,200 for family coverage.  All major insurance companies offer HSA compliant plans.  Employers may also offer an HSA compliant plan, since these policies tend to be less expensive.  If the employer makes contributions to your HSA it is excluded from your income.

Premium Savings.  Because of the higher deductibles and plan features, HSA compliant plans tend to cost less.  When I switched from a policy with a $2,000 general deductible and a $200 drug deductible to an overall deductible of $2,200, the premiums for my family were reduced from $754 per month to $450 per month.  That’s a total premium savings of $3,648 per year!

Tax Savings.  One of the best features of an HSA is the tax savings for contributing to the account.  Beginning in 2007, the contribution limit is no longer tied to the deductible.  The contribution limit for 2008 is $2,900 for self-only coverage and $5,800 for family coverage.  To the extent you make the contribution (as opposed to your employer), these amounts are fully tax deductible, no matter what your income.  If you are age 55 or older, you may contribute an additional $900 for 2008.  There is even a one time ability to take a distribution from your IRA to fund your HSA with no taxes or penalty.

In my tax bracket, the ability to deduct my contributions is significant.  I will contribute $5,800 for 2008 and save $2,030 on my taxes.  The total benefit to me for switching to an HSA compliant health plan, considering the premium and tax savings, is $5,678 for 2008, which nearly covers my $5,800 contribution!
Distributions from an HSA for “qualified medical expenses”, which are broadly defined and include expenses for yourself, your spouse and your dependents, are tax free forever!  Because the expenses only have to occur after the HSA has been established, virtually everyone will end up with qualified medical expenses at some point in their life.  You can take a qualified distribution at any point after the expense is incurred, even in later years, provided you keep track of the expenses.

Investment Opportunities.  Even better than the premium and tax savings is the ability to invest your HSA funds in non-traditional investments, just as you would in a self-directed IRA.  Many banks and other companies offer the convenience of an HSA account with a debit card for you to pay medical bills with.  However, if you are healthy and don’t have a lot of expenses or you can fund the expenses out of pocket, you can make your HSA account grow much faster with investments other than mutual funds or savings accounts which may pay very little.

With a self-directed HSA, you choose your HSA’s investments.  Common investment choices made by self-directed HSA participants at Quest IRA, Inc. in Houston, Texas include real estate, both domestic and foreign, options, secured and unsecured notes, including first and second liens against real estate, C corporation stock, limited liability companies, limited partnerships, trusts and much more.  For example, I combined my 2007 HSA contribution with my 401(k) and other self-directed accounts to fund a hard money loan with 2 points up front and 12% interest per year.

The Health Savings Account is truly the best of all worlds.  It can significantly reduce your health care premiums, reduce your taxes, and produce tax free wealth through non-traditional investments in a self-directed HSA.  With a self-directed HSA (or IRA), you don’t have to “think outside the box” when it comes to your HSA’s investments.  You just have to realize that the investment box is much larger than you think!

The Saver’s Tax Credit – How to get up to $2,000 FREE from the U.S. Government

By H. Quincy Long

            Tax time is coming, and many of you are considering whether or not to make a 2007 contribution to your Traditional or Roth IRA.  I have good news!  If you are at least 18 years old, you are not a full-time student, you are not claimed as a dependent on another person’s tax return and you meet the income requirements listed below, you are entitled to a tax credit of up to 50% of your contribution to almost any type of retirement plan, including a Roth IRA!  If you then take your refund from the government and put it back into your IRA, your retirement savings will increase by as much as 50%!

            Begun in 2002 as a temporary provision, the saver’s credit was made a permanent part of the tax code as part of the Pension Protection Act of 2006. To help preserve the value of the credit, income limits are now adjusted annually to keep pace with inflation.  To qualify for the Saver’s Tax Credit, you must have Modified Adjusted Gross Income (MAGI) within the following limits for 2007:

            Credit              Income for Married     Income for Head of    Income for

            Rate                 Filing Jointly               Household                   Others

            50%                 up to $31,000              up to $23,250              up to $15,500

            20%                 $31,001 to $34,000     $23,251 to $25,500     $15,501 to $17,000

            10%                 $34,001 to $52,000     $25,501 to $39,000     $17,001 to $26,000

            The maximum tax credit allowed for 2007 is $1,000 (with a $2,000 contribution), or up to $2,000 if married filing jointly and each spouse makes a contribution.  Simply attach Form 8880, Credit for Qualified Retirement Savings Contributions, to your income tax return, and you will receive up to a $2,000 tax credit.  A tax credit is a dollar for dollar reduction in your tax bill, as opposed to a tax deduction, which only reduces the amount of money on which you pay income taxes.  You may get more information on this credit from IRS Publication 590.

            To prevent abuse, the IRS has rules which will reduce the amount of contribution which qualifies for the saver’s tax credit if the IRA owner has taken distributions from any eligible employer plan or IRA during a specified testing period.  The testing period includes the two taxable years prior to the year the credit is claimed, plus the taxable year the credit is claimed and the following year up until the tax filing deadline for the year the credit is taken, including extensions.   For example, if Josh contributes $2,000 to his Roth IRA for 2007 but had previously removed $500 from his IRA in 2006 and removes an additional $500 in 2008 before October 15, only $1,000 of his $2,000 Roth IRA contribution for 2007 may be used toward the saver’s tax credit on his 2007 tax return.

            Let me give you an example.  Lucky Larry, a married man, was downsized from his job in the corporate world in December, 2006.  Larry decided that he wanted to be a real estate investor instead of looking for another j-o-b.  Things went fine in 2007, but Larry’s modified adjusted gross income after all of his expenses will be $30,000 due to his various write-offs, and his taxable income after the standard deduction and 2 exemptions will be $13,500.  Therefore his taxes before the tax credit will be $1,353 (see instructions for Form 1040, page 65).  He and his wife contribute $1,353 each to a self-directed Roth IRA at Quest IRA, Inc. which they can use to purchase real estate options, debt-leveraged real estate, and many other things.  Larry and his wife will receive a tax credit of $1,353 (50% of each of their contributions). 

            Although the maximum contribution for purposes of the tax credit is $2,000 each, the tax credit is non-refundable.  This means that the maximum tax credit Larry and his wife can receive is equal to the taxes they would otherwise pay.  With the tax credit, Larry’s income tax for 2007 is ZERO!  Larry and his wife wisely decide to contribute the tax refund back into their Quest IRA, Inc. self-directed Roth IRAs.  Each Roth IRA grows by 50% to $2,029.50 absolutely FREE, courtesy of the United States government!

How the Richer Family Grows Richer

H. Quincy Long

Ira N. Richer, a 56 year old self-employed consultant, his wife, Hope Tobe Richer, Ira’s 51 year old stay at home wife, and their 17 year old son, Will B. Richer are interested in saving money in self-directed accounts at Quest IRA, Inc. How much money can they contribute based on Ira’s $30,000 net earnings from his consulting practice?

Roth and Traditional IRAs

Roth IRA – Anytime from January 1, 2008 through April 15, 2009, Ira and Hope can both contribute to a Roth IRA for 2008.Even though Hope does not earn wages, she can still contribute to a Roth IRA based on Ira’s income, assuming they are married filing jointly for federal tax purposes.Even if he doesn’t claim net earnings from self-employment of over $30,000, Ira can contribute $6,000 into each Roth for 2008 ($5,000 base contribution plus a $1,000 catch up contribution since they were both at least 50 years of age by December 31, 2008).Assuming their son Will has compensation of at least the amount of his contribution, he may also contribute $5,000 to his own Roth IRA for 2008.

Traditional IRA – Ira and Hope could have contributed the amounts described under the Roth IRA into Traditional IRAs, but their total contributions to both their Traditional IRAs and their Roth IRAs cannot exceed the annual contribution limit of $6,000 per person over the age of 50.In this case they elected to put the entire contribution into their Roth IRAs.If neither Ira nor Hope were covered by a retirement plan at work, their contributions to a Traditional IRA would be fully deductible, no matter how much income they earned.

Roth Conversion – If Ira or Hope has money in a Traditional IRA (including a SEP IRA), that money can be converted into a Roth IRA provided that their Modified Adjusted Gross Income (MAGI) is $100,000 or less in the year they do the conversion.Any amount they convert is added to their taxable income for the year, but no penalties are assessed for doing a Roth conversion.Important Note:in 2010 the amount of modified adjusted gross income made by Ira and Hope will not affect their ability to do a Roth conversion.Also, they may split the taxes from the 2010 conversion and pay 50% in 2011 and 50% in 2012.For conversions in 2011 and after, taxes must be paid on the conversion income in the year the Traditional IRA was converted to the Roth.

Work Plans

Ira can also have an employer plan based on his self-employment consulting income.With any of the work plans discussed below, Ira must also cover any other employees under the plan.This may affect which of the plans he chooses for his business.We will assume that Ira has no employees.Having any of the work plans discussed below does not affect Ira’s or Hope’s ability to contribute to a Traditional or Roth IRA, but above certain income levels it will affect the deductibility of a Traditional IRA contribution.

SEP IRA – Ira can choose to have a SEP IRA plan into which he can contribute up to a maximum of 20% of his net earnings from self-employment, or 25% of his W-2 wages if he is paid through a company.Net earnings from self-employment are calculated for SEP IRA purposes by deducting one-half of his self-employment tax from his net profits as shown on Schedule C.The plan can be set up and funded at any time prior to Ira’s tax filing deadline, including extensions (ie. October 15, 2009 if Ira files for an extension).Since Ira’s net earnings from self-employment were $30,000 in our scenario, he can contribute up to $6,000 into his SEP IRA at Quest IRA, Inc. (the contribution limit would be $7,500 if Ira were paid W-2 wages from a company instead of reporting his income on Schedule C as self-employment income).If he wants to, in January of 2009 Ira can begin making contributions for 2009 to his SEP IRA.

SIMPLE IRA – Another alternative is for Ira to have a SIMPLE IRA for his consulting business.This type of plan is appropriate for those with lower income levels or for those who have employees and who don’t want to contribute an equal percent into their employees’ retirement plans as they do for themselves.Assuming he had the plan set up by October 1, 2008, Ira can contribute $10,500 of his net earnings from self-employment for 2008, plus an additional $2,500 catch up because he is over age 50 by December 31, 2008.The $13,000 is considered salary deferral and must be contributed by January 30, 2009.Ira can also contribute an additional $900 as an employer contribution by his tax filing deadline, including extensions (ie. October 15, 2009).For SIMPLE IRA purposes, net earnings from self-employment are calculated based on 92.35% of Ira’s net Schedule C income.Ira is considered both the employer and the employee since he is self-employed.The total 2008 SIMPLE IRA contribution is $13,000 in salary deferral and $900 in employer contribution for a total of $13,900.This is an improvement over what he can contribute to a SEP IRA at his income level, but at income levels above around $60,000 (or around $48,000 if under age 50) the SEP is more advantageous, absent other factors.

Profit Sharing/401(k) Plan – The plan into which Ira can put the most money is an Individual 401(k)/Profit Sharing plan.An Individual 401(k)/Profit Sharing plan must be set up by December 31, 2008 if Ira wants to contribute or defer compensation for 2008.In this plan Ira can defer $15,500 plus $5,000 catch up for 2008 out of his $30,000 net earnings from self-employment.Net earnings from self-employment is calculated for Individual 401(k)/Profit Sharing planpurposes by deducting one-half of his self-employment tax from his net profits as shown on Schedule C.In addition, Ira can contribute up to 20% of Ira’s net earnings or 25% of his wages if he is paid by a company into the plan, or $6,000.These contributions must be made by Ira’s tax filing deadline, including extensions.This means that for 2008, Ira can contribute $26,500 into his Individual 401(k) plan with only $30,000 in earned income!

Even better, starting in 2006, Ira’s salary deferral can be a Roth 401(k), which means that he will pay taxes on his salary deferral when he contributes, but will pay NO TAXES when the funds are distributed to him, provided they are qualified distributions.What an opportunity!Although Ira qualifies for a Roth IRA because of his income level, even if he makes too much money to qualify for a Roth IRA he can defer salary into a Roth 401(k).The employer contribution ($6,000 in Ira’s case) is pre-tax, so part of Ira’s withdrawals from the plan will be taxable and the portion relating to the Roth 401(k) will be tax free.

Additional Choices

Besides Traditional or Roth IRAs and an Individual 401(k) plan, SEP IRA or SIMPLE IRA for Ira’s consulting business, the Richer family can also have two other types of accounts.These are the Health Savings Account (HSA) and the Coverdell Education Savings Account (ESA).Like the other accounts they have at Quest IRA, Inc., the HSA and the ESA can be self-directed.Neither of these types of accounts is directly related to how much money Ira earns, although above certain income levels Ira and Hope could not contribute to Will’s Coverdell Education Savings Account.

Health Savings Accounts – Ira and Hope can save on taxes for 2008 by opening a Health Savings Account, or HSA.In order to do this, they have to have a special type of insurance plan, called a High Deductible Health Plan, or HDHP.Just having a plan with a high deductible does not necessarily qualify you for an HSA.Assuming Ira and Hope have a family plan, they can contribute up to $5,800 for 2008 up until April 15, 2009.Because Ira is over 55 years old, he can add a $900 catch up contribution for 2008 in addition to the regular contribution.Ira and Hope can split the contribution into 2 separate accounts or put all of it into one account.Starting in 2007 contributions are no longer limited by the deductible amount, as they were in years past.Even if Ira and Hope have the minimum deductible of $2,200 for a family plan, they can contribute the maximum of $5,800 for the year plus the catch up contribution. Contributions to HSA accounts are tax deductible, and there is no tax on the distributions if the money is used for qualified medical expenses.This truly is the best of both worlds!

Coverdell Education Savings Accounts (formerly Education IRA) – Since Will is under age 18, Ira can put up to $2,000 into a Coverdell ESA for 2008.Ira will receive no deduction for the contribution, but any earnings which are withdrawn for qualified education expenses are tax free.Qualified education expenses include certain expenses for grade school and high school as well as for college.

Summary

For the tax year of 2008, here is the maximum amount of money that the Richer family can put into self-directed accounts at Quest IRA, Inc. :

Maximum Contribution

For Richer Family

Ira’s Roth IRA$6,000

Hope’s Roth IRA$6,000

Will’s Roth IRA$5,000

Ira’s Individual (k)$26,500

Ira’s HSA$6,700

Will’s ESA$2,000

Total$52,200

Assuming all distributions are qualified distributions, the earnings from the Roth IRAs, the Roth 401(k), the HSA and the ESA are tax free forever!This means that the Richers can get richer by investing as much as $46,200 tax free and the balance on a tax deferred basis.All of these accounts can invest in real estate, real estate options, promissory notes, both secured and unsecured, LLCs, limited partnerships, private stock and much more.They can invest individually or in combination with each other.To find out more about these accounts, contact your closest Quest IRA, Inc. office today!