Tag Archives: Conversion

Contributions to a SEP IRA and ROTH IRA in the same year?

Question: I have a sep IRA, already contirbute maximum to Sep IRA this year, can i also contribute to Roth IRA in additional to Sep IRA? Thank you.”

Answer: The answer is yes, you can.  The SEP IRA is an employer plan, and it is the employer who is making the contribution (even if you are self-employed).  The Roth IRA is only dependent upon you having earned income at least in the amount of the contribution and not in excess of the income limits.  Even if you exceed the income limits, you can contribute to a traditional IRA and then do a Roth conversion.

Roth Conversion in 2011?


Hi Quincy.  I’m hoping you can give me your take on 2011 Roth conversions.  I have spoken to Nathan and Ryan and they seem to have different perspectives on this.  I have already done one Roth conversion this year and have recently closed on another property which I would like to convert to a Roth in 2011.  Nathan seems to think that this should not be a problem yet Ryan feels that it is unlikely that they will be allowed in 2011 (assuming I exceed that income limitations).  Is there any actual rules in place for 2011?  What are your thoughts on this?  Since we are very near year end I’d appreciate a response ASAP.. Thank you. (This question came in in 2010 where we now know the conversion rules for 2011)


Yes, I can.  The rules as they stand right now are that the $100,000 income limitation for converting to a Roth IRA has been permanently removed, which means that unless Congress changes the rules you will be able to convert in 2011.  The decision to convert or not is a complex one which can be affected by other tax issues, so you should always consult with your tax advisor before making a final decision.

Can I or When Can I Take Tax Free Penalty Free Distributions From My Converted Traditional to Roth IRA?

Question: My 35 year old son is converting $160,000 form a tradtitiional IRA to a Roth. Assuming a $50,000 tax bite, and assuming he pays the $50,000 with outside money so he converts the whole $160,000, can the $160,000 be accessed penalty free immediately because it becomes the basis and the tax has been paid?

Answer: Unfortunately not.  Assuming the conversion represents the only Roth money your son has, the conversion amount cannot be removed within 5 tax years without paying the premature distribution penalty of 10%.  The ordering rules for distributions from a Roth IRA are 1) contributions 2) conversions, and 3) profits.  So if your son has made contributions to a Roth IRA he can withdraw those at any time without penalty.  Beyond the contributions, conversions can be removed only after 5 years without penalty, unless he meets one of the other exceptions to the penalty rules (most commonly 59 ½).  Profits can only be withdrawn tax and penalty free as qualified distributions, meaning your son has had a Roth IRA somewhere for at least 5 years and meets one of four other tests (again, most commonly 59 1/2).  You may find the description of the ordering rules beginning on page 66 of IRS Publication 590, which you can review and download from the IRS at www.irs.gov.  Good luck with your investing!

Follow Up Question: Thank you for a quick response. I did go to the irs.gov. site. From the website and your email, this is what I understand. Please forgive any repetition. I have received very different answers from seminars and regional offices, so your  expert help is hugely valuable! I want my son to be clear and comfortable as he is concerned about accessible, penalty free rainy day money prior to age 59 1/2. I also want to be able to deliver correct information to other investors. Is this correct: if my son converts $160k of traditional IRA money and pays the taxes out of pocket, in 5 tax years he can access the $160k without penalty at approximately age 41?  He currently has $15k in an existing Roth he has had for 7 years. The contribution portion of the $15k can be taken today penalty free and the profit portion will be penalized if accessed prior to age 591/2. Correct? Any profit is subject to regular Roth rules and those conditions are clearly defined and I understand them. I will not continue to bother you, but knowledgeable experts are hard to find.

Follow Up Answer: Yes, according to the paragraphs describing the additional tax on distributions beginning on page 64 of the 2009 IRS Publication 590, your son must pay the 10% penalty for distributions of his conversion contribution from his Roth IRA made within 5 tax years of the conversion – in other words, if he converts in 2010 and takes a distribution before January 1, 2015 he will be subject to this penalty to the extent that this distribution exceeds his regular contributions to his Roth IRAs.  To figure the taxable part of any non-qualified distribution (as opposed to the penalty) use the Worksheet 2-3 on page 67 of Publication 590.  You will see from that worksheet that the amount of his regular Roth IRA contributions are not includible in income (line 12 subtracts these amounts out) and are therefore not subject to the 10% premature distribution penalty either (see the paragraph entitled Other Early Distributions  at the top of page 66, which indicates “you must pay the 10% additional tax on the taxable part of any distributions that are not qualified distributions”).

Having said this, as you know from the disclaimer at the bottom of my prior emails you are not able to rely on this email as tax advice, so you should absolutely contact your own tax advisor to verify the implications for your individual tax situation.  I would be curious to learn what you have heard from seminars and regional offices if you care to share it.  I know there is a lot of confusion out there on this topic, even by some professionals such as CPAs.  Perhaps the most confusing thing is the fact that there are 2 different 5 year clocks when it comes to Roth IRAs, one being the 5 years necessary for a distribution to be a qualified distribution and the other being the 5 year clock for conversion contributions before you can escape the 10% premature distribution penalty, as we have been discussing here.  Anyway, thank you for your question.  Let me know if I can assist you further. Have a great day!

Do Roth Conversions Make Sense? How to Analyze the 2010 Roth Conversion Opportunity

By: H. Quincy Long           

            How would you like to have tax free income when you retire?  Would you like to have the ability to leave a legacy of tax free income to your heirs when you die?  The great news is that there is a way to achieve these goals – it is through a Roth IRA.

            Historically, because of income limits for contributions to a Roth IRA and for converting a Traditional IRA into a Roth IRA, high income earners have not been able to utilize this incredible wealth building tool.  Fortunately, the conversion rules are changing so that almost anyone, regardless of their income level, can have a Roth IRA.  But is it really worth converting your Traditional IRA into a Roth IRA and paying taxes on the amount of your conversion if you are in a high tax bracket?  For me, the answer is a resounding yes.  I firmly believe it is worth the pain of conversion for the tremendous benefits of a large Roth IRA, especially given the flexibility of investing through a self-directed IRA.

            For Traditional to Roth IRA conversions in tax year 2009, the Modified Adjusted Gross Income (MAGI) limit for converting to a Roth IRA is $100,000, whether you are single or married filing jointly.  However, the Tax Increase Prevention and Reconciliation Act (TIPRA) removed the $100,000 MAGI limit for converting to a Roth IRA for tax years after 2009.  This means that beginning in 2010 virtually anyone who either has a Traditional IRA or a former employer’s retirement plan or who is eligible to contribute to a Traditional IRA will be entitled to convert that pre-tax account into a Roth IRA, regardless of income level.

            Even better, for conversions done in tax year 2010 only you are given the choice of paying all of the taxes in tax year 2010 or dividing the conversion income into tax years 2011 and 2012.  If you convert on January 2, 2010, you would not have to finish paying the taxes on your conversion until you filed your 2012 tax return in 2013 – more than 3 years after you converted your Traditional IRA!  One consideration in deciding whether to pay taxes on the conversion in 2010 or dividing the conversion income into 2011 and 2012 is that 2010 is the last tax year in which the tax rates are at a maximum of 35%.  Tax rates are scheduled to return to a maximum tax rate of 39.6% in 2011, and other tax brackets are scheduled to increase as well, so delaying the payment of taxes on the conversion will cost you some additional taxes in 2011 and 2012.  The benefit of delaying payment of the taxes is that you have longer to invest the money before the taxes need to be paid, whether the payment comes from the Roth IRA or from funds outside of the Roth IRA.

            The analysis of whether or not to convert your Traditional IRA to a Roth IRA is a complex one for most people, because it depends so much on your personal tax situation and your assumptions about what might happen in the future to your income and to tax rates, as well as how you invest your money.  From my own personal perspective, I make the simple assumption that tax free income in retirement is better than taxable income.  I can afford to pay my taxes now (not that I like it), and I would like to worry less about taxes when I retire.  I also don’t believe that tax rates will be going down in the future.  For me, the decision comes down to whether I want to pay taxes on the “acorn” (my Traditional IRA balance now) or the “oak tree” (my much higher IRA balance years in the future as I make withdrawals). 

            The way I analyze whether or not to convert to a Roth IRA is to calculate my “recovery period” – that is, the time it takes before my overall wealth recovers from the additional taxes I have to pay on the conversion.  If I can recover the cost of the taxes on the conversion before I might need the money in the Roth IRA, then I say it is worth doing, especially since the gains after the conversion are tax free forever.  Fortunately, with a self-directed IRA you are in total control of your investments, and the recovery period can be quite short.  There may also be a benefit if you are able to convert an asset now that may have a substantial increase in value later.

            Using my own situation as an example, I have been planning on doing a conversion in 2010 ever since the passage of TIPRA was announced in 2006.  My first step was to immediately begin making non-deductible Traditional IRA contributions.  Even though I am covered by a 401(k) plan at my company and earn more than the limits for making a deductible Traditional IRA contribution, this does not prevent me from making a non-deductible contribution since I am under age 70 ½.  The main reason I have been making non-deductible contributions to my Traditional IRA is to have more money to convert into a Roth IRA in 2010.  The best thing about this plan is that only the gains I make on the non-deductible contributions to the Traditional IRA will be taxed when I convert to a Roth IRA, since I have already paid taxes on that amount by not taking the deduction.

            I plan on converting approximately $100,000 in pre-tax Traditional IRA money in 2010.  The actual amount converted will be more like $150,000, but as I noted above my wife and I have been making non-deductible contributions to our Traditional IRAs since 2006, so the actual amount we pay taxes on will be less than the total conversion amount.  This means that my tax bill on the conversion will be $35,000 if I pay it all in tax year 2010 or $39,600 divided evenly between tax years 2011 and 2012, assuming I remain in the same tax bracket and Congress doesn’t make other changes to the tax code.

            To help analyze the conversion, I made some calculations of how long it would take me to recover the money I had to pay out in taxes at various rates of return, assuming a taxable conversion of $100,000 and a tax bite of $35,000.  I calculated my recovery period based on paying the taxes with funds outside of the IRA (which is my preference) and by paying taxes from funds withdrawn from the Roth IRA, including the early withdrawal penalty I would have to pay since I am under age 59 ½. 

            If I pay taxes with funds outside of my Roth IRA and can achieve a 12% return compounded monthly, my Roth IRA will grow to $135,000 in only 30 months, at which point I will have fully recovered the cost of the conversion.  A 6% yield on my investments will cause my recovery period to stretch to 60 months, while an 18% yield will result in a recovery period of only 20 months!  Of course paying taxes with funds outside of the IRA reduces my ability to invest that money in other assets for current income or to spend it on living expenses.  But if I have to withdraw the money from the Roth IRA to pay taxes and the early withdrawal penalty, the recovery period for my Roth IRA to achieve a $39,000 increase ($35,000 in taxes and a $3,900 premature distribution penalty) increases to 50 months at a 12% yield and 99 months for a 6% yield.  Paying the taxes from funds outside of my Roth IRA will result in a much larger account in the future also since the full $100,000 can be invested if taxes are paid with outside funds, while only $61,000 remains in the Roth IRA after withdrawal of sufficient funds to pay the taxes and penalties.

            I believe that since my IRAs are all self-directed I can easily recover the cost of the conversion (i.e. the taxes paid) in less than 3 years based on my investment strategy.  From that point forward I am building tax free wealth for me and my heirs.  How can I recover the taxes so quickly?  It’s easy!  Self-directed IRAs can invest in all types of non-traditional investments, including real estate, notes (both secured and unsecured), options, LLCs, limited partnerships and non-publicly traded stock in C corporations.  With a self-directed IRA you can take control of your retirement assets and invest in what you know best.

            In my retirement plan I invest in a lot of real estate secured notes, mostly at 12% interest with anywhere from 2-6% up front in points and fees.  I also own some stock in a 2 year old start up bank in Houston, Texas which is doing very well, and a small amount of stock in a Colorado bank.  As the notes mature I plan on purchasing real estate with my accounts, because I believe now is the best time to buy.  In some cases I may purchase the real estate itself and in other cases I will probably just purchase an option on real estate.  The bank stock will be converted at the market price in 2010, but when the banks sell in a few years I expect to receive a substantial boost in my retirement savings since banks most often sell at a multiple of their book value.  In the meantime, the notes and the real estate will produce cash flow for the IRA, and if I have done my investing correctly the real estate will also result in a substantial increase in my Roth IRA when it sells in a few years.

            Note that I have written this article from the perspective of someone who is in a high tax bracket.  A lower tax bracket will reduce the recovery period and is an even better bargain, especially if you can afford to pay the taxes from funds outside of the Roth IRA.  If you take advantage of the opportunities afforded to you by investing in non-traditional assets with your self-directed Roth IRA, you can truly retire wealthy with a pot of tax free gold at the end of the rainbow.

            H. Quincy Long is Certified IRA Services Professional (CISP) and an attorney and is President of Quest IRA, Inc., with offices in Houston, Austin,  and Dallas, Texas. In addition to Texas, Qunicy has opened an office in Mason, MI this year in December of  2011 and is planning to open an office in Seattle, Washington within the next 12 months.  He may be reached by email at Quincy@QuestIRA.com Nothing in this article is intended as tax, legal or investment advice.

Can I Have a Roth Too, Please? Yes, You Can!!!

By H. Quincy Long

            Most people want a Roth IRA once they understand the tremendous tax benefits.  You do not receive a tax deduction for contributing money to a Roth IRA, but qualified distributions are TAX FREE FOREVER.  Essentially the concept of a Roth IRA is that you pay taxes on the “acorn” (the initial contribution) instead of the “oak tree” (the potentially large amount in the Roth IRA after many years of tax deferred accumulation).  This is especially beneficial in a truly self-directed IRA, which can invest in real estate, notes, options, private company stock, LLCs, limited partnerships and other non-traditional asset

            Unfortunately, there are income limits for contributing to a Roth IRA or converting money from a Traditional IRA to a Roth IRA.  For contributions, a married couple filing jointly may not contribute if they have Modified Adjusted Gross Income (MAGI) of more than $176,000 for 2009.  For single individuals the MAGI limit is no more than $120,000 for 2009 to be able to contribute to a Roth IRA.  The news is even worse if you want to convert assets from a Traditional IRA to a Roth IRA.  Whether married or single, you are not eligible to do a Roth conversion if your MAGI is more than $100,000.

            For people who exceed these income limits, it might at first appear that they are left out in the cold when it comes to Roth IRAs.  Fortunately, this is not actually true.  There are at least 3 ways in which a person who exceeds the income limits may end up with a Roth IRA.  The key phrase is “end up with” in the preceding statement.

            The first method of acquiring a Roth IRA if you exceed the income limits is to inherit one.  There is no age discrimination for contributing to a Roth IRA, unlike the Traditional IRA.  Anyone with earned income within the limits can contribute.  Earned income is generally income on which you must pay Social Security and Medicare taxes.  Passive or investment income, including rents, interest and dividends do not count as earned income, but it is not that hard to create earned income.  An elderly relative or friend may be able to help in your business in some way, for example, and your payment to them for their assistance would be earned income.  They may even be predisposed to name you as their beneficiary in the event of their death.

When a Roth IRA is inherited, the new account owner must take required minimum distributions from the IRA, unless the inheritor is a spouse.  Required minimum distributions are not required for the original account owner.  However, this does not mean that the balance in the account cannot be invested, and it is easy, at least with a self-directed IRA, to create income which exceeds the yearly required minimum distributions.  Even better, if the person who died had a Roth IRA for at least 5 tax years, distributions from the account are tax free, even if the inheritor is under age 59 ½.  There is never a 10% premature distribution penalty either, since the distribution is due to death.

            A second method to acquire a Roth IRA has to do with excess contributions.  Many people do not really know whether their income will exceed the limits when they make their Roth IRA contribution, especially if they contribute early in the year.  This is certainly true of self-employed persons.  So what happens if you make a mistake by contributing early and it turns out your income exceeded the MAGI limit for the year? 

If you take action before your tax filing deadline, including extensions (generally October 15), you can recharacterize the contribution to a traditional IRA as long as you are under age 70 1/2, along with all of the net income attributable (NIA) to the contribution.  You may also remove the contribution from the Roth IRA, along with any net income attributable.  In this case the only penalty which you might have to pay is on the income attributed to the contribution, not on the contribution itself.  If you remove the contribution after your tax filing deadline plus extensions, it is unclear from the regulations whether you must also remove the net income attributable from the Roth IRA.  A third choice is to leave the contribution in the Roth IRA and pay a penalty on the excess contribution.  In many circumstances this may be the wisest choice.

If you leave the money in your Roth IRA, you are required to pay a penalty of 6% of the amount of the excess contribution for each year that the excess remains in the Roth IRA.  For example, if you make an excess contribution $4,000 to a Roth IRA and your MAGI exceeds the limit, your penalty is only $240 for each year the excess remains in the account.  This is the penalty regardless of how much money you make in the Roth!  Since the penalty only applies for as long as the excess contribution remains in the Roth IRA, you will no longer have to pay the penalty if you qualify for a Roth in a future year and do not contribute or if you remove the contribution.  Once you have a Roth IRA, the account may continue to be invested regardless of your current year income. 

            Finally, in 2010 the $100,000 MAGI limit for converting assets from a Traditional IRA to a Roth IRA is eliminated.  Although a person who exceeds the MAGI limit will still not be able to contribute to a Roth IRA, in 2010 and future years anyone may convert assets in a Traditional IRA to a Roth IRA, no matter what their income level.  The amount converted is generally added to your taxable income for the year of conversion to extent it exceeds any non-deductible contributions in the account.  For conversions in the year 2010 only, however, the person converting has the choice of paying 50% of the taxes on the conversion in 2011 and the other 50% in 2012.  You have 3 years to pay taxes on Roth conversions done in 2010!

            As I always say, there are worse things than not qualifying for a Roth IRA, such as qualifying for a Roth IRA!  Whether by inheriting a Roth IRA, through an inadvertent excess contribution, or by conversion in 2010, even those who are fortunate enough not to qualify for a Roth IRA due to income exceeding the MAGI limit may end up with a Roth IRA.  Even a small Roth IRA can be built into a large IRA with careful investing, which means that even the wealthy can have a substantial amount of tax free retirement income.

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.


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


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!

The Truth About Self-Directed IRAs and Other Accounts

By H. Quincy Long

There is a lot of confusion over self-directed IRAs and what is and is not possible.In this article we will disprove some of the more common self-directed IRA myths.

Myth #1 – Purchasing anything other than CDs, stocks, mutual funds or annuities is illegal in an IRA.

Truth:The only prohibitions contained in the Internal Revenue Code for IRAs are investments in life insurance contracts and in “collectibles”, which are defined to include any work of art, any rug or antique, any metal or gem (with certain exceptions for gold, silver, platinum or palladium bullion), any stamp or coin (with certain exceptions for gold, silver, or platinum coins issued by the United States or under the laws of any State), any alcoholic beverage, or any other tangible personal property specified by the Secretary of the Treasury (no other property has been specified as of this date).

Since there are so few restrictions contained in the law, almost anything else which can be documented can be purchased in your IRA.A “self-directed” IRA allows any investment not expressly prohibited by law.Common investment choices 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 a whole lot more.

Myth #2 – Only Roth IRAs can be self-directed.

Truth: Because of the power of tax free wealth accumulation in a self-directed Roth IRA, many articles are written on how to use a Roth IRA to invest in non-traditional investments.As a result, it is a surprisingly common misconception that a Roth IRA is the only account which can be self-directed.In fact, there are seven different types of accounts which can be self-directed.They are the 1) Roth IRA, 2) the Traditional IRA, 3) the SEP IRA, 4) the SIMPLE IRA, 5) the Individual 401(k), including the Roth 401(k), 6) the Coverdell Education Savings Account (ESA, formerly known as the Education IRA), and 7) the Health Savings Account (HSA).Not only can all of these accounts invest in non-traditional investments as indicated in Myth #1, but they can be combined together to purchase a single investment.

Myth #3 – I don’t qualify for a self-directed Roth or Traditional IRA because I am covered by a retirement plan at work or because I make too much money.

Truth:Almost anyone can have a self-directed account of some type.Although there are income limits for contributing to a Roth IRA (in 2008 the income limits are $169,000 for a married couple filing jointly and $116,000 for a single person or head of household), having a plan at work does not affect your ability to contribute to a Roth IRA, and there is no age limit either.With a Traditional IRA, you or your spouse having a retirement plan at work does affect the deductibility of your contribution, but anyone with earned income who is under age 70 1/2 can contribute to a Traditional IRA.There are no upper income limits for contributing to a Traditional IRA.Also, a Traditional IRA can receive funds from a prior employer’s 401(k) or other qualified plan.Additionally, you may be able to contribute to a Coverdell ESA for your children or grandchildren, nieces, nephews or even my children, if you are so inclined.If you have the right type of health insurance, called a High Deductible Health Plan, you can contribute to an HSA regardless of your income level.With an HSA, you may deduct your contributions to the account and qualified distributions are tax free forever!It’s the best of both worlds.All of this is in addition to any retirement plan you have at your job or for your self-employed business.

Myth #4 – I can’t have a self-directed 401(k) plan for my business because I am self-employed and file a Schedule C for my income.

Truth:You can have a self-directed SEP IRA, a SIMPLE IRA or a 401(k) plan even if you are self-employed and file your income on Schedule C of your personal tax return.With a SEP IRA, you can contribute up to 20% of your net earnings from self-employment (calculated by deducting one-half of your self-employment tax from your net profits as shown on Schedule C) or 25% of your wages from an employer, up to a maximum of $46,000 for 2008.With the SIMPLE IRA, you can defer up to the first $10,500 of your net earnings from self-employment (calculated by multiplying your net Schedule C income by 0.9235% for SIMPLE IRA purposes), plus an additional $2,500 of your net earnings if you are age 50 by the end of the year, plus you can contribute an additional 3% of your net earnings as an employer contribution.Beginning in 2002 even self-employed persons are entitled to have their own 401(k) plan.Better yet, in 2006 the Roth 401(k) was added, allowing even high income earners to contribute after tax dollars into an account where qualified distributions are tax free forever!With an Individual 401(k) you can defer up to $15,500 (for 2007 and 2008) of your net earnings from self-employment (calculated by deducting one-half of your self-employment tax from your net profits as shown on Schedule C), plus an additional $5,000 of your net earnings if you reach age 50 by the end of the year, plus you can contribute as much as an additional $30,500 based on up to 20% of your net earnings for2008 (or 25% of your wages from an employer).This means that a 50 plus year old self-employed person can contribute up to $51,000 for 2008!

Myth #5 – Because I have a small IRA and can only contribute $5,000, it’s not worth having a self-directed IRA.

Truth:Even small balance accounts can participate in non-traditional investing.Small balance accounts can be co-invested with larger accounts owned by you or even other people.For example, one recent hard money loan we funded had 10 different accounts participating.The smallest account to participate was for only $1,827.00!There are at least 4 ways you can participate in real estate investment even with a small IRA.First, you can wholesale property.You simply put the contract in the name of your IRA instead of your name.The earnest money comes from the IRA.When you assign the contract, the assignment fee goes back into your IRA.If using a Roth IRA, this profit is tax-free forever!Second, you can purchase an option on real estate, which then can be either exercised, assigned to a third party, or canceled for a fee.Third, you can purchase property in your IRA subject to existing financing or with a non-recourse loan from a bank, a hard money lender, a financial friend or a motivated seller.Profits from debt-financed property in your IRA may incur unrelated business income tax (UBIT), however.Finally, as mentioned above, your IRA can be a partner with other IRA or non-IRA investors.

Myth # 6 – If I want to purchase non-traditional investments in an IRA, I must first establish an LLC which will be owned by my IRA.

Truth:A very popular idea in the marketplace right now is that you can invest your IRA in an LLC where you (the IRA owner) are the manager of the LLC.Effectively you have “checkbook control” of your IRA funds.Providers generally charge thousands of dollars to set up these LLCs and sometimes mislead people into thinking that this is necessary to invest in real estate or other non-traditional investments.This is simply not true.Not only can an IRA hold title to real estate and other non-traditional investments directly with companies such as Quest IRA, Inc., but having “checkbook control” of your IRA funds through an LLC can lead to many traps for the unwary.Far from protecting your IRA from the prohibited transaction rules, these setups may in fact lead to an inadvertent prohibited transaction, which may cause your IRA to be distributed to you, sometimes with substantial penalties.This is not to say that there are not times when having your IRA make an investment through an LLC is a good idea, especially for asset protection purposes.Nonetheless, you must educate yourself completely as to the rules before deciding on this route.Having a “checkbook control” IRA owned LLC is kind of like skydiving without a parachute – it may be fun on the way down, but eventually you are likely to go SPLAT!

Myth #7 – I can borrow money from my IRA to purchase a vacation home for myself.

Truth:Although the Internal Revenue Code lists very few investment restrictions, certain transactions (as opposed to investments) are considered to be prohibited.If your IRA enters into a prohibited transaction, there are severe consequences, so it is important to understand what constitutes a prohibited transaction.

Essentially, the prohibited transaction rules were made to discourage disqualified persons from dealing with the assets of the plan in a self-dealing manner, either directly or indirectly. The assets of a plan are to be invested in a manner which benefits the plan itself and not the IRA owner (other than as a beneficiary of the IRA) or any other disqualified person.Investment transactions are supposed to be on an arms length basis.

As a result of these legal restrictions, a loan from your IRA or staying at a vacation home owned by your IRA, even if fair market rates are paid for interest or rent, would be prohibited.

Myth #8 – With a self-directed IRA, I can borrow my IRA funds to purchase real estate and then put all the profits back into the IRA.

Truth:When real estate or any other asset is purchased within a self-directed IRA, the money never leaves the IRA at all.Instead, the IRA exchanges cash for the asset, in the same way that an IRA at a brokerage house exchanges cash for shares of stock or a mutual fund.Therefore, the asset must be held in the name of the IRA.For example, if Max N. Vestor were to purchase an investment house in his self-directed IRA, the title would be held as “Quest IRA, Inc. FBO Max N. Vestor IRA #12345-11.”Since the IRA owns the asset, all expenses associated with the asset must be paid by the IRA and all profit resulting from that investment belongs to the IRA, including rents received and gains from the sale of the asset.

Myth #9 – If my IRA buys real estate, it must pay all cash for the property.An IRA cannot buy real estate with debt.

Truth:An IRA can own debt-financed property, either directly or indirectly through a non-taxed entity such as an LLC or partnership.Any debt must be non-recourse to the IRA and to any disqualified person.An IRA may have to pay Unrelated Debt Financed Income Tax (UDFIT) on its profits from debt-financed property.In general, taxes must be paid on profits from an IRA-owned property that is debt-financed, including profits from the sale or disposition of the property, in the same proportion that it had debt.For a simplified example, if the IRA puts 50% down, then 50% of its profits above $1,000 will be taxable.Although at first this sounds terrible, in fact leverage can be an extremely powerful tool in building your retirement wealth.The same leverage principle applies inside or outside of your IRA – you can do more with debt-financing than you can without it.One client was able to build her Roth IRA from $3,000 to over $33,000 in less than 4 months even after paying the taxes due by taking over a property subject to a debt and selling the property to another investor!

Myth #10 – An IRA cannot own a business.

Truth:A self-directed IRA is an amazingly flexible wealth building tool and can own almost anything, including a business.However, due to the conflict of interest rules you cannot work for a business owned by your IRA and get paid.Some companies have a plan to start a C corporation, adopt a 401(k) plan, roll an IRA into the 401(k) plan and purchase employer securities to effectively start a new business, but this is not a direct investment by the IRA in the business and is fairly expensive to set up.Also, if your IRA owns an interest in a business, either directly or indirectly through a non-taxed entity such as an LLC or partnership, the IRA may owe Unrelated Business Income Tax (UBIT) on its profits from the business.A solution to this problem may be to have the business owned by a C corporation or another taxable entity.

Preparing for 2010: Converting your Traditional IRA Assets to a Roth

Preparing for 2010:
Converting your Traditional IRA Assets to a Roth
by Hubert Bromma, CEO of Entrust
As we face an ailing U.S. economy bombarded by the subprime crisis, the rising cost of oil and the products that depend on it, and an expensive, ill-advised war, there is the opportunity for investors to profit from long-term gains at the expense of current economic problems. However, in the context of these current economic conditions, IRA holders can look toward the future and can take advantage of a change to the tax law that takes affect in 2010.

In 2010, regardless of your income, you can convert your traditional IRA assets to Roth IRA assets. Under the current law, you cannot convert a traditional IRA to a Roth if your adjusted gross income (AGI) exceeds $100,000. If any of your assets are currently undervalued, 2010 could be a great opportunity to convert your funds. The  assets will be taxed based on their fair market value as of December 31, 2010, and you also have the option of paying your tax bill over two years. You can pay the tax with cash outside of the IRA, which preserves your IRA assets. After the tax is paid, your earnings will never be taxed again.

Roth IRAs offer the added benefit that there are no required distributions. Unlike a traditional IRA, which requires that you begin taking minimum distributions starting at age 70½, with a Roth, you can let your assets sit and continue to grow. In a time when people work longer, you can amass wealth in a non-taxed environment for as long as you want.

Because you can convert as much or as little of your IRA as you want, you can choose to convert only the assets that have a current low value but that you anticipate having more value in the future. For example, if your self-directed IRA has real property that has been decreasing in value in today’s market but you expect a turnaround, that asset may be ideal to convert at the current fair market value.

Fair Market Value
Neither the Internal Revenue Code nor IRS regulations provide a general definition of fair market value for income tax purposes. The IRS regulations, however, use the following definition in connection with specific income tax issues as well as for estate and gift taxes:“The fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts.”

This is the definition adopted for purposes of valuing charitable contributions of property,pension plan assets,and real property interests disposed of by nonresident aliens and foreign corporations.The courts have also followed this definition when addressing tax issues.

You must determine the fair market value before converting your traditional, pre-taxed assets to Roth, post-taxed assets. This value is used to compute the federal tax, and possibly state tax, that you owe. The best way to establish the fair market value is through a qualified appraiser. The appraiser must have an arms-length relationship with the taxpayer and the asset. The IRS might also accept a recent bona fide offer from a third party who is not considered disqualified under IRS regulations involving IRAs and qualified retirement plans.

Debt-financed assets, such as real estate, must be valued at net asset value. This means that the fair market value subtracts the amount of debt remaining after the date of the appraisal or valuation. Private placements should be assessed by persons or firms qualified to make such appraisals. Cash, stocks and bonds, and publicly traded assets use the established values on the date required for valuation.

Plan Ahead to Minimize Tax and Maximize Gain

The object is to pay as little tax as is legally required and to pay the tax with non-IRA funds, thus preserving the funds that are never be taxed again. If you can, convert as much as possible, concentrating on assets that have the highest potential of future appreciation or income within your time horizon.Tax planning with a professional is always a good idea, but especially so in 2010 if you want to take full advantage of the new law. The amount you convert is added to your income for 2010, and your tax is calculated on your total adjusted gross income. So in 2010, it behooves you to have as little income as possible and plenty of losses. You can also spread the tax burden and pay part in 2011 and 2012.

After you have converted the asset, you can withdraw all or part of it at any time without paying federal taxes if you are at least 59½ years old. However, you may owe state tax. States differ on how assets in IRAs are taxed, and you should make sure that your have adhered to your state’s tax requirements.

The biggest question you have to think about is how well is your crystal ball working; how well can you and your tax advisors foretell your economic and tax-paying future?
Clearly, the more flexibility that you have and the more time that you have will give you more opportunity for appreciation and improve the possibility of the conversion paying for itself. But if past history and inflationary pressures are any indication, if , for example, your real estate investment is valued at 35% less than when your IRA purchased it, the increase in value over time should not only make up the 35% but even more. So converting now at its lowest fair market value may be a wise investment.

Doing The Numbers

It can be daunting to figure out the tax implications when taking inflation and cost of living indicators into account. If your property is in a traditional IRA, when you take distributions, which remember are required, you pay tax on that property at your ordinary income tax rate. Some pundits suggest that your tax rate will be lower when you are older and retire. This may be, but tax rates have hardly decreased over time.Just to take a simple case, let’s say your property has a fair market value of $100,000 today. If the property appreciates as a result of inflation by 2.5% annually over 20 years, the fair market value will be $163,000. You will be paying tax on an asset valued at least 63% higher just due to inflation. Paying tax in 20 years at 35% leaves you with a property worth about $106,000, without taking into consideration any gain as a result of appreciation.

Your cost of living may also increase at a nominal annual rate of 3.5%, based on current rates. That means you have to make up the difference between the fair market value of the property and what your real cost of living is on the amount that you need to live on, or $199,000. In this scenario, you need the property to appreciate to at least $306,000. Tax on $306,000 is $107,000, leaving you with the $199,000 that you need to just break even with the original fair market value. So in this case, you hope for either better appreciation or lower taxes.

The income on the property also plays a big role over time. Let’s say that your property has a 7% net operating income annually. Over 20 years, that equals about $314,000. You also invest the income in money markets that make 4%, adding another $15,000. So when you add your $329,000 in income over 20 years to the fair market value of $306,000, you end up with an IRA worth $635,000! Tax on a distribution of $635,000 at the rate of 35% is about $222,000, leaving you with $413,000, a little more than twice as much than the IRA had in real dollar terms.

If you had paid the tax with money outside the IRA in 2010, you would pay $35,000 (35%) on the $100,000 fair market value. Taking into account how much you could have made on the tax you paid in 2010 over 20 years-we’re using 14.8% compounded annually, which totals about $553,000-and adding that to the $413,000 in the above scenario, your IRA is valued at nearly $628,000 ($996,000 taxed at 35%) rather than $635,000. But that money does not get taxed on distribution. You end up with $628,000 and not $413,000.

Is It Worth It?

In summary, if you pay tax in 2010 on a low cost basis, the outcome in the long term can be substantially better if your assets earn a good return and they appreciate in value. If you expect very high appreciation and income, converting to a Roth IRA in 2010 could be profitable. Most importantly, do the numbers with the advice and input of competent accounting and tax professionals. And you also need to think about paying taxes 20 years from now. In our example, the tax bite is $338,000 in 20 years, not $35,000 in 2010. Keep in mind that you can spread the tax over two years. If you plan now, you can possibly minimize your tax burden by managing your income and losses. But who knows, the value of dollar may be relatively the same and render the question moot.