Types of Retirement Plans

There are a variety of self directed IRAs and small business retirement plans to best suit your needs: individual plans such as the traditional IRA and Roth IRA; small business plans such as the SEP, SIMPLE, and solo 401(k); and health and educational savings accounts.

What Is a Traditional IRA?

Created in 1974, the Traditional IRA is a tax-deferred account in which contributions are made with pre-tax dollars subject to certain conditions pertaining to active participation in a qualified plan and provided certain contribution limits are not exceeded. This allows the money contributed to the Traditional IRA to compound tax-free until funds are withdrawn. All earnings in a Traditional IRA are tax-deferred until withdrawn by the IRA owner or his/her beneficiary (unless subject to unrelated business income tax or the prohibited transaction rules are violated).

Anyone who is under the age of 70½ and has compensation* is eligible to make a contribution to a Traditional IRA.

*Compensation is defined as the wages, salaries, commissions, bonus, alimony and any other amount that you receive for providing personal services. For individuals who are self-employed, sole proprietors and partners in a a partnership, “earned income” is another term for compensation. Passive income such as interest, dividends and most rental income are not considered compensation for the purpose of funding an IRA.

Traditional IRA Contribution Limits

The contribution limits on traditional IRAs and Roth IRAs is $5,500.

Traditional IRA Catch-up Contributions

If you reach the age of 50 before the end of the calendar year, then you’re entitled to an additional catch-up contribution of $1,000. That brings your total contribution to $6,500 if you’er age 50 or older by the end of the year.

Traditional IRA Eligibility

You can set up and make contributions to a Traditional IRA if you meet BOTH of these requirements:

  • You (or, if you file a joint return, your spouse) received taxable compensation* during the year
  • You were not age 70½ by the end of the year

If both spouses have compensation – If both you and your spouse have compensation and are under age 70½, each of you can set up an IRA. You cannot both participate in the same IRA.

You can have a Traditional IRA whether or not you are covered by any other retirement plan. In 2012, the modified adjusted gross income or AGI contribution limits for traditional IRAs were raised. If you are covered by a retirement plan at work, then your tax-deductible contribution to a traditional IRA is phased-out if:

  • More than $92,000 but less than $112,000 for a married couple filing a joint return or for a qualifying widow(er)
  • More than $58,000 but less than $68,000 for a single individual or head of household
  • Less than $10,000 for a married individual filing a separate return

Traditional IRA Rules

Guidance regarding the rules and restrictions imposed upon IRAs can be found in IRS PUBLICATION 590

If you don’t follow the rules set forth for Traditional IRAs, the tax-deferred status of your account could be questioned. This could lead to disqualification of the IRA and severe tax consequences.

Prohibited transactions and prohibited investments in a Traditional IRA are clearly defined rules by the IRS.

Prohibited Transactions

Generally, a prohibited transaction is any improper use of your Traditional IRA or annuity by you, your beneficiary, or any disqualified person.

Disqualified persons include your fiduciary and members of your family (spouse, ancestor, lineal descendant, and any spouse of a lineal descendant).

The following are examples of prohibited transactions with a Traditional IRA:

  • Borrowing money from it
  • Selling property to it
  • Receiving unreasonable compensation for managing it
  • Using it as security for a loan
  • Buying property for personal use (present or future) with IRA funds

Fiduciary – For IRA purposes, a fiduciary is someone who does any of the following:

  • Exercises any discretionary authority or discretionary control in managing your IRA, or exercises any authority or control in managing or disposing of your IRA’s assets
  • Provides investment advice to your IRA for a fee, or has any authority or responsibility to do so.
  • Has any discretionary authority or discretionary responsibility in administering your IRA

Effect on an IRA – Generally, if you or your beneficiary engages in a prohibited transaction in connection with your Traditional IRA at any time during the year, the account stops being an IRA as of the first day of that year.

Effect on you or your beneficiary – If your account stops being an IRA because you or your beneficiary engaged in a prohibited transaction, the account is treated as though it distributed all of its assets to you at their fair market values on the first day of the year. If the total of those values is more than your basis in the IRA, you’ll have a taxable gain that’s included in your income.

Prohibited Transactions – Investment in Collectibles

If your Traditional IRA invests in collectibles, the amount invested is considered to be distributed to you in the year it was invested. You may also have to pay the 10% additional tax on early distributions.

Collectibles include:

  • Artworks
  • Rugs
  • Antiques
  • Metals
  • Gems
  • Stamps
  • Coins
  • Alcoholic beverages, and Certain other tangible personal property.

Exceptions

Your IRA can invest in the following:

  • Gold coins of one, one-half, one-quarter, or one-tenth ounce minted by the U.S. Treasury Department
  • One-ounce silver coins minted by the U.S. Treasury Department
  • Certain platinum coins
  • Certain gold, silver, palladium, and platinum bullion.

Age 70½ Rule

Contributions cannot be made to your Traditional IRA for the year in which you reach age 70½ or for any year after that.

For IRA purposes, you reach 70½ on the date that’s six calendar months after the 70th anniversary of your birth. For example, if you were born on June 30, 1937, the 70th anniversary of your birth is June 30, 2007—therefore you reached age 70½ on December 30, 2007. If you were born on July 1, 1937, the 70th anniversary of your birth was July 1, 2007—and you turned 70½ on January 1, 2008.

Early Distributions

You can withdraw funds from a Traditional IRA without penalty at any time after you have attained the age of 59½. If you decide to withdraw money from your Traditional IRA account prior to the attainment of age 59½ you will be subject to the imposition of a 10% early distribution penalty tax.

Are there exceptions to the 10% early distribution penalty tax?

Yes, there are several exceptions to the 10% early distribution penalty tax. Among the exceptions recognized under the Internal Revenue Code are the distributions due to the following events:

  • Death
  • Disability
  • Higher education expense of the IRA owner, spouse and/or children
  • Unreimbursed medical expenses that exceed 7.5% of your adjusted gross income
  • Medical insurance premiums
  • Expenses associated with buying or building a first home
  • Part of a series of substantially equal periodic payments made for the life (or life expectancy) of the IRA owner or the joint lives (or joint life expectancy) of the IRA owner and beneficiary
  • Payment of any IRS levy
  • Qualified reservist distribution

For additional information regarding the exceptions to the early distribution rules, please read IRS PUBLICATION 590.

What Is a Roth IRA?

Created in 1997 by Senator Roth of Delaware, the Roth IRA is a tax-free savings plan. Contributions are made with after-tax dollars and are NOT tax deductible. All funds within the Roth IRA compound tax-free and all withdrawals from the account are also tax free (as long as the account owner is 59½ and the account has been opened for five years).

One of the main benefits of a Roth IRA is that there’s no required mandatory distribution (RMD) at age 70½. Individuals can continue to contribute as long as they like, and all withdrawals continue to be tax free (if the account has been open for at least five years).

Anyone who has earned income and falls within the MAGI (Modified Adjusted Gross Income) limits can establish a Roth IRA.

Roth IRA Contribution Limits

The contribution limits on traditional IRAs and Roth IRAs is $5,500.

Roth IRA Catch-up Contributions

If you reach the age of 50 before the end of the calendar year, then you’re entitled to an additional catch-up contribution of $1,000. That brings your total contribution to $6,500 if you’re age 50 or older by the end of the year.

Roth IRA Eligibility

Generally, you can contribute to a Roth IRA if you have taxable compensation* and your modified adjusted gross income (AGI) is:

  • Joint filers with modified adjusted gross income up to $193,000 can make a full contribution. If your adjusted gross income is in excess of $193,000, then you cannot make a contribution to a Roth IRA in 2016.
  • Single filers with modified adjusted gross income up to $131,000 can make a full contribution. If your adjusted gross income is in excess of $131,000, then you cannot make a contribution to a Roth IRA.

You can contribute to your Roth IRA regardless of your age. You can also contribute to a Roth IRA for your spouse.

*Compensation is defined as the wages, salaries, commissions, bonuses, alimony and any other amount that you receive for providing personal services. For individuals who are self-employed, sole proprietors and partners in a partnership, “earned income” is another term for compensation. Passive income such as interest, dividends and most rental income are not considered compensation for the purpose of funding an IRA.

2012-roth-ira-agi-deduction-limits

Roth IRA Rules

Guidance regarding the rules and restrictions imposed upon Roth IRAs can be found in IRS PUBLICATION 590

If you don’t follow the rules for Roth IRAs, the tax-deferred status of the account could be questioned. This could lead to the disqualification of the IRA and severe tax consequences.

Prohibited transactions and prohibited investments in a Roth IRA are clearly defined by the IRS.

Prohibited Transactions

Generally, a prohibited transaction is any improper use of your Roth IRA or annuity by you, your beneficiary, or any disqualified person.

Disqualified persons include your fiduciary and members of your family (spouse, ancestor, lineal descendant, and any spouse of a lineal descendant).

The following are examples of prohibited transactions with a Roth IRA:

  • Borrowing money from it
  • Selling property to it
  • Receiving unreasonable compensation for managing it
  • Using it as security for a loan
  • Buying property for personal use (present or future) with IRA funds

Fiduciary – For IRA purposes, a fiduciary is someone who does any of the following:

Exercises any discretionary authority or discretionary control in managing your IRA, or exercises any authority or control in managing or disposing of its assets
Provides investment advice to your IRA for a fee, or has any authority or responsibility to do so
Has any discretionary authority or discretionary responsibility in administering your IRA.

Effect on an IRA – Generally, if you or your beneficiary engages in a prohibited transaction in connection with your Roth IRA at any time during the year, the account stops being an IRA as of the first day of that year.

Effect on you or your beneficiary – If your account stops being an IRA because you or your beneficiary engaged in a prohibited transaction, the account is treated as though it distributed all of its assets to you at their fair market values on the first day of the year. If the total of those values is more than your basis in the IRA, you’ll have a taxable gain that’s included in your income.

Prohibited Transactions – Investment in Collectibles

If your Roth IRA invests in collectibles, the amount invested is considered to be distributed to you in the year it was invested. You may also have to pay the 10% additional tax on early distributions.

Collectibles include:

  • Artworks
  • Rugs
  • Antiques
  • Metals
  • Gems
  • Stamps
  • Coins
  • Alcoholic beverages
  • Certain other tangible personal property

Exceptions

Your Roth IRA can invest in the following:

  • Gold coins of one, one-half, one-quarter, or one-tenth ounce minted by the U.S. Treasury Department
  • One-ounce silver coins minted by the U.S. Treasury Department
  • Certain platinum coins
  • Certain gold, silver, palladium, and platinum bullion.

Qualified Distributions

You do not include in your gross income qualified distributions or distributions that are a return of your regular contributions from your Roth IRA(s). You also do not include distributions from your Roth IRA that you roll over tax free into another Roth IRA. You may have to include part of other distributions in your income.

Basis of distributed property – The basis of property distributed from a Roth IRA is the property’s fair market value (FMV) on the date of distribution, whether or not the distribution is a qualified distribution.

Withdrawals of contributions by due date – If you withdraw contributions (including any net earnings on the contributions) by the due date of your return for the year in which you made the contribution, the contributions are treated as if you never made them. If you have an extension to file your return, you can withdraw the contributions and earnings by the extended due date. The withdrawal of contributions is tax free, but you must include the earnings on the contributions in income for the year in which you made the contributions.

What Are Qualified Distributions?

A qualified distribution is any payment or distribution from your Roth IRA that meets the following requirements:

It’s made after the five-year period beginning with the first taxable year for which you made a contribution was made to a Roth IRA that was set up for your benefit.
The payment or distribution is:

  • Made on or after the date you reach age 59½
  • Made because you’re disabled
  • Made to a beneficiary or to your estate after your death
  • Made to buy, build or rebuild a first home (up to a maximum amount of $10,000)

Additional Tax on Early Distributions

If you receive a distribution that’s not a qualified distribution, you may have to pay the 10% additional tax on early distributions.

Exceptions

You’ve reached age 59½.

  • You’re disabled.
  • You’re the beneficiary of a deceased IRA owner.
  • You use the distribution to pay certain qualified first-time homebuyer amounts.
  • The distributions are part of a series of substantially equal payments.
  • You have significant unreimbursed medical expenses.
  • You’re paying medical insurance premiums after losing your job.
  • The distributions aren’t more than your qualified higher education expenses.
  • The distribution is due to an IRS levy of the qualified plan.
  • The distribution is a qualified reservist distribution.

Do You Have to Withdraw or Use Assets?

You’re not required to take distributions from your Roth IRA at any age. The minimum distribution rules that apply to traditional IRAs do not apply to Roth IRAs while the owner is alive. However, after the death of a Roth IRA owner, certain minimum distribution rules that apply to traditional IRAs also apply to Roth IRAs (see the next section, Distributions after Owner’s Death).

Distributions after Owner’s Death

If a Roth IRA owner dies, the minimum distribution rules that apply to traditional IRAs also apply to Roth IRAs. It’s as though the Roth IRA owner died before his or her required beginning date.

Distributions to beneficiaries – Generally, the entire interest in the Roth IRA must be distributed by the end of the fifth calendar year after the year of the owner’s death, unless the interest is payable to a designated beneficiary over the life or life expectancy of the designated beneficiary.

If paid as an annuity, the entire interest must be paid over a period not greater than the designated beneficiary’s life expectancy, and distributions must begin before the end of the calendar year following the year of death. Distributions from another Roth IRA cannot be substituted for these distributions unless the other Roth IRA was inherited from the same deceased IRA owner.

If the sole beneficiary is the spouse, he or she can do ONE of the following:

  • Delay distributions until the deceased IRA owner would have reached age 70½
  • Treat the Roth IRA as his or her own

Combining with other Roth IRAs – A beneficiary can combine an inherited Roth IRA with another Roth IRA maintained by the beneficiary only if ONE of these conditions is met:

  • The beneficiary inherited the other Roth IRA from the same deceased IRA owner
  • The beneficiary was the spouse of the deceased IRA owner, was the sole beneficiary of the Roth IRA, and elects to treat it as his or her own IRA

What is a self-directed 401(k)?

A self-directed 401(k) is technically no different than any other 401(k) or IRA. It’s unique because of the available investment options.

Most custodians only allow approved stocks, bonds, mutual funds and CDs. A truly self directed IRA/401(k) custodian, such as Equity Trust, allows those types of investments PLUS real estate, notes, private placements, tax lien certificates and much more.

What are the benefits of a self directed 401(k)?

In addition to the tremendous 401(k) benefits (tax-free profits, tax deductions, asset protection and estate planning), you can invest tax-free in investments that you know and understand, which through the power of compounding interest, can create true wealth for you and your family.

Why haven’t I heard of a self directed 401(k) before?

While the concept of investing in real estate and other assets in retirement plans has been around for more than 30 years, it hasn’t received a great deal of attention. Why? Most custodians that offer 401(k)s (banks and brokerage firms) focus on mutual funds and CDs—because they have vested financial interests in having you select those investments from them.

Because the majority of custodians focus on stocks and CDs, there’s a common misperception that these are your only investment options for retirement plans. But this is not the case.

My CPA/attorney/financial advisor hasn’t heard of a self directed 401(k). What should I do?

It’s not uncommon for trusted advisors to never have heard of self directed 401(k)s, given the relatively unknown nature of these accounts.

At Equity Trust, we’ve worked with thousands of professional advisors across the country to educate them regarding IRA, 401(k), and self directed 401(k) rules so they can best customize their advice to meet your personal needs.

Are self directed 401(k)s allowed under IRS rules?

Yes—as long as you follow relevant rules.

IRS Publications 560 and 590 clearly state the rules and regulations governing IRAs and qualified retirement plans such as 401(k)s.

Are there special rules for self directed 401(k) investments?

Yes. To ensure compliance, you should be familiar with specific rules for 401(k)s, and, in particular, self directed 401(k)s.

There are certain types of transactions that you cannot perform through a 401(k). Most importantly, the IRS prohibits “self-dealing,” investments in which you or family members of lineal descent have prior ownership. For more information, please see IRA RULES.

Are my self directed 401(k) investments guaranteed?

No investment (aside from FDIC-insured deposits) is guaranteed. However, most successful investors feel that the investment risk in assets they know and understand is much less than the risk associated with making only conventional 401(k) investments.

Is a self directed 401(k) for everyone?

Self directed 401(k)s are not for everyone. They’re for those who want to create wealth using their knowledge of investing in assets other than stocks, bonds, and CDs.

SEP (Simplified Employee Pension)

Designed for self-employed individuals and small business owners (typically with up to 25 employees), the SEP allows annual contributions of up to $53,000 without getting involved in a more complex qualified plan such as a 401(k). Contributions to an SEP are tax deductible, and earnings within the account are tax free until withdrawal.

An employer may contribute up to 25% of each employee’s annual compensation with a maximum of $53,000.

Why Should I Open an SEP?

If you want to contribute the highest amounts possible toward your retirement account and qualify for the highest annual tax-deductions, then an SEP might be your best option.

Eligibility

Any employer—whether a corporation, partnership, or self-employed individual—may establish the plan, even if there’s only one employee. Employees must meet ALL of these requirements:

  • Be at least 21 years of age
  • Have worked for the business during any three of the past five years
  • Have earned the $500 annual minimum required compensation

Spouses and children may also participate in the plan and open their own SEP IRAs—as long as they’re employees of the company and meet the income requirements.

SIMPLE (Savings Incentive Match Plan for Employees)

What is a SIMPLE?

The SIMPLE is a plan for small businesses with 100 or fewer employees who have no other qualified plans. It’s popular with investors who pay themselves less than $45,000 per year. With a SIMPLE plan, contributions are tax deductible, and earnings within the account are tax free until withdrawal.

SIMPLE Contribution Limits

A SIMPLE allows employee contributions of up to $12,500 if you’re under age 50, and up to $15,500 if you’re 50.

Employer Matching Contributions

Employers are generally required to match each employee’s salary reduction contributions, on a dollar-for-dollar basis, up to 3% of the employee’s compensation.

Deducting Contributions

You can deduct SIMPLE contributions for the tax year within which the contributions were made.

SIMPLE Eligibility

You can set up a SIMPLE IRA plan if you meet BOTH of these requirements:

  • You meet the employee limit.
  • You do not maintain another qualified plan, unless the other plan is for collective bargaining employees.

Employee Limit

You can set up a SIMPLE IRA plan only if you had 100 or fewer employees who received $5,000 or more in compensation from you for the preceding year. Under this rule, you must take into account all employees who were employed at any time during the calendar year, regardless of whether they’re eligible to participate.

The SIMPLE IRA plan generally must be the only retirement plan to which you make contributions, or to which benefits accrue, for service in any year beginning with the year in which the SIMPLE IRA plan becomes effective.

Setting Up a SIMPLE IRA

SIMPLE IRAs are the individual retirement accounts or annuities into which the contributions are deposited. A SIMPLE IRA must be set up for each eligible employee. The participant and trustee (or custodian) can use the following model trust and custodial account documents to set up the SIMPLE:

  • Forms 5305-S, SIMPLE Individual Retirement Trust Account
  • 5305-SA, SIMPLE Individual Retirement Custodial Account

SIMPLE Rules

The rules and guidelines for SIMPLE IRAs are from IRS Publication 560 and 590. These deal with qualified plans, individual IRAs, and Roth IRAs.

If you don’t follow the rules set forth for SIMPLE IRAs, the tax-deferred status of the account could be questioned. This could lead to disqualification of the IRA and severe tax consequences.

Prohibited transactions and investments in a SIMPLE IRA are clearly defined by the IRS.

Prohibited Transactions

Generally, a prohibited transaction is any improper use of your SIMPLE or IRA or annuity by you, your beneficiary, or any disqualified person.

Disqualified persons include your fiduciary and members of your family (spouse, ancestor, lineal descendant, and any spouse of a lineal descendant).

The following are examples of prohibited transactions with a SIMPLE IRA.

  • Borrowing money from it
  • Selling property to it
  • Receiving unreasonable compensation for managing it
  • Using it as security for a loan
  • Buying property for personal use (present or future) with IRA funds

Fiduciary

For IRA purposes, a fiduciary is someone who does any of the following.

  • Exercises any discretionary authority or discretionary control in managing your IRA, or exercises any authority or control in managing or disposing of your IRA assets
  • Provides investment advice to your IRA for a fee, or has any authority or responsibility to do so
  • Has any discretionary authority or discretionary responsibility in administering your IRA

Prohibited Transactions – Investment in Collectibles

If your SIMPLE IRA invests in collectibles, the amount invested is considered to be distributed to you in the year it was invested. You may also have to pay the 10% additional tax on early distributions.

Collectibles include:

  • Artworks
  • Rugs
  • Antiques
  • Metals
  • Gems
  • Stamps
  • Coins
  • Alcoholic beverages
  • Certain other tangible personal property

Exceptions

Your SIMPLE can invest in the following:

  • Gold coins of one, one-half, one-quarter, or one-tenth ounce minted by the U.S. Treasury Department
  • One-ounce silver coins minted by the Treasury Department
  • Certain platinum coins
  • Certain gold, silver, palladium, and platinum bullion

Distributions (Withdrawals)

Distributions from a SIMPLE IRA are subject to IRA rules and generally are included in income for the year in which they’re received.

2016 Traditional IRA AGI Deduction Limits
(If Covered by a Retirement Plan at Work)

Filing Status Full Deduction Phase Out No Deduction
Single, head of household $61,000 or less $61,000 – $71,000 $71,000 or more
Married filing jointly $98,000 or less $98,000 – $118,000 $118,000 or more
Married filing separately  Not Eligible Less than $10,000 $10,000 or more