Roth 401K Investments - 1

Background: The Roth IRA
No deductions going in, but all profits are tax free going out. Contributions made to a Roth are not deductible, but distributions are tax-free upon retirement. This is especially appealing to investors who expect to earn above average rates on investments within their IRA, as this means that the earnings on these investments are tax-free.

The downside to the Roth IRA is that not all Americans are qualified to have one. If you currently make more than $110,000 as a single tax payer or $160,000 filing jointly, you do not qualify to open this type of account. Not so with the Roth 401(k)! Anyone can contribute, regardless of income.

In addition to qualifying restrictions, the contributions limits of the Roth IRA are low compared to the 401(k)--only $4,000 in 2006, with a $1,000 additional catch-up contribution for those age 50 or older. There are no age restrictions with the Roth IRA. The account owner 1.) may continue to make contributions to and 2.) need not take distributions from the account when they reach age 70�.

When the account owner is ready to take distributions, they may do so, tax-free, as long as the account has been open for five years, and they are age 59� or older.

Now every American can enjoy Roth benefits
The new Roth 401(k) allows greater "Roth" type contributions for everyone, with no income limits. Beginning in 2006, 401(k) and Solo(k) plans will be capable of allowing employees to make their contributions as Roth contributions. These Roth contributions are tax-free upon distribution, and any investment earnings in the account compound tax-free as well.

Also, unlike the Roth IRA, Roth 401(k) contributions are allowable regardless of income level, permitting many taxpayers, who would not otherwise be eligible, to participate in a Roth account.

Contribute up to $43,000 to your 401(k) or Solo(k), with up to $20,000 as Roth contributions! Like the regular 401(k) or Solo(k), the maximum employee contribution to a Roth 401(k) is $15,000 for 2006, plus another $5,000 in catch-up contributions if the participant reaches age 50 or older in that year.

Please consider that when an employer (or, in the case of the Solo(k), the business owner) makes a matching contribution to the employee's plan, those funds cannot be contributed to the Roth portion of the account. Only the employee's after-tax contributions and the related earnings on those contributions are permitted in the Roth 401(k).

Any employer matching must be contributed to the participant's standard 401(k) account. Employer matches will still be made with pre-tax dollars, and the match will accumulate in a separate account that will be taxed as ordinary income at withdrawal. And, like the regular 401(k) or Solo(k), the total maximum contribution from both sources is $43,000 in 2006.

Example: John is a self-employed real estate investor and has a Solo(k) plan that he contributes to each year. This year, he set up his plan to allow Roth contributions in addition to his regular Solo(k) contributions beginning in January of 2006. John's compensation as an "employee" of his company will be $100,000 is 2006.

When making his deferral elections, John wants to make the most of his opportunity to make Roth contributions and decides to defer 1% of his pay ($1,000) as standard Solo(k) contributions with an additional 14% ($14,000) as a designated Roth contribution. He may do this because his combined contributions do not exceed the IRS limit of $15,000 for the 2006 tax year.

Then, putting on his "business owner" hat, John decides to match 100% of his combined contributions, or $15,000. He may do this because the total match is less than 20% of his earnings, which is the maximum amount that may be matched under a Solo(k) plan. According to IRS regulations, all matched funds must be made to John's regular tax-deferred account.

The total amount contributed to John's Solo(k) in 2006 is:
• $ 1,000 "employee" regular tax-deferred contribution to his Solo(k)
• $14,000 "employee" tax-free Roth contributions to his Solo(k)
• $15,000 "employer" match, placed in regular tax-deferred Solo(k) account
$30,000 in total contributions
The rules are similar, but different
The proposed rules released by the IRS, thus far, for the Roth 401(k) are similar to those for the Roth IRA, but there are some important differences. In a Roth 401(k), income taxes are paid at the time of contribution.

Earnings and withdrawals are not taxed if withdrawals begin after age 59�, and if five years have elapsed from the date of the first contribution to the plan. Taxes and penalties are waived if a participant dies or is disabled.

Rollover to a Roth IRA to avoid taking distributions at 70�! As in a 401(k), Roth 401(k) participants must take minimum distributions (tax-free, of course) beginning the year after they turn 70�. However, the Roth 401(k) can be rolled into a Roth IRA, relieving the participant from taking these minimum distributions.

The opportunity might not last . . .
Roth 401(k) plans are scheduled to expire at the end of 2010. It is possible that after 2010, Roth contributions could remain in the plan, but no new Roth contributions could be made after that time. Congress may, of course, extend these provisions before this occurs. Should the Roth 401(k) become popular, this seems a likely prospect.
ROTH 401(k) highlights
Higher contribution limits. Roth 401(k) participants may make the maximum contribution allowable under 401(k) rules. The 2006 401(k) or Solo(k) contribution limits allow employees under age 50 to sock away up to $15,000 or $20,000 for employees age 50 or older.

For those who want to save after-tax money, this is a much quicker route than saving in the Roth IRA, which has contribution limits of $4,000 for those under age 50 and $5,000 for those age 50 and above in 2006. As an added benefit, Roth 401(k) participants may still have and contribute the maximum allowable amount to a Roth IRA in addition to their Roth 401(k) contributions.

Tax benefits: Roth contributions may be withdrawn tax-free and penalty-free as long as the participant is at least 59� years of age and has held the account for at least five years.

Easier participant qualification: Everyone qualifies! The Roth 401(k) is open to anyone who has a regular 401(k) or Solo(k). This is a boon to higher-paid employees who may be excluded from having a Roth IRA account because of its income limitations.

Solo or Individual 401(k) participants can modify their plans to include Roth contributions. Previously established 401(k) or Solo(k) plans can easily be modified to allow for Roth contributions.

Contributions are irrevocable. Once the money goes into the account, it falls under all of the IRS rules and penalties for 401(k) or Solo(k) accounts. Participants may not later change their minds and move the funds into their regular tax-deferred account.

Distribution requirements. The Roth 401(k) has the same distribution requirements as the 401(k) or Solo(k). Participants must begin taking minimum distributions by age 70�. This contrasts with the Roth IRA, which has no distribution requirements. Account holders can get around this distribution requirement by rolling over their account into a Roth IRA.

Rollover options. Participants can roll over Roth 401(k) contributions to a Roth IRA upon retirement or termination of employment.
How to get started
Once the IRS has issued final rules and regulations concerning the Roth 401(k), employers wishing to offer this option to their employees must have their existing 401(k) or Solo(k) plans amended to be able to accept Roth contributions. Current clients of Equity Trust Company will continue to receive updates on the status of the Roth 401(k) as additional information is made available.

Continuing along the same lines during my research I found a great article about IRA's.

This article is by Alan B.

Here’s a take on retirement planning from a youngster with a full head of hair and his whole life ahead of him:

When I first began investing in real estate, I was 22 years old and I wanted to make money for two reasons: 1) To finish paying for college, and 2) To generate enough cash and equity to be able to live off my passive investments as soon as humanly possible. This meant that I needed access to every dollar I earned (as well as dollars I borrowed) in order to buy more houses, create more wealth, and get to the point where I could retire early.

Like many of you, I heard how amazing self-directed Roth IRAs are for real estate investors who use them to invest in real estate and grow their nest egg by leaps and bounds, tax-deferred. But every time I came close to actually getting started, this little voice would pop up in the back of my mind:

“I need my money NOW, not when I’m 60!”

I rationed that if I were going to wait until I was 60 to retire and take money out, then a tax-deferred retirement account made sense. But since I planned on retiring and living off my investments at the age of 25 or 30, I figured, “What’s the point?”

Here’s four points I should have considered:

Point #1: Why not? The opportunity to have at least a portion of your hard-earned money safe from the clutches of the government is too good to pass on. When no taxes are paid on interest earned, even small amounts of savings can add up over time. If you want to use as much of your income as you can to live on, or to do deals, consider investing at least a small percentage of your income or profits in an IRA.

What if you put a mere 1% of your income into an IRA account? If you earn $60,000 per year and invest only 1% of it, that is only $50 per month—not something that is going to have a major immediate impact on your ability to buy more properties. But it will add up in 30 years if you can earn at least 10% per year, which for creative real estate investors is low.

After all, aren’t we in a business where you can wholesale a deal and make $5,000 in 15 days with $0.00 of your own to begin with? If you can make an infinite return, then trust me, you can earn an ROI of at least 10% per year. So why not sock away some savings or at least do one deal in your IRA? I think the chance alone to legally thumb your nose at the IRS is priceless.

Point #2: Diversify a little. Having success with high-return real estate investments does not mean the principle of diversifying is not applicable to you. Even the world’s wealthiest people diversify their investments. They don’t just keep reinvesting 100% of their money in one thing, because what if it stopped working and you lost it all?

You could separate your IRA funds from your other savings and investments and use them exclusively for some other kind of investment, like high-interest loans, buying liens and judgments, or even (gag me) mutual funds.

Point #3: You can still borrow it back. My rationale for not putting money in an IRA in order to have it available to use for deals does not add up when you consider that you can use IRA money to do deals. Of course, there are rules about how it’s supposed to be done appropriately so as not to be considered self-dealing, so follow those, of course. I’ll leave that subject to the IRA experts.

Your money will still available for you to use for deals with the added benefit of growing your profits tax-free until you take them out. The only downside is that it won’t be available to use for anything else, like paying your bills. For this reason, I recommend having adequate savings to cover you in the event of a temporary cash crunch.

Point #4: Forced plans force success. The only time I’ve ever consistently and effectively saved money or paid down debts over time has been when it’s an automatic plan of some kind.

When I decided to pay off my car loan, I just couldn’t bring myself to part with a check for $6,000 all at once. For two years, I kept saying I would do it in one lump sum, but never got around to it and kept waiting for a better time which never came. So I set up automatic payments with my bank, who sent a check for 1/12th of the balance each month until it was paid off in a year without me even thinking about it.

My concern is that many people, like the old Me, keep putting off using an IRA until “someday” when they will begin using it to invest in all of their deals. I prefer doing it in an automatic, consistent method that does not rely on you remembering to put aside money, and is done a little at a time.

And I believe it’s wise to keep your investment money separate from your other funds. Do you remember Mark Haroldsen’s story in Financial Genius about the shame of “dipping into your capital?” What better way to keep that from happening than to store it apart from the rest where you won’t be tempted to squander it?

In Conclusion

For these reasons, I think it’s smart to use a Roth IRA to invest in real estate (or anything else that you can), even at, nay, especially at a young age. The younger you are, the more you have to gain by having all of your investment returns working for you rather than for the government.

The years are going to go by whether or not your investments are growing tax-free, so why not do it? If you haven’t taken advantage of this incredible financial strategy, I recommend doing it now because “someday” rarely comes.

Not to dampen anyone's spirits, but I have seen a program developed by one of Obama's high level advisors, another "redistribute the wealth" advocates.

The program is to nationalize 401k's and IRAs, giving instead a low fixed return AND confiscating 50% of the assets upon death of the "owner." Currently, of course, 100% of the assets are the owner's property.

How many successful REIs do you suppose favor the notion of redistributing the wealth (any more than the tax code already does it)?

You might want to be on the lookout for signs of implementation. You think an Obama Congress could never do that? Congress has proved that it can do whatever it can get away with, constitutional or not.

cactusbob

Coach rhuges, I just read through all your posts and savored every piece (My husband and I have been Roth IRA savers (and lovers of) ever since the program started). I like the perspective of both the writers' views and your own. I wanted to say that first. And then, cactusbob, I read with shock your post. Yikes! I guess a person shouldn't change their whole investing plan on a "what if", but it sure gives one something to think about (and plan ahead to object to).

Thank you, coach rhuges, for giving this subject some exposure. I was wondering, too, if you had any insight on universal life insurance as a source of investing $? Last year I looked into a program that used this venue as a leverage tool for RE investing. Any thoughts?

Thank you,

Rina