Self Directed IRA – Caution

Self directed IRA schemes have a great chance of being involved in prohibited transaction and hence the owner of these retirement benefits face the potential danger of their IRA account being disqualified. This was discussed and decided in the Peek V. Comr. Case. The details of this case are explained below.

A fire safety business was considered a potential investment opportunity by two taxpayers. A broker, who was facilitating the sale, connected these tax payers to a third party agent who managed the process further. This agent explained a technique to the tax payers which involved them to set up a self directed IRA, move funds from their existing IRA schemes to the self directed schemes, set up a company, sell shares of the company and direct the funds into the self directed IRA scheme and finally use these funds to buy a business interest.

The paperwork for this scheme suggested that any prohibited transaction undertaken would prove harmful for the whole objective of this strategy. The paperwork was also accompanied by a letter from the firm’s accountant explaining the prohibited transaction rules clearly, though no personal guaranties were specified.

The scheme went as per plan and the transferred funds were used to purchase the assets of the fire safety business. This transaction included a promissory note from the company to the sellers for one fifth of the total sales price. A couple of years later, the tax payers moved to Roth IRAs from their original IRAs and hence when the company was finally sold, the payments were finally transferred to Roth IRAs.

The taxpayers’ income was fully adjusted to include the capital gains acquired from company stock sales by the IRS and the justification provided by them was that personal guaranties were equivalent to prohibited transactions. The assets from the IRA were deemed to have been distributed to these guaranties. The IRS reasoned that section 4975©(1) (B) disallows tax payers from creating loans or loan guaranties indirectly to their IRAs. The Roth IRAs discontinue its existence if it is funded by company owned stock.

The tax payers had to suffer additional burden of 20% in penalties for not declaring the sales of the company. Their tax advisers could not be trusted upon, because they were the promoter of this sales strategy. The advisers were not given full information either because they were not transparent with the advisors and did not inform them about their decision to personally guarantee their loans.

This is a good example for investors to understand the prohibition rules clearly and what transactions to proceed with and what transactions to avoid. It becomes doubly complicated when dealing with investment in retirement funds as the rules pertaining to the IRA accounts are more comprehensive than the other funds. This case also explains the needs to be fully transparent with the tax advisers as they are the ones who represent a particular tax strategy and no transaction should be carried out without their knowledge.

Strategies for Funding and Managing your 401(k)

The 401(k) fund is undergoing a few changes that are bound to affect almost everyone in its coverage. As such, if you are planning to fund your retirement using the 401(k) accounts, it is about time that you took a keen interest in the changes that are in the offing. Of course,  the largest change is going to be in the amount that you will be required to contribute towards your retirement. The government is in the process of setting up a thrifts savings plan that will increase this value from $500—from $17,000 to $17,500. These changes are expect6ed to be in effect as from the 31st of December this year. This is a good thing fro most people as it means the amount of money that will be available to you upon retirement will increase. To take advantage of these chances it is important that you perform an audit to determine that you paying as much as you can legally. In addition, some significant changes that have been added include changes in the disclosure provisions. From the start of the coming year, the first that 401(k) participants will be eligible to receive quarterly and annual statements listing fees, which are to be charged to the account.

So what are some of the strategies that you can put in place in order to ensure that you maximise the 401(k) strategy? To start with, you should be keen on the amount that you pay in fees. The percentage that you pay in order to manage your account may at the end of the day be more than you can actually handle if care is not taken. If it is possible for you to minimise the amount that you pay in fees, then the better for you. You can minimise these fees by investing in low cost index funds or by managing the fund yourself. It is also important that you keep yourself from trying to tap into your retirement funds at an early age. The temptation is often great especially if you are going through some tough economic times. However, keeping yourself aware of the danger you pose through such an action goes a long way in keeping you level headed.

It is essential that you come up with an investment plan and stick with it. At times,  some investments like the stock market tend to fluctuate with time depending on the market direction. This is usually one of the main reasons for people changing their strategies. However, it is often not advisable to change the execution of your strategy midway, especially if it involves spending more than you are comfortable with. You can also use the roll over strategy in cases where you have a large sum in the works and you would like to invest as well. Often, the cash cheque is tempting enough that most people would rather take it instead of investing it. Taking your time to fine tune the 401 (k) accounts is a good strategy that pays off at the end of the day.