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Trading Futures In Your IRA

Futures trading is essentially buying and selling commodities (grains, cattle, OJ, etc) but in addition includes buying and selling contracts 0f foreign currency, precious metals, bonds, energy (oil/gas) and other items whose price fluctuates from day to day.  Futures traders make money by betting that prices will go up or down and trading the right to buy or sell at a given price and a set time frame.  You can trade futures in your self directed IRA.  However, while futures trading is not expressly prohibited in retirement accounts, there are a number of things to consider before executing trades.

Even though the IRS does not prohibit trading in an IRA, what you can and cannot do in your IRA will be determined by the custodian you use.  Many custodians or plan sponsors do not allow futures trading in your IRA and some just restrict trading certain commodities.  Most 401k and plan sponsors offer a limited selection of investment options.  In the same manner, many companies who offer IRA accounts place restrictions on types of investments to reduce their liability.  If you want to trade futures in your IRA or 401k, the key term is “self-directed.”  Self-directed accounts allow you to take complete control of your investment choices and typically allow futures and futures options trading.  You can also setup a proper solo 401k to be able to invest in many of these alternative investments.

In most cases, day traders make a large number of trades per week in order to generate a profit.  In order to trade a futures contract which are highly leverages, your broker will require that you keep a certain value of assets available in your account to cover all open trades, also known as margin.  Margin is not expressly prohibited by the IRS for IRAs, but have come under scrutiny in the last several years because some say they essentially use IRA assets as collateral for a loan which is an activity that is prohibited under IRA rules.  Traders should be extremely careful to get good advise from a competent attorney and follow all account rules to avoid losing the tax-protected status of their IRA accounts and incurring IRS penalties.

IRAs, 401ks and other qualified retirement plans are tax-protected, meaning that earnings in the account are not taxed immediately as they would be in a regular investment account.  Trading futures in an IRA or 401k allows you to defer your tax obligation and pay it over a longer period of time in retirement. If the account is a Roth IRA, you may not pay tax at all.  This is a great benefit to those who do well with futures trading.  However, futures trading can have a downside as well and if you have losses you cannot write off losses in retirement accounts like you could on your taxes.  This means that if you have a bad year you cannot deduct those losses from your taxable income and reduce the amount of tax you owe.  The National Futures Association warns that futures trading is very risky and as a trader myself I understand the pitfalls.  Therefore, if you chose to trade futures, choose a reputable broker and learn as much as you can about the processes and risks associated with speculative trading before you place your first order.  Also, get some training from a reputable trading education company.  Never trade with money you can’t afford to lose, and beware of any investment advisor or guru offering unrealistic profits or easy money.  Trading should not be looked at as a get rich quick scheme but should be looked at as long term wealth creation.



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Contributions and Deductions

The Internal Revenue Code for the 401k plans (IRC Section 401k) is different than that for IRAs (which uses IRC 408).  The  IRS establishes maximum amounts that people can invest into 401k plans each year and the money inside a 401k plan benefits from the same kind of tax deferral that the IRS affords to funds invested in individual retirement accounts. IRS guidelines provide restrictions based on both dollar amounts and in some cases on  percentage of income.

Looking at history, the United States Revenue Act of 1978 included an amendment to Section 401k of the IRS tax code. The measure allowed employers to pay a portion of each employees pay into a tax-deferred compensation plan. In the beginning these plans were not synonymous with retirement accounts, but by 1980  a few companies drew up proposals to establish 401k retirement plans.  Many companies since then have reduced or discontinued defined benefit retirement plans because 401k plans are less expensive to operate.  As of 2011, the IRS allows taxpayers to contribute $16,500 into 401k plans and $22,000 for employees who are over the age of 50. Contributions to SIMPLE plans for business employers with less than 100 employees and no other plan in place,  have maximums of $11,500 and individuals over the age of 50 can invest $14,000. The IRS uses cost-of living calculations to change annual contribution limits.

Employers can match employee contributions without reducing the employee’s eligibility for salary deferral.  Most companies cap matching contributions at 50 percent of the amount invested by the employee. Other companies impose an overall maximum contribution equal to say 6 percent of the employees annual salary. The IRS allows employers to match contributions of only up to 3 percent in SIMPLE plans.  The IRS allows people to make annual contributions of up to $5,000 to Roth individual retirement accounts or $6,000 for people over the age of 50.  Roth IRA contributions do not impact 401k contributions or vice versa.  The IRS allows some people who participate in 401k plans to also make contributions to traditional IRA plans. As of 2011, single people earning less than $56,000 or married couples earning less than $90,000 can get a full deduction in a traditional IRA and still are able to deduct the $16,500 for their 401k accounts.  For higher earner their are phase out amounts and it is best to consult your CPA to determine their eligibility to participate in both plans.

The IRS uses contribution amounts when assessing tax deductions rather than account values. If you invest $16,500 and your investment falls in value to $8,000 during the same year, you cannot make additional contributions to bring your 401k back to the maximum. If you invest too much in a 401k plan, you must withdraw excess funds before April 15 following the calender year in which you invested. Over-the-limit contributions left in 401k accounts are subject to double taxation whic is never a good thing.


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Investing In A Business With Your IRA

Many people do not know that they can invest in a business or even their own business (caution: you must follow the IRS rules for self dealing) using a self directed IRA. If you think a business has alot of potential to be a long-term success, why not make an investment in it using your retirement plan? It can be done, but you have to follow the IRS rules and be careful for self dealing if you are investing in a business you have ownership interest in (discussed below). If you are investing in a business that is an unrelated party then there should be no issues.

This isn’t the same as borrowing from your 401k. I believe it is not wise for a entrepreneur to borrow against your retirement assets since you do not get a return. On the other hand, using a self directed IRA allows you to build your retirement by getting a return on your investment. If you invest in a business that gives you interest income and some equity in the company, this is the best of both worlds. In my opinion, self-directed IRAs are an under appreciated tool for allowing entrepreneurs and their friends to invest retirement funds into a business.

As always, take care to do it right and to not cross the IRS. But investing funds from your self-directed IRA into your business or another business is a viable and potentially wise alternative you should consider. In fact, your siblings, friends and business associates can also invest in your business from their retirement funds and ensure their capital gains get favorable tax treatment. This could make an otherwise break-even investment proposition seem more attractive. In addition, it could make your investors more patient by extending their investment horizon to their retirement years, which is a huge benefit from your perspective. By suggesting self-directed IRAs to potential investors that you’re in discussions with, you can increase the chances that they close and that they become your long-term financial partners.

Here’s how it works. Move your IRA funds into a self-directed IRA. Then, direct your IRA to make an equity investment into the business of your choice. Many people have put small amounts of money in their IRA and grew they retirement dramatically when the company went public and all the returns go back into your tax free IRA. If your investing in your own business be careful and be aware of the self dealing rules. The trick is that the IRS is serious about IRAs being used to build funds for retirement and is on the lookout for schemes to use IRAs to enrich your life now.

So lets look at these important rules:

1. Don’t investment in S corporations. This is simply because of the tax definitions of this legal structure.
2. Respect the list of “prohibited transactions.” While friends, business associates and siblings may invest in your business via a self-directed IRA, your parents, children or a spouse may not.
3. You can’t be the key employee and key investor in the business. You can’t own more than 50 percent of the business in which you invest, and you can’t have a controlling interest in the company. Basically, someone else has to have the right to hire or fire you. The IRS wants to make sure you aren’t self-dealing or moving retirement funds in a way that might benefit you in the present through a salary or other immediate payments.

In addition to a startup type business, you can also buy a new business with your IRA. The business is then subject to a tax called the unrelated business income tax (UBIT), since IRAs are otherwise tax-free. But your equity position still appreciates in your IRA tax-free. AGAIN BE CAREFUL AND GET GOOD LEGAL ADVISE since there are fairly detailed tax and securities law involved with this and IRS rules for self dealing, so consult with trusted experts in the field.

I personally think it is cleaner if you don’t use your own IRA funds for buying a business but instead raised money from a handful of investors who will purchased stock or equity positions using their self-directed IRAs. Most of these investors have a long-term investment view and are cooperative and patient.

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How A Company Bankruptcy Affects Your 401K

In today’s uncertain times, people are asking questions concerning the security of their retirement savings plan like a 401k at their workplace.   But there’s good news. Your 401(k) account cannot be taken to pay for company debts.  The questions come from a lack of understanding of how 401k are structured and how they work.  It is really not that complicated and hopefully after reading this article, you will understand how these qualified plans work.

The first thing you have to understand is that YOU own the 401k (at least the funds that are vested).  The funds that are not vested just means that some portion of the account may have some strings attached.  Investopedia defines vested as ” the lawful right of an individual or entity to gain access to tangible or intangible property now or in the future. A vested interest is an entitled benefit, which can be conveyed to a separate party. There is usually a vesting period before the claimant can gain access to the asset or property.  Due to the right of ownership, the benefit cannot be taken away.  Typically any money that you contribute yourself is fully vested from the moment you put it into the plan. Employer matching contributions, however, may have some vesting requirements.  A common one is that an additional percentage of the company contribution is vested for every year that you work for the employer. The company’s portion is not fully vested until the conditions are met.  So any money that you’ve contributed is fully yours. And any portion of the company’s contributed that is vested also belongs to you. You own it.

The other thing that needs to be understood is what the “plan administrator”.   The administrator oversees the plan for you. The administrator will collect contributions from you and your employer, invest and distribute them per your instructions and the law, and keep track of the funds and provide reports to you and when appropriate to the IRS.  Chances are that you’ll never meet the administrator in person. You’re much more likely to talk by phone or to use forms available in your human resources department to send instructions to them.  Remember, they do not own your account.  They just service it for you.  For that service they charge a fee.

The other thing which needs to be discussed is the investments within the account.  The administrator will have a number of investment choices available for you.  Typically, they have stocks, mutual funds and some safer options like bonds, U.S. Treasury bills or maybe CDs.  Many plans include the employer’s common stock if it’s publicly traded.  Naturally, the company is happy to have employees invest in it.  But that can be dangerous.  If the company struggles, not only could you lose your job, any shares in company stock could lose most of their value.  If the company goes downhill so will the value of the company stock and therefore your 401k value.  This is the biggest danger to your account.  Just remember, your 401k account cannot be used to pay company debts.  In order to protect yourself, it is wise to limit the amount of company stock you have in your retirement account.  If you get shares of the company as the company’s contribution, then find out from the plan administrator when you’re allowed to sell those shares.  Then sell them and reinvest the money in something else.  There is one other risk if your employer goes out of business.  A bankrupt company could leave an “orphaned” plan.  That’s when the company and the administrator have abandoned the plan.  That would severely restrict your ability to get at your money or change investment options.

You can go to the Department Of Labor  and has a FAQ page on abandon plans (go to http://www.dol.gov/ebsa/faqs/faq-abplanreg.html).  In short a custodian will be appointed and the funds distributed to you, so you can reinvest it. If your employer has declared bankruptcy, take immediate action. Contact the plan administrator. During the winding-down period that accompanies bankruptcies, the administrator may still be able to respond to your instructions. Once you get your money reinvest it.  I suggest setting up a self directed IRA or a solo 401k.   DO NOT spend the money since the tax penalty is high.

In summary, if your company does declare bankruptcy, your savings could be in jeopardy because of falling company stock value (if you own company stock) or your inability to get out of your investments and control your account.  The company’s creditors will not be able to get at your 401k savings, so that is not an issue.