Fulcrum Self-Directed: Better Options for Your Retirment Savings

Tax Credits for a Self-Directed IRA or 401(k)

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If you are an individual (or business) who qualifies to establish a SEP-IRA, SIMPLE IRA or 401(k) qualified plan, such as a multi-participant or Solo 401(k) plans, you can qualify for tax credits for  certain types of self-directed IRAs and a Solo 401(k) plan.

Yes, you read that correctly! The IRS will permit your business to qualify for tax credits for a self-directed  SEP-IRA, SIMPLE IRA or 401(k) plan if you qualify for any of these plans. This benefit, amongst many others, is just another reason for one to consider this type of plan. The Solo 401(k) plan, which many also refer to as a self-directed 401(k) or Uni-K has many benefits that surpass the benefits of an IRA.

We all know the usual benefits of self-direction, and the receipt of tax credits for a self-directed IRA or 401(k) creation can just be added to the list. But, any time the IRS is “giving” us something there are rules to be followed and requirements to be met. And I won’t disappoint you…while the requirements are not burdensome, there are some rules.

So…

How Does a Business Qualify for the Tax Credit?

1)  If you have 100 or fewer employees who received at least $5,000 in compensation;

2)  You had at least one participant who was a non-highly compensated employee; and

3)  In the 3 tax years before the first year you are eligible for the credit, your employees weren’t substantially the same employees who received contributions or accrued benefits in another plan sponsored by you…a member or a controlled group that includes you, or a predecessor of either.

How do I File for the Tax Credit?

As business owner you will file Form 8881 to request the tax credit.

Amount of the Tax Credit

The amount of the tax credit is 50% of the expenses (e.g., start up costs) up to a maximum of $500 per year.

What Expenses and Services?

1)  Set up and administration of the plan, and

2)  Educate your employees about the plan

What Tax Years are Covered?

A credit can be claimed for each of the first three years of the plan. You may also choose to start claiming the credit in the tax year before the tax year in which the plan becomes effective.

Obviously, you can’t deduct the start-up costs and claim the credit for the same expenses…but, you knew that.

For more information feel free to review IRS Publication 560 (Retirement Plans for small Business (SEP, SIMPLE, and Qualified Plans).

As always, the information provided is intended to be educational in nature. It is not intended, nor should it be interpreted as, any form of tax, legal, financial or investment advice. You must consult with your respective professional in all such matters.

Types of Self-Directed Retirement Plans

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When it comes to self-directed retirement plans, any plan can–generally speaking–be self-directed. That is true whether it is a self-directed Traditional IRA, Roth IRA, SEP IRA or SIMPLE IRA. Whether you have a company-sponsored 401(k) plan or an Individual 401(k) plan–also referred to and marketed as a Uni-K, Solo 401(k) or self-directed 401(k)–they can ALL be self-directed.

While any of these plans can be self-directed, the majority of plans that are self-directed are the Traditional and Roth IRA, along with the Solo 401(k).

Self-directed or not, however, you should consider all of the retirement options that are available to you.

Fair Market Value for an IRA

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The primary reporting requirement for an IRA is Form 5498 which identifies the annual FMV (Fair Market Valuation) on the assets held by the IRA. In the case of a regular IRA (non-self-directed), this step is an easy “snapshot” of the account (e.g., stocks, mutual funds) that can be taken quickly and accurately.

In the case of a self-directed IRA LLC, it is the responsibility of the IRA LLC manager (probably you) to report the FMV of  the IRA to the IRA custodian so they, in turn, can report that value to the IRS annually. Historically, with many self-directed custodians, this may be as easy as the IRA LLC account manager simply informing the custodian of the value.

It is important to note that even IF this was the only request that the custodian was making of you, as the Manager of the IRA LLC you must account and operate the plan in full compliance and expectation of the IRS. This would include the annual valuation of the assets of your IRA LLC, regardless of what the custodian asks for.

However, effective in 2015, the FMV process is going to be a bit more detailed as the IRS is imposing stricter FMV reporting requirements on custodians to provide a more meaningful FMV on assets that may be difficult to value.

The IRS has noted:

“New information-reporting requirements are proposed to apply to certain IRA investments with no readily available fair market value. Reportable investments may include:

• Nonpublicly traded stock.

• Partnership or [limited-liability] interests.

• Real estate, options.

• Other hard-to-value investments.”

So with this new ruling coming into play for 2015, all IRA custodians (especially self-directed IRA custodians) will be required to complete the form with hard-to-value assets. One would expect that IRAs could fall under some regulatory scrutiny. Let’s face it, FMV valuations are of utmost importance to the IRS when an individual is executing a Roth conversion or distributions from the plan (e.g., Required Minimum Distributions (RMDs)). It is totally understandable that the IRS wants to ensure they are receiving their tax receipts on these transactions.

How Could This Change SAVE You Money?

Now, as a side note: There may be an unplanned benefit with more detailed accounting of the FMV as it relates to Roth conversions and distributions. Has anyone thought about the possibility of your hard-t0-value IRA asset losing value? For example, if your self-directed IRA purchased real estate for $100,000 and then, unfortunately, lost $30,000 in fair market value, the correct FMV would be $70,000 on the IRA asset, and not $100,000.

While this seems like common sense, it may surprise you that some IRA custodians will NOT value an IRA for LESS than what it had as a beginning balance.  Quite honestly, they may be concerned that without a full and credible FMV being executed, the value is not actually correct.

They could also be…greedy.

You see many self-directed IRA custodians receive fees from account values. If your IRA has legitimately lost value, their fees may be reduced if they reflected a new FMV that is lower. Understanding and correcting that could actually save you money in custodian fees.

So, What is FMV? (and we will keep it easy)

First, let’s keep a couple of concepts in mind:

  • FMV is not some IRS form that tells you what assets are worth (you know that…asset valuation is typically made by appraisers)
  • FMV values can be significantly different between States and areas of states (e.g., New York City vs. Omaha, NE; New York City vs. Syracuse, NY)
  • FMV and Market Value (MV) are not the same and will not necessarily result in the same value on the same property being evaluated

In more simplistic terms, what is MV and what is FMV?

Market Value — In simple terms, Market Value is the value of an asset (e.g., real estate) on a specified date when a sale occurs between a seller and buyer.  Think of this: if an asset was sold today, what would it sell for? What is the market value as of that date?

Fair Market Value — With FMV, there is an assumption that the asset is not being sold. However, for valuation purposes, what would be the value if there was a hypothetical sale. The IRS gives some clarification on FMV:

“In a profit-sharing, money purchase, or stock bonus plan, the assets’ valuation will determine a participant’s account value, and ultimately, a participant’s distribution. In a defined contribution plan, Revenue Ruling 80–155, 1980–1 C.B. 84 provides that since amounts allocated or distributed to a participant must be ascertainable, plans must value their trust investments at least once a year, on a specified date, and according to a method consistently followed and uniformly applied”

Treasury Regulations state (the following text specifically addresses estate valuation issues, but the same principal applies to the definition of a FMV):

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 to sell and both having reasonable knowledge of relevant facts. The fair market value of a particular item of property…..is not to be determined by a forced sale price.  Nor is the fair market value of an item of property to be determined by the sale price of the item in a market other than that in which such item is most commonly sold to the public, taking into account the location of the item wherever appropriate.

It continues by noting:

Thus, in the case of an item of property…..which is generally obtained by the public in the retail market, the fair market value of such an item of property is the price at which the item or a comparable item would be sold at retail.

Finally:

For example, in the case of shares of stock or bonds, such unit of property is generally a share of stock or a bond….Property shall not be returned at the value at which it is assessed for local tax purposes unless that value represents the fair market value as of the applicable valuation date. All relevant facts and elements of value as of the applicable valuation date shall be considered in every case.

The bottom line is that with the IRA LLC valuation, a credible value will need to be identified. The question that many people will practically ask is: If an IRA LLC has real estate within the plan, will due diligence dictate that an appraisal be executed on the property OR will a comparative analysis (comp) be acceptable? A more logical answer to that question may undoubtedly hinge on whether any distribution or Roth conversion is being executed for the plan.  Let’s break that down a bit further:

Example: Jo is 40 years of age and is the manager of her IRA LLC. She has a $300,000 (value) IRA LLC in which she has two assets: a $200,000 piece of property and $100,000 (cash). Based on her age, Jo will not be taking any distributions from the plan and she is not executing a Roth conversion to her IRA. Since there are no concerns with either distributions or conversions, would the IRS find it acceptable that Jo secure a comparative analysis (comp) on the property from a licensed and competent realtor or would they require an appraisal. The hopeful thinking by many IRA LLC managers is that, in this example, a comp would suffice in establishing the FMV. Obviously, the property is not being sold (meets FMV standards) and no distributions/conversions are occurring.

Feel free to visit with your IRA custodian and inquire if they have been provided final instructions from the IRS on the proper completion and filing of Form 5498.

The “Life” of a 401(k) Plan

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Almost like a person, your 401(k) plan has its own “life” that can best be described as the plan’s establishment, operation and termination. For most individuals who are the Trustee of this type of plan, the plan begins and ends. Between these two dates is the operation of the plan. As you probably know, the establishment, operation and termination of the plan must adhere to various IRS and DOL regulations.

In comparison to a multi-participant 401(k) plan, the individual self-administered 401(k) plan has significantly fewer compliance reporting requirements. These requirements make an individual 401(k) plan ideal for the self-employed individual in that the plan is much easier to administer and operate than the multi-participant plan.

Establishment – The individual, self-directed 401(k) plan, like any 401(k) plan, must be established in compliance with IRS and DOL requirements. The primary tool involved in establishing the plan are the plan’s operating documents (e.g., Adoption Agreement, Basic Plan Document) accompanied with an IRS satisfactory opinion letter confirming that the plan documents meet the IRS’ requirements for a 401(k) plan. These documents must be written to be in operational compliance for the plan and the IRS must approve the plan’s documents.

Further, even with the proper documents in place, the plan and its assets must be appropriately cared for by establishing account(s) to hold and invest the plan’s assets and invest these assets in compliance with tax law. While the account for the 401(k) can be at any financial institution that will accept the plan’s funds, it is the responsibility of the plan’s Trustee to ensure that the assets are properly protected and invested.

Operation – The operation of the plan is of vital importance. While it is exciting to control the investments of the plan, the 401(k) Trustee assumes the responsibility of operating the plan in full compliance with IRS and DOL regulations.

Aspects of the plan that need to be addressed include: 401(k) plan documents, amendment, updating and re-statement of plan documents, plan investments, plan transfers and rollovers, employee and employer contributions, adherence to IRS and DOL Prohibited Transactions, plan tax reporting and plan termination.

Termination – For most individuals, the plan will be terminated at some future date. Like any “living” entity, the plan will be terminated once the business discontinues its business activities. It is important that the Trustee understands this and properly terminates the plan when needed.

Time Required to Fund Your Self-Directed IRA

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Realistically, how long does it take to fund your plan? You are creating a plan and you should have a very realistic and conservative idea on the time required to fund your self-directed IRA.

I always advise folks to expect a 2 – 3 week time frame for this process. The reason for the delay is not the self-directed company. Typically, their work in establishing IRA LLC plan documents can be done within a couple of days up to a week.

As a quick refresher, the IRA LLC structure will permit you (or your designee) to be the manager of the LLC of which the IRA (and the IRA only) is the sole member of the LLC. As manager, you will have checkbook control of your funds and can invest on behalf of the LLC and the sole-member IRA. As always, you must follow all IRS regulations.

Another Self-Directed Company Says This Can be Done in Days!

First, let’s establish some ground rules. Can an IRA that is not going to have funds transferred or rolled over into the plan be established within a week…possibly. However, let’s assume that funds will be transferred or rolled over into the newly-established IRA.

There is a difference between the time needed to prepare the IRA LLC documents and the actual funding of the IRA LLC. What is humorous are companies that say, suggest or even hint that this can happen within a matter of days. I guess if the sun and moon are in perfect alignment, sure, anything can potentially happen…but, even then, it won’t be a matter of days. Why?

If a self-directed company is being totally honest and frank with you, they will tell you that the following reasons (and there can be more) dictate the expediency of establishing and funding your IRA LLC account. With mailing (or even over night options) requirements, do you think all of the following can be done in a “matter of days” (between two custodians)?

1)  Mailing/Over Night Processing — Applications, forms, transfer requests for funds, receipt of transferred funds

2)  IRA Custodian Opening Account — They don’t just instantly open an account even when they receive your application

3)  “Transferring” IRA Custodian Processing Transfer Funds Back to Self-Directed IRA Custodian — This is not immediate

4)  “Holding” Times — After receipt of transferred funds, most custodians will have a minimum 3-day hold on releasing funds to your IRA LLC

Whew!  As you can see, any suggestion that this process can be fully executed within a matter of days is folly. It just ain’t going to happen…even if you pay for wires and over night mailings. And, this doesn’t take into consideration if you make an error.

I even saw a company that said that they will assist you in the “transfer” of funds. Now, what they may have meant is that they will assist you in completing a “transfer” form for your signature. But, please note, a self-directed company cannot and will not be involved in requesting the transfer of funds. Why? Because they are NOT the custodian and ONLY the IRA custodian can request funds in transfer. Even a suggestion that the self-directed company can, magically, assist you in making sure the transfer of funds is executed expeditiously is…incorrect.

Be excited about establishing your self-directed IRA! You are entering into an exciting venture, and one that can be of great benefit to you. Just expect a bit more time than just a “matter of days” for your self-directed IRA and its IRA LLC to be established and funded.