IRS Announces 2018 Retirement and Health Savings Account Contribution Amounts

The IRS announced new contribution amounts for retirement accounts in 2018 and there are some winners and losers in the bunch. The biggest win goes to 401(k) owners, including solo K owners, who saw employee contribution amounts go from $18,000 to $18,500. Health savings account owners got a small victory with individual contribution maximums increasing $50 to $3,450 and family contribution amounts increasing $150 to $6,900. IRA owners don’t get a win with no increase in the maximum contribution amount for Traditional or Roth IRAs. The IRA maximum contribution amount is still $5,500 and hasn’t increased since 2013.

Here’s a quick breakdown on the changes.

– 401(k) contributions also increased on the employee and employer side. Employee contribution limitations increased from $18,000 to $18,500 for 2018. The additional catch-up contribution for those 50 and older stays the same at $6,000. The annual maximum 401(k) (defined contribution) total contribution amount increased from $54,000 to $55,000 ($61,000 for those 50 and older).

– HSAs contribution limits increased ($50 indiv/$150 fam) from $3,400 individual and $6,750 family to $3,450 individual and $6,900 family.

– IRA contribution limitations (roth and traditional) stayed at $5,500 as did the $1,000 catch-up amount for those 50 and older.

There were additional modest increases to defined benefit plans and to certain income phase-out rules. Please refer to the IRS announcement for more details here.

These accounts provide tax advantageous ways for an individual to either save for retirement or to pay for their medical expenses. If you’re looking for tax deductions, you should determine which of these accounts is best for you. Keep in mind there are qualification and phase out rules that apply so make sure you’re getting competent advice about which accounts should be set up in your specific situation.

The IRS Does Not Approve IRA Investments – “IRA Approved” or “IRS Approved” Terms Are False

Photo of the exterior of the IRS building in Washington, DC.There has been a significant increase in the amount of marketing directed towards IRA owners for non-publicly traded investments. Many of these investment sponsors and promoters are using marketing slogans like “IRS Approved” or “IRA Approved”. Don’t be fooled though, as the IRS does not review or approve investments, nor do they comment or issue statements on investments in an IRA. In fact, the IRS recently revised and updated IRS Publication 3125 titled, “The IRS Does Not Approve IRA Investments,” in an effort to inform IRA investors.

 

IRAs Can Invest into Non-Publicly Traded Investments (Real Estate, LLCs and Precious Metals)

Yes, it’s true that a self-directed IRA can invest into real estate, LLCs, LPs, private stock, venture or hedge funds, start-ups and qualifying precious metals, among other things. However, just because you can invest in all of these assets doesn’t mean that you should. Make sure you’re investing your IRA into assets you are familiar with, and with persons and companies with whom you have thoroughly vetted. Non-publicly traded investments can be easier to understand and vet than a mutual fund prospectus, but you need to be careful when investing your funds with another person or when buying investments from third-parties who regularly sell to IRA owners using comforting, yet totally false, representations like “IRA Approved” or “IRS Approved.”

“IRA Approved” or “IRS Approved” Representations are False

In Publication 3125, “The IRS Does Not Approve IRA Investments,” the IRS provided some guidelines for IRA owners to evaluate and protect their account from “IRA Approved Schemes.”

  1. Avoid any investment touted as “IRA Approved” or otherwise endorsed by the IRS.
  2. Don’t buy an investment on the basis of a television “infomercial” or radio advertisement.
  3. Beware of promises or no-risk, sky-high returns on exotic investments from your retirement account.
  4. Never transfer or rollover your IRA or other retirement funds directly to an investment promoter.
  5. Proceed with caution when you are encouraged to invest in a “general partnership” or “limited liability company”.
  6. Don’t be swayed by the fact that a bank or trust department is serving as an IRA custodian.
  7. Always check out an investment and promoter before you turn over your money.
  8. Educate yourself about IRAs and retirement planning.
  9. Exercise extra caution during tax season when it comes to making IRA investments.

As a self-directed IRA investor, you are solely responsible for investment decisions, and as a result you must make certain that you understand the investments you are selecting and the associated risks. Beware of slogans and terms like “IRA Approved” or “IRS Approved,” as such slogans are just false. In addition to the consideration from the IRS above, I’ve previously written my own “Self Directed IRA Investment Due Diligence Top Ten List” which includes additional tips and questions to ask when investing your hard-earned retirement plan dollars with others.

Take the IRS guidelines and my Top Ten List into consideration when investing your IRA, but in the end, don’t be scared about investing into non-publicly traded investments. Rather, keep the risk and opportunities in perspective, and realize that you may need to get out of your comfort zone by asking pointed questions, demanding additional documentation, or simply saying “no.” Remember: You are the best person to protect your retirement.

Self-Directed Beneficiary IRAs: RMD and Investing Tips

Photo of a man hugging his mother in the kitchen with the text "Self-Directed Beneficiary IRAs: RMD and Investing Tips."If you’ve inherited an IRA from a parent or other loved one, it is likely that you have a beneficiary IRA. These can be powerful accounts, but you need to understand the required minimum distribution (“RMD”) rules for your beneficiary IRA to properly utilize it. The inherited IRA may be a traditional or Roth IRA and there are three different distribution options you may elect when you inherit the IRA.

Distribution Options

You will have three distribution options upon the death of your loved one to receive the funds from their IRA. In general, the best option is the “Life Expectancy Method” as it allows you to delay the withdrawal of funds from the IRA, and allows the money invested to grow tax-deferred (traditional) or tax-free (Roth). The three options are outlined fully below:

1. Lump Sum

The first option is to simply take a lump-sum and be taxed on the full distribution. There is no 10% early withdrawal penalty (regardless of your age or their deceased owner), but you are taxed on the amount distributed if it is a traditional IRA. You’re also giving up the tax-deferred (traditional) or tax-free (Roth) benefits of the account. Don’t take this option. It’s the worst tax and financial option you have.

2. Life Expectancy Method

The Life Expectancy Method is the best option. Under this option, you take distributions from the inherited IRA over your life-time based on the value of the account. These distributions are required for traditional IRAs and even for inherited Roth IRAs. For example, if you inherited a $100,000 IRA at age 50, you would have to take about $3,000 a year as a required minimum distribution each year. The RMD amount changes each year as you age and as the account value grows or decreases. There is no 10% early withdrawal penalty. Traditional beneficiary IRA distributions are taxable to the beneficiary, and Roth IRA distributions are tax-free. And yes, beneficiary Roth IRAs are subject to RMD even though there is no RMD for regular Roth IRAs.

3. 5-Year Method

This option is available to all inherited Roth accounts, but is only available to inherited traditional IRAs where the deceased account owner was under age 70 1/2 at the date of their death. Under this option, the beneficiary IRA is not subject to RMD. However, it must be fully distributed by December 31st of the fifth year following the year of the account owner’s death. There is no 10% early withdrawal penalty, and distributions are subject to tax. Again, this option is only available to traditional accounts.

Investing with a Self-Directed Beneficiary IRA

Yes, you can self-direct your beneficiary IRA. Before you do, make sure you understand the amount of funds you’ll need to take as an RMD, and that you will have available cash in the account to cover the those RMDs. As I described above, assume you are 50 and inherited a beneficiary IRA for $100,000. You will need to take annual distributions of around $3,000. So, if you invest all of the $100,000 into an illiquid asset, then you will be unable to take RMDs and force the IRA account to pay stiff penalties. Consequently, when making a self-directed investment from a beneficiary IRA, you must take into account the amount of the investment, the total value of the account, and the time-line of the investment (when will it generate cash back to the IRA). If you inherited the $100,000 account above, you may decide to only invest $70,000 of the beneficiary IRA into an illiquid investment (e.g. real estate or private company), while leaving the other $30,000 to be invested into liquid investments like publicly-traded stocks, CDs, cash or mutual funds. This will leave funds available for RMD until such time as the illiquid investment generates income or is sold for profit.

Stretching out the benefits of an inherited IRA can be powerful, but make sure you plan for RMDs before you make any self-directed investment from your beneficiary IRA.

Penalty-Free Early IRA Distributions for College Education Expenses

Students walking across the campus of Duke University with the text "Penalty-Free Early IRA Distributions for College Education Expenses."Do you have tuition or other college expenses due for yourself, your spouse, or your child? Would you like to use your IRA to pay for these expenses? Would you like to avoid the 10% early withdrawal penalty for accessing your IRA funds before you are age 59 ½? This article outlines how you can avoid the 10% early withdrawal penalty when using your IRA to pay for higher education expenses.

Whether you should actually take a distribution from your IRA to pay for the higher education expenses of your child is another topic. Sadly, too many parents have raided their own retirement savings to pay for their children’s college education expenses. They then reach retirement age with a sliver of what savings or retirement accounts they could’ve otherwise relied on. Everyone’s situation and goals are unique but if you have decided to use IRA funds to help pay for educational expenses here’s how you can avoid the 10% penalty for accessing your own money.

10% Penalty Exception Rules for Higher Education Expenses

Here’s a quick breakdown on how the 10% withdrawal penalty can be avoided when you use IRA funds to pay for qualifying higher education expenses.

1. Who can the IRA money be used for?

 Your IRA funds may be used for qualifying higher education expenses of the IRA owner, their spouse, children, and their descendants.

2. What schools qualify?

Any school eligible to participate in federal student aid programs qualifies. This would include public and private colleges as well as vocational schools. Any school where you, your spouse, or your child completed a FAFSA application will qualify.

3. What expenses qualify?

There is a broad list of qualifying expenses. These include tuition, fees, books, supplies, and equipment. Also, room and board is included if the student is enrolled at least halftime.

4. How much is exempt?

The amount of your distribution that is exempt from tax is computed in three steps. First, determine the total qualifying expenses (tuition, fees, books, room and board, etc.) Second, reduce the qualifying expenses by any tax-free education expenses. These include Coverdell IRA distributions, federal grants (e.g. Pell grants), and any veterans or employer assistance received. Third, subtract and tax-free education assistance from the total qualifying expenses incurred and this gives you the total qualifying amount that you may take an early withdrawal from your IRA and avoid the 10% penalty.

Example

Here’s a quick example to illustrate theses rules: You’re age 53 and have an IRA you’d like to access to help cover your daughter’s education expenses. Your daughter Jane is attending Harrison University, a private college that participates in federal student aid programs.

Her expenses for the year are as follows:

  • Tuition: $22,000
  • Room and Board: $13,000
  • Books: $1,000
  • Supplies: $500
  • Equipment: $500
  • Total Qualifying Expenses: $37,000

Jane received the following aid:

  • Federal Grant: $2,400
  • Coverdell IRA Payment: $5,000
  • Federal Student Loan: $10,500 (loans do not reduce the qualifying expenses)
  • Total Tax-Free Assistance: $7,400
  • Total Amount Eligible for a Penalty-Free 10% Early Withdrawal: $29,600

You decide to take a $10,000 withdrawal from your IRA. Since the total amount eligible is $29,600, the entire distribution will be penalty-free. Keep in mind that while the $10,000 distribution is penalty-free it is still included into the taxable income of the IRA owner.

For more details on the 10% early withdrawal exception for higher education expenses, refer to IRS Publication 970. Also, the above example presumes the IRA owner has a traditional IRA. If the IRA owner has a Roth IRA, there are different considerations and distribution rules.

Self-Directed IRAs, the DOL Fiduciary Rule, and Private Investment Denials

The so-called “DOL Fiduciary Rule” went into effect in June and has caused negative repercussions on self-directed retirement account investors who self-directed their IRA, 401(k), or pension into alternative investments. Many self-directed investors have been shut out from investing into private offerings – real estate funds, private placements, start-ups, private REITs, etc. – as investment sponsors or private companies raising funds fear that, by accepting the self-directed retirement account’s investment, they will be labeled a “fiduciary” and will need to adhere to fiduciary rules really meant for investment advisers.

What is a Fiduciary?

The Department of Labor (“DOL”) recently expanded the definition of who a “fiduciary” is to include any person or entity who renders “investment advice” for a fee or other compensation. The fee doesn’t need to be from the compensation itself, but just has to flow from the investment. Here’s the problem: If you run a private fund, start-up, or a real estate partnership, and you take investment dollars from a retirement account, then the DOL definition may include you as a fiduciary since your investment documents will likely contain information that would be considered “investment advice.” And, since you will indirectly receiving compensation as a part of management of the fund or start-up, then you are indirectly receiving a fee for providing investment advice and may consequently be deemed a fiduciary.

Fiduciary Rule Repercussions

Most investment sponsors dread being labelled a fiduciary as they are placed with very high legal standards including as the duty of prudence, the duty of loyalty, and they have to avoid self-dealing prohibited transactions that may arise if they are receiving any compensation that isn’t found to be “reasonable”. In short, application of the fiduciary rule makes them re-align the company’s or management’s interests to be in the best interest of the invested retirement account. While this sounds like a good deal for the retirement account investor – and it is – it puts the interests of management at odds with the retirement account, and creates significant liability to management if they accept retirement plan dollars when they are a fiduciary.

The fiduciary rule was primarily intended to apply to an adviser advising a client so that the investment adviser recommended investments in the best interest of the client, not just the highest paying commission for the adviser. Although that makes sense, the new definition is so broad that it also could apply to the company raising funds from a self-directed IRA or 401(k), and force those companies to reject investment dollars from self-directed IRAs and 401(k)s.

Exceptions

There are two exceptions to the Fiduciary Rule that will allow a self-directed retirement account to invest into a private investment offering: Independent Fiduciaries and Best Interest Contract Exemption.

Independent Fiduciary

If the self-directed retirement account investor has an independent fiduciary, then that fiduciary is responsible for their investment advice and the offering company won’t be deemed a fiduciary. An independent fiduciary would include a registered investment adviser or a broker-dealer. Consequently, if a self-directed IRA investor had an investment adviser who reviewed the investment, then the offering company would likely not be deemed a fiduciary for this investment. I’ve seen numerous companies starting to require this for all retirement account investments. For those clients who already use an investment adviser, this is easier to comply with. But, most self-directed investors do not use an adviser, and as a result would need to spend money to engage one for the purposes of reviewing the investment just so they could qualify to invest.

Best Interest Contract Exemption (BICE)

The second exemption is the best interest contract exemption, otherwise known as “BICE.” BICE provides that a person is exempt from the fiduciary rule, but has lengthy requirements that really won’t work for an investment sponsor or someone raising private capital from an IRA. Based on the requirements, it will really only work for advisers or insurance companies offering financial products.

What to Do Moving Forward?

Many private investment offerings are not restricting self-directed accounts yet. They are either agreeing that they are fiduciaries and are taking that into account their company’s operations or they are taking the legal position that the fiduciary rule doesn’t apply to them, which may be correct as the law is new and still unclear. However, if you end up being restricted from investing your self-directed IRA or 401(k) into a private investment because the offering company is worried about the fiduciary rule, you may choose to rely on the Independent Fiduciary exemption and could engage an investment adviser – if you don’t already have one – to review this investment and serve as the fiduciary for the investment.