Maximize Your Self Directed IRA Contributions with Government-Sponsored Retirement Plans at Equity Trust Company

Maximize IRA contributions for your retirement

As savvy investors, individuals who self direct their IRAs to invest in real estate or other alternative assets will want to maximize the contributions they are allowed to make toward their retirement. Most people are aware of the Traditional and the Roth IRAs. However, they may not be aware that government-sponsored retirement plans are also available for self-employed individuals and small business owners, in addition to their Traditional or Roth IRA.

Real estate investors need to realize that they are eligible to take full advantage of small business retirement plans created by the federal government. These plans are as easy to set up as Traditional or Roth IRAs. Once established, these plans become similar to Traditional and Roth IRAs, yet they allow individuals to contribute considerably more than the $4,000 limit which took effect in 2007 for those plans. However, not all self-directed IRA custodians are the same! See Why Equity Trust is the Preferred Choice.

"You can contribute more than $4,000 to an IRA?"

Speaking across the country to thousands of real estate investors each year, we always love hearing how excited these investors become when they learn that they are able to combine their present investment strategy (e.g., lease options, rehabs, foreclosures, rentals, raw land, notes etc.) with the incredible forces that IRAs offer. (For more information on IRA Basics.)

They love the fact that they are able to choose how and where to invest their retirement savings in ways they already know and understand. What really astounds them is the realization of how much faster their money is able to compound without the eroding factor of taxes. See the power of compound interest in a tax-free account for yourself with the Equity Trust Self-Directed IRA Wealth Calculator.

This seemingly endless enthusiasm hits a speed bump, though, when they realize that with a Traditional or Roth IRA they are only allowed to contribute $4,000 for 2007 ($5,000 for 2008. "What can I possibly do with $4,000?"

Our first response is, "Well, how much would you like to put into an IRA this year...$5,000, $10,000, $20,000?" These are all possible options.

At this point, they usually perk up and ask, "How is that possible? I’ve never heard of that before." This response is not unusual since most IRA custodians don't bother spending the time to explain the merits of small business retirement plans - the SEP, the SIMPLE and the Individual(k) or Solo(k).

People often assume that the term “SIMPLE IRA” refers to a “Traditional IRA”, but this could not be further from the truth. The Traditional IRA and the SIMPLE IRA are not the same. The SIMPLE IRA ( Savings Incentive Match Plan for Employees) is a small business retirement plan, not to be confused with the Traditional IRA, which is for individuals.

Real estate investors often wear two hats - employer and employee

In many instances, real estate investors will wear two hats, as it pertains to SEP, SIMPLE and Individual(k) retirement plans: that of employee and employer. In this case, both contributions (employer & employee) go directly to the investor's IRA! Also keep in mind that, in addition to these plans, real estate investors can have an individual IRA (Traditional or Roth).

No matter what hat you wear - be it a sole proprietor, partner, owner of an incorporated or unincorporated business, consultant or independent contractor - you are eligible for either a SEP, a SIMPLE or an Individual(k) Plan. The only question is, which plan is right for you?

Which small business retirement plan is right for you?

Now that we have established that even a single real estate investor qualifies for one of these plans, let's discuss the basic characteristics, so that you can evaluate which one is right for you. Please note that annual compensation refers to salary/wages for employees or earned income for those self-employed. If you receive only rental income (passive income), you will need to pay yourself a salary for managing your properties (earned income) to be eligible for an IRA.

The SEP IRA (Simplified Employee Pension Plan)

The Simplified Employee Pension Plan (SEP) enables business owners to make IRA contributions of up to $44,000 in 2007 (increasing to $45,000 in 2008 and then subject to annual cost-of-living adjustments for later years) toward their own and their employees’ retirement, without getting involved or setting up a more complex qualified arrangement, such as a Code Section 401(k) plan.

With a SEP, contributions are made to an Equity Trust IRA set up by, or for, each eligible employee. SEP IRAs are owned and controlled by the employee, unless the SEP IRA has adopted the permitted disparity rules. The employer makes contributions to his own SEP IRA, as well as the SEP IRA of any employees, and must contribute the same percentage for all eligible employees. However, an employer may choose each year whether to contribute to this plan and is under no obligation to offer it each year.

Business Eligibility - Any employer, whether a corporation, partnership, or self-employed individual, may establish the plan, even if there is only one employee.
Employee Eligibility - Employees must be at least 21 years of age, have worked for the business during any three of the past five years, and earned the annual minimum required compensation of $500 in 2007.
Spousal Eligibility - Your spouse and children may also participate in the plan and open their own SEP IRAs - as long as they are employees of the company and meet the income requirements.
Employer Contribution - An employer may contribute up to 25% of each eligible employee's annual compensation up to a maximum of $44,000 in 2007 (increasing to $45,000 in 2008 and then subject to annual cost-of-living adjustments for later years). In making any employer contributions, for 2007 only compensation up to $220,000 can be considered (increasing to $225,000 in 2008). The employer is allowed to make contributions annually, but is not required to make any contribution for any particular year.
Deductions - Employers may deduct every qualified dollar they contribute from their taxable income.
Catch-up Provision - None in the SEP

As with Traditional and Roth IRAs, clients can use funds from their SEP IRA to invest in any of the various investment vehicles offered by Equity Trust Company (see Self-Directed IRA Investment Opportunities at Equity Trust).

Click for more information on a self-directed SEP IRA at Equity Trust.

The SIMPLE IRA (Savings Incentive Match Plan for Employees)

We often recommend that investors who receive less than $50,000 in annual compensation choose the SIMPLE IRA plan. This will allow them to contribute the maximum amount to their IRA. Another favorable point about this plan is that, if you have employees other than your family, as the employer you are only responsible to match if the employee contributes funds first. In addition to these benefits, after two years you may be able to convert your SIMPLE IRA to a Roth.

With a SIMPLE plan, employees can choose to make salary reduction/deferral contributions directly into an Equity Trust SIMPLE IRA, rather than receiving these amounts as part of their regular salary. There is a maximum employee contribution of $10,500 for 2007 , increasing to $10,500 in 2008. In addition, if you are 50 years of age or older, the maximum employee contribution is $13,000 in 2007, increasing to $13,000 in 2008.

Under a SIMPLE IRA an employer must make either a matching contribution related to the employee's elective contribution on a dollar-for-dollar basis up to a limit of 3% of the employee's compensation or, in the alternative, a nonelective employer contribution to each employee equal to 2% of each eligible employee's compensation.

Business Eligibility - Generally, small businesses (which include self-employed individuals, sole proprietors, partnerships and corporations) that employ 100 or fewer employees are eligible.
Employee Eligibility - The employee must have earned at least $5,000 in the two preceding years and reasonably expect to earn at least $5,000 for the current year. These requirements are the maximum and can be reduced by the employer.
Spousal Eligibility - Your spouse and children may also participate in the plan and open their own SIMPLE IRAs - as long as they are employees of the company and meet the income requirements.
Employee Contributions - Employees may contribute up to 100% of their annual compensation up to $10,500 for 2007 and $10,500 in 2008. In addition, if you are 50 years of age or older, the maximum employee contribution is $13,000 in 2007, increasing to $13,000 in 2008.
Employer Contributions - An employer must make either a matching contribution related to the employee's elective contribution on a dollar-for-dollar basis up to a limit of 3% of the employee's compensation or, in the alternative, the employer can make a nonelective employer contribution to each employee equal to 2% of such eligible employee's compensation.
Deductions - Employees may deduct their contributions from personal taxable income, while the employer may deduct the matching amount from the business' taxable income. If you are self-employed, you receive both of these deductions!

As with Traditional and Roth IRAs, clients can use funds from their SIMPLE IRA to invest in any of the various investment vehicles offered at Equity Trust Company (see Self-Directed IRA Investment Opportunities at Equity Trust).

Click for more information on a self-directed SIMPLE IRA at Equity Trust.

The Individual(k) or Solo(k) Plan

In response to tax changes that became effective in 2002, Equity Trust Company set up arrangements known as Individual (k) Plans (sometimes referred to as Solo (k) Plans) that enable sole proprietorships, partnerships, and single person corporations to set up and contribute to an arrangement that offers the same benefits as a conventional 401 (k) plan offered by larger companies.

Two components comprise the maximum Individual(k) plan contribution: an employee salary deferral contribution and an employer profit sharing contribution (see how a self-directed Individual(k) at Equity Trust works).

For 2007, each owner working in the business is able to contribute up to lesser of 100% of compensation or $15,500. After 2007, this $15,500 will be indexed to inflation and adjusted by the Treasury Department. In addition, the separate profit sharing contribution, if any, that can be made to an Individual (k) arrangement is limited to 25% of the employee's compensation up to the annual compensation cap (if the business is a corporation) or 20% of the employee's self-employment income (if a sole proprietorship or partnership). The annual compensation cap in 2007 is $220,000 and $225,000 for 2008 and then subject to annual cost-of-living adjustments for later years. There is a total contribution limit applicable from both sources of $44,000 in 2007 ($45,000 in 2008) and then subject to annual cost-of -living adjustments for later years).

In addition to the contribution limits stated above, an employee 50 years of age or older may also make an additional "catch-up" contribution to the Individual (k) plan. The permissible "catch-up" contribution amount for 2007 is $5,000 . If the employee is 50 years of age or older, the total contribution limit for 2007 will be $49,000 and $50,000 for 2008.

Also remember that spouses are eligible to open their own Individual(k) account provided they have separate income and are covered in the plan.

Business Eligibility - It must be the only plan maintained by the business and the business cannot be considered part of a controlled group under tax law.
Employee Eligibility - Individual(k) plans are only appropriate for a sole proprietor or a business (either a partnership or a corporation) in which only the owner(s) and spouse(s) will be covered by the plan.
Spousal Eligibility - Your spouse may also participate in the plan and open his/her own Individual(k) Plan - as long as he/she is an employee of the company.
Employee Contributions - The employee is able to contribute up to $15,500 through salary deferral, although this may not exceed 100% of pay.
Employer Contributions - The employer profit sharing contribution limit is up to 25% of pay, or 20% for self-employed.
Total Contribution Limit - There is a total contribution limit, from both the employee salary deferral contribution and the employer profit sharing contribution, of $44,000 ($45,000 in 2008) and only income up to $220,000 ($225,000 in 2008) can be considered.
Deductions - Employees may deduct their contributions from personal taxable income, while the employer may deduct the matching amount from the business' taxable income. If you are self-employed, you receive both of these deductions!

As with Traditional and Roth IRAs, clients can use funds from their Individual(k) Plan to invest in any of the various investment vehicles offered at Equity Trust Company (see Self-Directed IRA Investment Opportunities at Equity Trust).

Click for more information on a self-directed Individual(k) Plan at Equity Trust.

Don’t forget the “catch up”

If you are 50 years of age or older you will be able to make additional contributions known as "catch-up" contributions to certain arrangements. For 2007, if you are participating in either a Traditional IRA or Roth IRA you can make an additional "catch-up" contribution of $1,000. For 2007, you can make an additional "catch-up" contribution of $2,500 to a SIMPLE IRA. Catch-up for 2008 is $2,500. For 2007, if you are participating in an Individual (k) Plan, you can make an additional "catch-up" contribution of $5,000 (this "catch-up" contribution amount will then be indexed for inflation and increase in $500 increments starting in 2007).

Compare for Yourself

See our comparison of the self-directed SEP IRA and self directed SIMPLE IRA plans.

See the self-directed Individual(k) Plan at Equity Trust.

See the power of compound interest in a tax-free account for yourself with the Equity Trust Self- Directed IRA Wealth Calculator.

See how much you can contribute using the Equity Trust small business retirement plan calculator.

Supercharge your Roth IRA

One feature of both the SEP and SIMPLE IRA that most investors are not aware of is that contributions made to both of these IRAs can be converted to a Roth IRA. Imagine being able to enjoy the contribution limits of a SEP or SIMPLE IRA and the tax-free status of a Roth IRA. It must be noted that a SEP IRA can be immediately converted, while a SIMPLE IRA must wait two years from the date of the first contribution to be eligible for a Roth conversion.

Remember that, when you make a Roth conversion, a taxable event has been created. The amount you decide to convert will be added to your annual income for that year. But don't forget that you will receive a deduction for contributions to a SEP or SIMPLE IRA, making the conversion practically a wash.

Click for more information on conversion to a self-directed Roth IRA at Equity Trust.

Don’t forget your other family members

If your spouse has income, or you file jointly, do not forget about having him/her open a self directed Traditional or Roth IRA. In addition, he/she is eligible to participate in a SEP, SIMPLE or Individual(k) Plan if he/she has income from your business.

Your children can also have an IRA account if they have income, including from your business.

Don’t forget other tax-advantaged investment plans

Do not forget about the self-directed Health Savings Account (HSA) at Equity Trust to reduce your health insurance premiums by as much as 70%, and HSA contributions are tax-deductible (subject to limitations). Set aside funds in your HSA to pay current and future medical expenses. An individual may contribute the lesser of his/her plan deductible or $2,850 in 2007 ($2,900 in 2008, and a family may contribute the lesser of their plan deductible or $5,650 in 2007 ($5,800 in 2008 annually.

Also, amounts deposited into a self-directed Coverdell Education Savings Account (ESA) at Equity Trust grow tax-free until distributed, though contributions to an ESA are not tax deductible. The annual contribution limit is $2,000 for each beneficiary, no matter how many Coverdell ESAs are set up for that beneficiary.

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