Over the last few years, Americans have struggled to recover from the devastation of their IRA and 401(k) stock portfolios. “Steady the course” and “Ride it out” are Wall Street’s mantras to get people to keep their dwindling retirement assets in commission-generating stocks.
But not all of them are buying it.
After decades of a monopolistic stranglehold by Wall Street, a handful of non-Wall Street companies have emerged to offer alternatives to standard Wall Street products. This competition truly benefits you, the consumer, by offering a wide range of investment options that can often be safer and more lucrative than stocks, bonds, and mutual funds.
Though more and more people are becoming aware of the fact that there are alternatives to typical IRAs or 401(k)s, the information readily available about all of the alternative retirement plans (Self-Directed IRAs, Check Book Control Self-Directed IRAs, SEPs, etc.) is often disparate and overwhelming. No wonder Americans are confused and opt not to change anything.
A lack of knowledge regarding your retirement options can add years to your time on the job and result in many missed opportunities. But it doesn’t have to be that way. A moment taken to understand your retirement plan options can lead to a lifetime of financial security.
What Are Your Alternatives?
To put it simply: You can invest in products other than stocks, bonds, and mutual funds with your retirement plan. These “alternative” investment products include, but are not limited to, real estate, tax liens, and even businesses. But … to be allowed to invest in these investment products, your retirement plan must be “Self-Directed.”
Anybody can have a Self-Directed retirement plan. These plans are not limited to certain people or business owners or the self-employed. You can have a Self-Directed plan.
There are several types of Self-Directed retirement plans, and some innovative companies are busy creating a host of even more variations that appeal to people who want to diversify their IRA portfolios beyond Wall Street. Depending on the type of plan you choose, you will be able to invest in different things. Each offers certain advantages.
Let’s take a look at just one of them.
The Solo or Entrepreneurial 401(k)
This is one of the newest and most innovative individual (as opposed to group) retirement vehicles available today.
The Solo or Entrepreneurial 401(k) is designed for sole proprietors or a business in which only the owner(s) and spouse(s) will be covered by the plan. It can allow contributions of twice as much or more than other individual retirement plans, depending on income.
This plan is well suited for people who want to start up a business or buy a franchise. It allows you to use the funds in your retirement plan to invest in the business of your choice. You simply set up your business as a corporation, and your Solo or Entrepreneurial 401(k) becomes a shareholder. (I’ll explain that in a bit more detail in just a moment.)
A Solo or Entrepreneurial 401(k) allows you to either actively work in the business as an employee or to choose not to participate in the business. In the latter case, you could hire a full-time manager and employees for your new business and maintain your old job.
If you choose to act as an employee of the corporation, you can actually draw a competitive salary. (It must be the norm; you cannot gouge.) This means you would get paid to perform a legitimate function in the business. If, for example, the business is a real estate investment, you could get paid to manage the property.
All employees (including you, if you choose to work for the corporation) will be responsible for taxes on their own wages, and the corporation will be responsible for taxes on its earnings. But here’s the good part: Earnings made by your retirement plan as a shareholder in the corporation compound tax-deferred.
Buying a business with a Solo or Entrepreneurial 401(k) enables you to fully utilize the money in your retirement account and create an income stream now and tax-deferred appreciation.
And when the business is well established and has increased in value, you can sell it for a nice profit … and defer taxes on those gains as long as they go into your retirement account.
Here’s how a “facilitator” like Guidant Financial makes the Solo or Entrepreneurial 401(k) work:
1. You form a new “C” corporation with the help of a facilitator. The facilitator will work with your attorney and/or CPA or accountant during the formation process.
2. You set up a corporation sponsored 401(k) plan that is designed to permit investments into your corporation. The 401(k) plan comes complete with a favorable determination letter from the IRS.
3. You roll over to the new 401(k) plan. The facilitator helps you during this sensitive process of moving retirement funds from your previous employer or IRA into the new 401(k) plan.
4. Your new 401(k) plan purchases stock in the corporation. The 401(k) plan now holds stock in the corporation, and the corporation is debt-free and cash-rich from the sale of the stock. Because the corporation has funds, it can now purchase real estate, a new business, or (if sufficient funds are available) a franchise like Subway or McDonald’s.
It could even buy a U.S. Post Office building… Buying a U.S. Post Office
A U.S. Post Office building, depending on location and size, is an affordable, conservative investment. It can provide 4 percent to 8 percent annual cash on cash, plus appreciation on the property. For example, there is a U.S. Post Office in Medicine Bow, Wyoming (population 400) for sale at $65,000 that generates $600 in monthly rents.
Of course, there are much larger Post Offices with much higher rents and asking prices. But let’s take a look at how the Solo or Entrepreneurial 401(k) would work with this one.
You form a Solo or Entrepreneurial 401(k) that pays $65,000 cash for the Post Office building. The taxes are $1,950 annually (at 3 percent) and the insurance is $650 (at 1 percent. The Post Office pays everything else: utilities, maintenance and repairs, etc.
Annual Rent: $7,200.00 ($600 monthly)
Annual Expenses: $2,600.00
Net Cash Flow: $4,600.00 ($383.33 monthly)
Yield, cash on cash: 7.08 percent
Return on Investment (ROI): 12.08 percent (assumes 5 percent appreciation)
And over the years, your rental income will increase, leading to greater monthly cash flow in addition to continuing appreciation.
If you stack up this conservative investment with the U.S. Government as a tenant against most Wall Street products, you can see it does quite well.
Or, if you prefer to participate more actively in your investment, a Solo or Entrepreneurial 401(k) will allow you to buy a business at prices that range from $15,000 to $1,500,000.
Just One of Many New Alternatives for Your Retirement Savings …
I hope I have helped to shed some light on the exciting range of new retirement products available to you. Remember, there are several types of Self-Directed plans. Depending on your personal goals and situation, one will be exactly right for you. In my next article for ETR, I’ll tell you about the brand new Roth 401(k), which just became available in January 2006, and the groundbreaking opportunities it offers for the next five years.
“Today more people believe in UFOs than believe that Social Security will take care of their retirement.”
– Steve Cook
(Ed. Note: Tom Phelan is a nationally recognized speaker and authority on the topic of Self-Directed IRAs and Tax Advantaged Real Estate Investing.)