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How Can You Minimize Taxes and Maximize Taxes By Investing In IRA's?
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Listen to the audio
- To listen to this interview snippet, just click the play button above (twice if necessary).
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In this audio snippet, you'll hear about:
- People that do this well only do this
- Huge tax advantages and other advantages of putting part of your money toward retirement plans
- Traditional IRA provides tax deduction today
- ROTH IRA does not provide tax deduction today, but money can be taken out tax free upon retiring
- Traditional IRA and ROTH IRA are personal in nature
- Other plans available for corporate entities, but you need to speak to a professional about it
- Self–directed ROTH IRA – average purpose should not use this. It is not an investing vehicle
- Other vehicle are far more aggressive –
- Simple IRA – very complicated – can put somewhere in the $16K range in it
- SEP IRA – available to both sole props and small corps – must be available to all employees – you can effectively contribute 25% of income, up to $44K/yr
- If you can take a low compensation from your corporation, you can only contribute 25% of the compensation portion to your SEP IRA
- SEP IRA is not based on distributions, it is based on compensation (don't let stock brokers tell you otherwise)
- Definted contribution plans and defined retirement plans – with help of actuary and pension consultant you can actually contribute far more to a defined benefit plan than any of the other plans – a toy for the rich – one client of Yosef's is putting $300K this year into one
Audio Transcript
Travis:
Let's
move on to something a little bit different. It has as much to do with
the benefits of an incorporation or LLC as it does with taxes, but
since you know so much about this, I wanted to run it by you. The
question is about SEP IRAs or Roths, and how you can minimize your
taxes and maximize the benefits of the corporate entity by investing in
these.
Yosef:
OK. I can only provide you general information on the use of SEP IRAs
and traditional IRAS, or Roth IRAs. The reason why it's general
information is because the people that do this well only do this.
Travis:
Oh, really?
Yosef:
Yeah. In fact, let me run you through what I typically advice clients,
in general, and you can decide from there where to take things.
Travis:
OK.
Yosef:
If you're working for a corporation, most companies have some sort of
employee benefits. It induces employees and employers to contribute
towards retirement. If you're working a company that doesn't have it,
I'd probably really reconsider working there.
Travis:
[laughs] Right.
Yosef:
Because there are huge tax advantages to deferring a portion of your
income towards retirement. I mean, there are a lot of advantages,
actually. And it's important that we as a nation save our money. It has
both a long–term impact to ourselves as we get older and retire, and
there's also a short–term stimulation of the economy that happens as
well. Which is why Congress provides such benefits for retirement.
That
being said, by default, if someone does not have a retirement program
in their company, they can still contribute up to $4,000 a year, if
they're below the age of 50, to a traditional IRA, or to a Roth IRA.
Now, traditional IRA allows you to contribute the money and get a tax
deduction today. But again, these are just general rules. There are a
number of exceptions. If you haven't earned any money, you won't be
able to contribute to an IRA at all. Well actually, you could
contribute to an IRA, but you won't be able to deduct that contribution.
And
of course, contributing to an IRA has a number of advantages. One is
that you can, in some cases, deduct that portion of your income from
your taxes today, and secondly, the income in the IRA itself grows
tax–deferred. So let's say you were to throw that money into a mutual
fund that was making 10 to 12 percent, you would not be taxed on the
earnings of that mutual fund before the money was pulled out for
retirement. That's one advantage of contributing to a traditional IRA.
Of
course, if you were contributing to a Roth IRA, you would not be taxed
at all on the growth of that money, even at retirement. Because what
happens is that, today you're not entitled to deduct the money from
your taxes, too.
I don't know if that actually was clear
enough. But again, a traditional IRA, generally, provides you with a
tax deduction today, in exchange for claiming that income and paying
taxes when you retire. A Roth IRA does not provide you with a deduction
on your taxes today, but then again, it allows you to take the money
out tax–free upon retirement.
Travis:
And are these taxes in relation to your corporate entity or your personal taxes?
Yosef:
Well, the traditional IRA and Roth IRA that I just described are both personal in nature.
Travis:
OK.
Yosef:
Now, there are variations that corporations can use, and those variations are far more complex.
Travis:
Of course.
Yosef:
You really have to speak to a pension professional to understand them.
And to make sure that you're following them accordingly.
I
get a lot of people coming to my office that want me to help them with
a self–directed Roth IRA. It's been a very hot topic lately. It's not
something that I would recommend for the average person to even
consider.
Travis:
All right.
Yosef:
Because the purpose of the IRA is to save money towards your
retirement. It's not supposed to be a vehicle that you use to invest,
just to have an easy way of making big bucks with a very small cost.
Travis:
OK. It's not a day trader thing to do, huh?
Yosef:
Most day traders that I know of––not all, but most––end up losing a
substantial portion of money at some stage in their career. Now, if
that money was Roth IRA money, they wouldn't be able to use that loss
against their other income. That would be a shame.
Travis:
Yeah.
Yosef:
If the day trader is looking to have that tax benefit against other
income. So that's where I don't necessarily think a self–directed Roth
IRA works for everyone. For people who are disciplined, people who have
a larger strategy, I think it could be a great vehicle. But again, it's
always going to depend on the facts and circumstances.
Travis:
Very interesting.
Yosef:
That being said, there are other vehicles that are far more aggressive.
There's a simple IRA, which is used in conjunction with a corporation
which has multiple employees. I'm not even going to try to explain that
to you right now because it gets very complicated, but it does allow,
between the employee and employer, to defer somewhere in the $16,000
range of income for retirement.
Travis:
That's a good chunk of money.
Yosef:
It's pretty substantial. There's also what's commonly known as the SEP
IRA. Now, what's interesting is nobody really knows what SEP stands
for. I always thought that S–E–P stood for Self–Employment Plan. It
means Simplified Employee Pension. And the reason I bring that up is
because that's really what it is. It's not a self–employment plan. What
it is is a simplified employee pension program.
Travis:
OK.
Yosef:
And it's available to both sole–proprietors as well as small
corporations. It's got to be something that's available to all your
employees.
Travis:
All right.
Yosef:
And there are certain regulations as to how that's done. But you can,
effectively, contribute about 25 percent of your income into a SEP IRA.
That's about $44,000 a year.
Travis:
Oh, goodness.
Yosef:
Which is a really nice chunk of money. What people need to realize,
though, is like this. We had this discussion earlier in the
conversation about distributions and compensation from S corporations.
If you're one of those lucky few that can take a very low compensation
from your corporation, you're only going to be able to contribute 25
percent of the compensation portion to a SEP IRA.
Travis:
Ah, OK. Important.
Yosef:
It's so important, because I have had stock brokers and financial
advisors tell my clients to the contrary all the time. And that's
wrong. It's clearly wrong. The SEP IRA contribution is not based on
your distributions; it's based on your compensation.
And
I can tell you that, for a number of small business owners, when you
look at the choices: do I take a $200,000 salary, or do I take a
$60,000 salary and take the rest as distributions. When you look at the
savings and self–employment tax, that generally seems to outweigh the
benefit of a SEP IRA deduction. Again, but if the business owner has a
long–range business or investment plan for his retirement money, then
he should disregard that savings and go for it.
Travis:
Right, because the $44,000 will outweigh the tax benefits of the distributions.
Yosef:
Right. But again, you have to go through these with your tax advisor, because the calculations are not simple.
Travis:
Right.
Yosef:
And they can materially affect both short–term and long–term financial consequences.
Travis:
OK. All right. Yosef, I'm ready to move on to a few LLC–specific questions, if that's all right with you.
Yosef:
Let me just elaborate with a few sentences on two more things which I think are important for people to consider.
Travis:
Please do.
Yosef:
There are far more sophisticated retirement plans called defined contribution plans and defined benefit plans.
I
just want to say a few things about defined benefit plans, because, if
you're a small business owner, with the help of an actuary and a
pension consultant, you can actually contribute far more to a defined
benefit plan than any of the other plans noted so far. I have a client
right now in his early 50s: he and his wife combined are contributing
$300,000 this year to a defined benefit plan.
Travis:
Wow.
Yosef:
It's an extraordinary vehicle. And again, it's a toy for the rich, not
for the middle class, shall I say. I don't want to [laughs] sound
discriminatory.
But
it costs money. You have to employ the use of an actuary. There's got
to be a plan specialist involved. But for those interested in deferring
a lot of their money towards retirement, it's a great vehicle, and
people don't take enough advantage of it.
Travis:
Well, this whole topic sounds like something that I should seek out a
pension professional and just really expand on all of this, because it
sounds really important.
Yosef:
Yeah, I can't import upon that enough. And I think that anybody that
you speak to, they need to take their retirement seriously. And part of
taking their retirement seriously would be to consult with someone in
this area.
Travis:
I couldn't agree more.
Yosef:
There are people that, all they do is just retirement planning, setting up pensions, etcetera.
Travis:
OK. I'll see if I can't seek out a qualified professional. Maybe you could recommend somebody to me down the road.
Yosef:
Absolutely. There's a number that I actually work with, because again,
I don't necessarily feel particularly qualified in this area, beyond
the general ideas. And I typically send my clients to someone who I can
appreciate for having the necessary advice as well as the
professionalism necessary.
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