Estate planning opportunities with regards to Self directed IRA and 401k plans
Unfortunately IRA and 401k retirement accounts are often ignored within the estate planning world. The reasons for this include:
- Retirement accounts are not on top of many client’s minds because the accounts seem “untouchable” during working years;
- Clients assume that retirement accounts will be depleted during their lifetime – a fact that is very rarely true; and
- Clients (and their advisors) do not always recognize the amazing federal law “gifts” that apply to retirement accounts – which can potentially be used to a client’s advantage (and the advantage of his/her heirs) for 50+ years.
An article of mine, which explores the powerful combination of a Roth IRA and a “Legacy Trust”, was published in the Puget Sound Business Journal’s Estate Planning Supplement on March 15th.
Self Directed IRA: What does it mean?
At their core, an IRA is an IRA, i.e. there is no underlying legal difference between a self-directed IRA and any other IRA.
Nonetheless, the term “self-directed IRA” is generally (and confusingly) used to refer to three very different types of IRA accounts:
- An IRA held by a traditional type of broker (e.g. Charles Schwab) that allows the IRA owner to direct investments into any stock, bond, mutual fund, etc. that the broker offers.
- An IRA held by a unique type of custodian that invests directly into “nontraditional” assets, e.g. real estate, promissory notes, privately-held companies, etc. In other words, the legal owner of the asset would be “ABC Trust Company FBO John Doe, IRA”.
- An IRA held by a similar unique custodian that first purchases ownership in a Limited Liability Company, with the LLC executing the investments. The LLC is either 100% owned by the IRA or fractionally owned by the IRA and other investors (which might or might not be other IRAs).
Each investment method has its own pros and cons and investors should consider all options before moving forward.
Changes to the self directed IRA and 401k rules this year
The most significant change that no one seems to be paying attention to is the brand new “in-plan” Roth conversion rules.
In the past, clients with 401(k) accounts with their current employer had very limited options for moving pre-tax 401(k) funds into post-tax Roth 401(k) accounts. For example, in the past, a 50-year-old Microsoft employee who has $500k in her 401(k) account could not convert some or all of the account into the plan’s Roth component.
However, many clients would like to convert at least some of their account into post-tax funds (and, of course, pay the tax associated with the Roth conversion) in order to create a pool of pre-tax and post-tax retirement funds. That type of planning is now possible, with the end result of more income tax flexibility in retirement years.