Investing within Retirement Accounts

Hi, we’ve decided that we need retirement accounts because we need to pay for our retirement beyond Social Security. We’ve made contributions to those retirement accounts along the line, and we’re, so we’ve got some money in them. So, let’s talk about what you can invest that money in. Let’s talk about our 401k and 503b plans first.

All those plans generally come with a set of investments that is dictated by whoever holds that account. It may have a committee at your company that decides these investments or otherwise. But a couple things to be aware of, you need to direct it. It doesn’t automatically just divvy up your money as you put it in there and put it in these investments.

You need to look, pick and choose. Some investments might be right for you, some investments might not be right for you depending on your age and you’re close to retirement. You might want a more secure bond fund as you age, say in your 50s because you’re closer to retirement, than an aggressive stock fund at that age.

Or, if you’re in your 20s, if you take a little bit of a hit because you’re in an aggressive stock fund, it’s not going to be the end of the world to your retirement. So, you need to look at those choices. Another word of caution, many times with 401k plans or 503b plans, the contributions go in and go in and sit in the cash account until you invest them.

So, make sure that those funds get invested. Cash may earn interest, but if interest is low, it’s not doing you any benefit. It’s not going to grow at the rate you need it to grow for your retirement. We’re not going to talk anymore about the specific investments there, because it’s really not a personal decision, it’s a pick decision amongst a bunch of choices that have already been picked for you. But let’s talk about your IRA accounts, those can be self-managed. And what can you buy in those? And what can you own in those? Is everything and anything fair game? Can you use that money for anything?

Are there consequences to owning specific types of assets that go beyond what we generally consider? Obviously, the regular investments that we talk about, regular bonds, stocks, ETFs, mutual funds, all are fine in IRA accounts. One caution, Debt. You can own a publicly traded bond. For some reason that’s exempt from this rule.

But if you have any other kind of debt, say you want to make a personal loan from your IRA to someone, you can’t do that. It cannot hold debt. That means options, which are essentially debt, cannot be held in an IRA. So, let’s go further. What about some other investment accounts, things that you might want to put in it?

Let’s talk about precious metals, gold, silver, you hear that advertisement on the radio and on TV, “buy gold in your IRA”! You’ve all heard it. Some people encourage you to put your house in your IRA, or real estate, or maybe your part of your business interest that you have a privately owned business.

All these have consequences and things to think about. Yes, they’re all allowed. No, not all custodians will deal with them, so you’ve got to be careful about who is holding your IRA account. And no, you can’t just hold it in your name. It is a trust. It needs a fiduciary.

So, let’s talk about some real estate.  You have really two types of real estate, or three types in the world, but we’re going to lump commercial rental real estate and, residential rental real estate together, because it’s still rental real estate on your home, or a vacation home. All of these are allowed in your IRA.

However, and this is a big however, once you reach the point that you have to take distributions from your Traditional IRA, you have to have those assets valued. And they have to be valued at minimum every other year. And by value that isn’t called, “John Smith down the block”, that’s a real estate agent and say, give me an idea what my properties were.

It’s got to be formal. So, and why is that? Well, that valuation will de determine your required minimum distribution that you must take each year. It’s like getting the fair market value of a stock. Obviously, those are published every day, but not for your real estate. So, you have to have an appraised value at least every other year on this.

Let’s talk about the rental real estate. Rental real estate generates, hopefully, income, which is why you put it in your IRA because it’s growing tax free. However, this is a big however, that’s unrelated business income to the IRA. The IRA isn’t in the business of renting real estate. It’s in the business of saving for your retirement.

So, there is a set of rules called Unrelated Business Taxable Income, or UBTI. And that has to be filed on a tax return every year and tax paid. There is a sliding sale of that tax, it goes up pretty quick, but the key thing is, is filing that return. And failure to file obviously has almost the same penalties as, as failure to file on your personal return.

So, you have nonpayment penalties, non-filing penalties, it can mount up very quickly. So, that’s a thing to remember.

On the publicly traded side, the publicly traded partnerships and REITs can also generate unrelated business taxable income and force the filing of return for your IRA. So that’s something you need to be aware of. There’s a fairly high threshold for that before you have to file, but it’s, again one of those indexed amounts, so you need to look at that and you need to be aware of that filing requirement annually.

Annually. Again, just like your tax return. Let’s talk about some precious metals. And gold and gold bars and stuff. They’re fine to hold in your account. However, the idea of a non-taxable account is to shield growth and income from taxation. The problem with some precious metals, and as we’ve seen if you look over, not a 10-year history, but a 30-year history, which is what you’re really talking about with your retirement account, is they’ve been up and down and up and down.

And there’s going to become a time where you’re going to need liquidity in your IRA account. Why? You’re going to reach the age where you have to take a distribution. You’re going to be required to take that and you’re going to need some way to pay that to yourself, i.e. cash. Now, can you make an in-kind distribution?

Yes, but it’s hard to slice off a little piece of a gold bar to send to yourself, so it really doesn’t work. Those are not particularly liquid, they’re not particularly easy to deal with and value, but there is a marketplace for them, so they’re much easier than the real estate. Now, what happens if you don’t take your distribution?

Well, it’s a 50% tax penalty, so, you know, you don’t want to pay half of it back again to the government. Nobody does. So, you need to remember that. You’ve got to have this liquidity once you reach your full retirement age where you’re required to take distributions. Now, how do you deal with that if you don’t have liquidity?

Well, you obviously have to sell something. So that’s, you know, could be a rush. So, my suggestion is if you really want to hold the precious metals in your account and think that they’re going to appreciate highly, which is what you want in your account for your retirement, it’s not a taxable account, then look at some of the gold and silver and precious metal ETFs that are out there.

Those are perfectly fine and they’re a lot more liquid than a gold bar. So, there’s a couple other things that you need. to think about collectibles. Collectibles are, much like real estate, something that requires valuation every year or to get to your required minimum distribution.

Much like real estate, they’re illiquid. So again, there’s something you need to think about before getting it. And there’s one other surprising thing. Acquiring a collectible in an IRA account is a distribution from the IRA account to you. You put it in there, but if you’re less than 59 and a half and you acquire this collectible, let’s pick a baseball bat of some kind. And you buy it, it’s a distribution from your IRA account, and it could be subject to a 10% tax penalty if you’re under age 59 and a half. Nice to own but could be expensive for you. Distributions at that age would also be taxable subject to ordinary income. So, these are all things to be aware of.

There are a couple more caveats that I want to give you as we think about this. Some people think, “Oh, I’ll just put a lot of bonds that are yielding well in my account”. And then they go out and buy municipal bonds and put them in their IRA account, or even U. S. Treasuries. Well, let’s step back from this and look at the bigger picture.

Municipal bonds aren’t subject to federal tax, and depending on whether you buy a bond that’s for the state you live in or not, it might not be subject to state tax, that income. So, you’re putting something that’s not subject to tax in a non-taxable account. It doesn’t get you your biggest bang for your buck.

You could probably find a higher yielding commercial. bond and put it in the account and still not pay tax, then whatever you’ve decided in the municipal area. A little bit the same thing on U.S. Treasuries. U.S. Treasury interest, although it’s subject to federal taxation, is not subject to state taxation.

This is only valid if you live in a state that has state tax, but you’re not saving yourself as much as you could. So, although they may be a good investment for your IRA. They may not be the best investment for your IRA, and you want to maximize growth and whatever you’re giving up taxability wise. The final point I want to raise on this is thinking about what is in your IRA and changing over your lifetime.

Many firms offer structured portfolios for IRAs based on your age and years to retirement. And you might want to look at those. Even if you decide that you don’t like that pool of investments they’ve chosen in that structure, you might want to say, well, how did they structure this? Is it bond heavy, stock heavy, whatever heavy?

And, say, I’m 20 now, so I can afford to take more risk. That’s great. But now, I just reached 60 and I’m looking to retire in, in 5 to 7 years, or whatever your time frame is. And I want to be able to play golf, and so I want to preserve what I have in my retirement account, which has grown nicely all the time I’ve worked.

And so, let’s go a little bit more conservative. Let’s go into some, some better bond funds or whatever that is, or maybe just even a blue-chip stock fund. So, your investment strategy changes over time. What’s right at 20 is not, maybe not right at 60. So, don’t forget to look at it periodically.

Don’t let it be kind of like the shoemaker’s children’s shoes, forgotten!

IRS Publications: 1040, 8606, 590A and 590B