- November 7, 2019
- Posted by: august19
- Category: Podcast
There’s nothing like making money in a retirement account. From self-directed IRAs to solo 401(k), Chris Seveney and Gail Anthony Greenberg tackle the power of these tax havens. In this episode, we move to talk about 401(k) with Chris sharing his 401(k) program where he puts his retirement fund. Chris shares his experience on what it is and how it grew his retirement while taking us on what he experienced with IRA before leaving for 401(k). Telling us about his company and investments, Chris then explains the things 401(k) has to offer and more.
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Solo 401(k): Finance Worthy Investment With Chris Seveney
It is our turn to talk to Chris about 401(k).
I’m excited. I love this topic.
There’s nothing like making money in a retirement account.
No, there is not. For those who haven’t read it, our prior episode was on self-directed IRAs. As we near the end of the year, we want to remind about people finishing the books, taxes, and stuff. The power of tax havens like self-directed IRAs and solo 401(k). I strongly recommend you go back because a lot of great information from Gail talking about her self-directed IRA and Roth IRAs, which are even more powerful.
I don’t know why anyone would not do a Roth.
I believe there is of Roth solo 401(k) but I’m not even going to go there because I know zero about it. Solo 401(k) I have once. I would like to share my experiences with some of what it is? How I’ve used it and how it is exponentially grown my retirement?
How long have you had a solo 401(k)?
I created it when I started note investing. First, to have a solo 401(k) you have to have a company that has not only passive income but earned income.
It’s like W-2 income. You have to be paying yourself.
Most investors if they’re doing it on their own don’t have a W-2 job typically or got a W-2 from somewhere. That’s the first thing that you need. The other major component to it is you can’t have full-time employees. You can’t have a business with four employees because you can’t. It’s not a solo 401(k) then you’d have to offer a full 401(k) program. I have a W-2 job and my company has about 100 employees, we have a 401(k) plan. That’s why it’s called solo. It’s for you. If you have a spouse, you can hire somebody part-time. They have to work under 1,000 hours a year. Be careful of even buying into a business that you buy that has employees. There are a lot of rules and I’m not going to go through because they’re extensive. Essentially, if you’re a one-man shop or it’s you and your wife and you’ve had some income coming in the door, for example, from note investing where you get JV partners and you’re making money on those deals. That is taxes, ordinary income. That’s W-2 income.
Probably everyone in range of our voices, if they’re doing JV deals, could have a 401(k)?
If you’re using your own cash to do these deals or you have a note business, you most likely can qualify.
As long as you have an LLC or an Inc. set up.
Here’s why I love it. First, IRA contributions are $5,500 or $6,500 per year. A solo 401(k) is around $18,000 or $19,000. It goes up based on inflation and things like that. You’re already three times more is what you can put in.There's nothing like making money in a retirement account. Click To Tweet
It’s up to $25,000 if you’re an old geezer.
The other component to that is depending on the type of LLC or company you have, whether it’s a C-corp, S-corp or an LLC, depending on that, you can take profits from the company and contribute up to a total of $53,000 per year. As an example, your note business made $100,000. You paid yourself $20,000, and you get that paycheck, you can put $18,000 of it into your 401(k) and then take the $2,000. On top of that, it’s either 20% or 25%, depending on the LLC of profits, the company can contribute as a corporate contribution to the IRA. If you made $100,000 basically you took $20,000, there’s $80,000 left and it was 25%. That’s what another $20,000, roughly. The company itself could contribute 25% of the profits. All of a sudden on $100,000, you put roughly $38,000 away in your 401(k) to grow tax-free.
I assume that money then is not part of your taxable income?
No, your taxable income goes from $100,000 down to $60,000 something. If you’re in a 30% tax bracket, that’s $10,000 in savings. That one component of it is the amount of contribution. In essence, you can put up the $50,000 a year if you’re making good money in your company compared to an IRA that’s $5,000 to $6,000. Think about if you have 3 to 4 good years, you’ve got $150,000 and a solo 401(k) in $15,000 into an IRA. You can have an IRA and the solo 401(k).
I was thinking about it.
One question that everyone always asks is, “I work at W-2 job and I contribute to my 401(k) through them.” That is okay to an extent. As long as your contributions are not more than $18,000 or whatever the limit is per year, you’re okay. If the W-2 job you contributed $10,000 with your note business, you could contribute another $8,000 of your money. Your company can contribute 20% to 25% depending on the type of entity of its profits as a corporate contribution. You can still stash a good amount of money away. That’s a question that people ask a lot and that’s one of the questions I ask.
You have a W-2 job. Do you not contribute the full amount? You’d probably get matching funds, too.
I get matching funds through my company. I do max out my 401(k) or pretty close to it through my company. What I do is at the end of the year I see how much my company from my W-2 job contributed and whatever the balance is, then I contribute that from my note business is what I’ll contribute.
You’re saying if you didn’t end up putting away the $18,000, I’m confused.
Let say my W-2 job, at the end of the year I realized I only put in $16,000, not $18,000. What I’ll do is wait until the end of the year with my note business and take the profits at the end of the year, my final check and put in enough to max out my 401(k).
It’d be $2,000 or whatever the number is.
Give an example similar to IRAs of deals that I have done with my solo 401(k). I had bought a performing note that had an unpaid balance of $39,000. The interest rate was at the time only about 6.5%. I paid about $26,000 for it. It panned out to about a 14% return. A strong borrower is paying property at equity. I had it for about fourteen months. The borrower paid it off. All of that, I’d made about $6,000 in payments and then the total pay off was about $37,500. The borrower paid it off, so my $20,000 something investment ended up netting me $40,000 something. Essentially, I made about 55% on that deal all tax-free. Another example of a deal I have done was I had bought a note for $3,000 in Pennsylvania. It was on about $35,000 property and the payoff was over $50,000. I’d always thought, “This is going to take the property back. I was going to look to turn it into a rental.” The day before foreclosure, which you can foreclose with your 401(k), IRA. Some people get scared that, “I can’t do that.” I’m not doing any of the work.
It’s no different than the IRA. You can’t do any physical work in the sense that I can’t go put a roof on it or anything to enhance its value. Hiring a consultant or lawyer is like hiring a property manager to manage your rentals. The day before foreclosure, I filed for bankruptcy and ended up working out a loan mod that the interest rate was 12%. The payoff ended up being close to $70,000. I dropped the interest rate down to 8% and discounted the UPB by about $25,000. Most people are like, “That’s a sweetheart deal.” They’re paying $900 a month because they want to try and get the house paid off within eight years. When you look at the numbers, I paid $3,000. I did have to spend about $6,000 in legal expenses. I’m in it for $9,000. In the first year, it’s paid itself off. Everything after that for the next seven years is all tax-free income until I retire and start taking that out. Another example of the power of growing money and my wife and I both have W-2, so she and I have a higher tax bracket.
When you start looking at some of these numbers and you’re paying taxes where the first number’s a three in front of them, it can grow your retirement savings extremely quickly and I’m working both angles. I’m still contributing to my W-2 and I’m still making money. I’m investing with my own 401(k). I’m not using all of my retirement account where I can blow it on a deal. I have two buckets. I have the one I can’t touch with my company, which has a good amount of money on it and I have this other one as well.
Can you roll over your company 401(k) into your 401(k)?
No, but if you switch employers, when you move from company to company, you can. When you leave a company you have three options. It’s interesting and this is how I started my solo 401(k). I left the company in 2006. I went to a company for a year and went back to my original company. In 2012 and 2016 at a time I made moves. When you move from one company to another you have two options. They tell you can leave it with your existing company or you can roll it into the new company that you’re working for. Those are the options you have. For some reason, they forget to tell you that you could roll it into a self-directed IRA, a solo 401(k) that you can take control of it as yourself. Gail, can you imagine that these large financial institutions wouldn’t tell you that you could manage your money yourself? What I left a company in 2016 with my company, I took a percentage of that money and rolled it into the solo 401(k). I left some of it and I took some of it. I’ve been there for three years. That’s been growing in my company, plus all the contributions. I took an amount that was roughly about $100,000.
That some people may say it was play money, but it was money for me to invest. Those are some of the powers of the solo 401(k). Another comment I’ll mention about them is they are checkbook control or mine is, I should say. One of the challenges that if you do the checkbook control is whoever you have set it up, make sure they give you the specific instructions to go to the bank. When you go to the bank to set up this type of account, a lot of times they’ll look at you like you’ve got six heads. I went to Wells Fargo with mine and handed them the paperwork and said, “Some places confuse people.” Wells goes, “No, we’re familiar with this and we understand them, but some of your smaller banks may not.” I know Wells is always in the news for things. I use them for a lot of stuff and I’ve never had issues with them. I’ve found them to be very helpful actually.
You seem to have a good branch near you. That’s a good point because when you do a checkbook control IRA, you have LLC paperwork. I find it is best to go to the bank and not even say it’s an IRA because that confuses them because they have a whole different protocol for IRA accounts versus straight business accounts. This is a straight business account. That’s all you need to know.
The solo 401(k) is like an LLC, but it’s got its own EIN number and stuff. They give you all the paperwork. One of the things with it and I think it’s similar to an IRA is the titling. The name of the LLC with the individuals’ names as the trustees is how a 401(k) is. An IRA is for the benefit of the individual’s name and usually the custodian first. That’s one thing I’ll mention too because whether it’s an IRA or solo 401(k) that popped in my head. We ran into this with the fund that we talk about in another episode. When you’re filling out paperwork for a deal, if you’re using your IRA or solo 401(k), make sure that’s what you put down. I ran into that once also with a seller on a contract where early on I was like, “I’m buying these two on my entity and these two on my 401(k).” I put everything in one name and figured out when they go over servicing this is what they’ll go and they’re like, “No, you can’t do that.”
I find it’s best when you’re even contemplating a deal, contact your IRA or a 401(k) custodian and send them the W-9 and ask them exactly, “How do I fill this out?” Because I filled out some with my IRA, LLCs name as the name and it turns out you don’t. You put your IRA custodial account as the name and then doing business as your LLC name. I made plenty of wrong mistakes. Luckily, we’re not situations like the fund where everything has to be totally picture-perfect.
I remember too is if you have expenses, like your due diligence, your title reports and stuff, that’s going to come from IRA. Some people will say, “I don’t know if I’m buying it with my IRA or not.” At the end of the day, if you’re buying it with your IRA, make sure the IRA paid for it. If it was paid out of a different account, make sure you reimbursed that account. You track it and you stipulate why? It’s going to happen. You try and avoid it, but sometimes even you pay a bill. I’ve got eight Wells Fargo bank accounts and they set it to a standard one, sometimes some of them are set to that 401(k) and mail it out. It was for another property. You got to reimburse yourself.
I’ve had that particularly if you have an insurance claim or something. My regular LLC name is very similar to my IRA LLC name and there’s been lots of confusion. I did not think about that when I was setting them up and naming them. I have on occasion deposited the wrong check into the wrong account. You don’t have to worry. It’s not like the IRS shows up the next day and takes your IRA away from you. What you do have to do, I’ve had occasion to do this several times, you need to write out an affidavit of exactly what happens, how you fixed it, get it notarized and put it in the file folder, for God forbid, in case anyone ever wants to know.
The thing too with the solo 401(k) is the name. If your company’s like ABC LLC, your solo 401(k) is ABC LLC solo 401(k) plan. The name of your LLC with the solo 401(k) plan added to the end of it.
That is confusing. That’s easy to mess up. I could see that.
It is especially when your bank accounts only list the first ten digits of something or whatever it is. You’ve got to be careful with that.
We should talk about what are the main difference is between a self-directed IRA versus a 401(k) because these are big.
Besides the contribution limits, the other big one is that if you finance a property, you’re not paying taxes, which we ended on the last episode on IRA is the whole UBIT thing.
It’s the 35% tax.Any investment that you go into, make sure you do your proper due diligence on it. Click To Tweet
You’re paying taxes on whatever number it is, whether it’s finance or the percent of whatever that number is, solo 401(k) or not. Let me give you an example of how this can grow for you. Take that deal that I talked about where I roughly had a $25,000 investment that ended up paying the end of the day a little over $40,000 on. My $25,000 grew to $40,000. I turn around and take that $40,000 and invest in a property that’s a rental that I finance. It’s $100,000 property that I finance $60,000 and I put 40% down. It is similar to an IRA where it is non-recourse but say that property was paying $1,500 in rent. At $1,500 in rent when that comes in the door minus the principal, interest payment and property management fees and stuff like that, say that number is $60,000 loan is probably going to be $1,000 a month, rough numbers. That $1,000 a month is all tax-free growing in your IRA. Essentially you took $25,000 and in 1.5 years turned into $40,000. Took that $40,000 and put into $100,000 investment. All that rental income is coming in the door and say you’re netting $1,000 a month. Your original money, you’re making 50% on. That can be done in two years.
The speed of building wealth in real estate is beyond description. We should probably adopt the language of tax-deferred. This is not a Roth, but you can have a Roth. In my understanding, you could even create a Roth and convert from this solo 401(k). Assuming it was titled the same way. You could convert from this 401(k), which is not a Roth into a Roth 401(k).
That’s something that I need to look into in this whole financing component too. I knew about it, but it’s starting to hit me. Why am I not doing this component? It can be super powerful. You’re right, it’s tax-deferred and it’s not tax-free. When you go to take it out, eventually you will. Most people when they go to take it out have probably retired from their W-2s and may be paying a lower tax bracket.
Yes, not you. You’re going to be in debt when you retire.
Besides the contribution limits, that is the other major component. That’s why you’ll see a lot of people say a solo 401(k) is better than an IRA. Is it better or worse? I don’t know. I’m not an expert in it, but both of them are both extremely powerful and depending on your situation. One is better than the other. Talk to somebody who’s an expert in this and not your brother, your cousin or us. You mentioned the solo 401(k) and I’m telling you it’s all this great stuff and so forth. When you talk to Brian, he’s like, “It’s probably not for you.”
It’s only because of my situation timing-wise.
Your situation and every other person’s situation are different. Because something works for you or me, it might not work for somebody reading or something maybe like, “That works for me,” or for anybody. If you’re a passive investor, probably you can’t do a solo 401(k) because you don’t have an LLC. Here’s the other thing, let’s say you have a plumbing business and you’ve got twenty people working for you and you also invest in real estate and notes. You can’t have a solo 401(k) because you’ve got a company that already has twenty employees.
They’d have to work less than 19 hours a week for them not to be people who didn’t have to have 401(k).
It’s 1,000 hours per year. If you have three people, you can’t have three people each working 990 hours. It’s a full-time equivalent.
It’s the aggregate time that you have employees working. Let’s have a little detail that everybody gets hung-up on. I don’t think we have the depth to explain each one of these, but I’ll run down the list. The first one is no need for a custodian. You’re not reporting to anyone about what you’re doing or even the value.
Every year, I do report back to the company that set it up for me. I fill out a piece of paper for them to report back to. I don’t need to tell them what I’ve invested in. I need to tell them what the value of the account is.
That is the same for an IRA. I don’t have to document what I’ve been doing and what it’s made or anything like that. I have to give them a number that they give to the IRS of what is the value of the account. They are in place there. Although they don’t get involved in my day-to-day, they are the big brother that is watching and documenting contributions and distribution. That’s their stacking trade. It says that you can borrow from your 401(k). Do you know what the rules are in that?
You can take out a loan up to 50% of the value that’s in there that you have to pay it back at interest rates. It’s a max of five years. If you wanted to take out a loan and use that for investments or something else you can, but that’s exclusive of your 401(k). Whatever money made from the money you took the loan out on, you would pay taxes on. If you want to go buy a car, you could take a loan from your 401(k) versus paying Ford Motor Company. I don’t know why you would. You could take a loan, go buy a car, and then you have a car, but you’re getting a bank loan, you took a loan from your 401(k).
You do have to pay interest to your 401(k). The difference is you’re getting the money so you don’t mind.
You’re paying yourself interest. The recommendation is 5% to 6%, and a five-year limit is the length of the loan.
That’s a big one. Tax exemption for leverage real estate profits. What they’re saying in their twisted way here is you don’t have to pay you a bit.
You can leverage a property and all the money you get from that leverage is tax-deferred.
If you had a Roth solo 401(k), it would be tax-free. Stronger asset protection. I’m not sure I understand what they mean there. If your IRA was sued. Retirement accounts, in general, have a rather strong asset protection. As we always say, OJ Simpson lost a massive civil suit and he still has all of his retirement money. There is a little bit more risk with an IRA. The 401(k) does have some heightened asset protection. If you’re on the fence, it might be the thing that pushes you over. Safety from prohibited transactions. In the IRA episode, if you were to do a prohibited transaction, there is a possibility, hopefully, it’s not big. That your entire IRA they could find it invalid and they could liquidate it in the sense that you have this account still, but it is no longer an IRA. Any taxes, penalties and whatever would be due right away that would close on that. Those are the big ones. From my point of view, I’m trying to retire.
One of my big decisions in bringing in rentals in addition to doing note deals was, first of all, I didn’t want all my IRA investments to be in an investment that was going to extinguish itself eventually when the notes reach their maturity date. I feel a certain obligation to my children to have something in my IRA that’ll still be there when the time comes for them. I have used my gains in notes to fund rentals that will be cashflowing in perpetuity. It matters a lot to me. I’m not looking to leverage real estate. That’s the main reason that I’m not financing properties. I don’t want to saddle my children with the management responsibility to be paying mortgages and also having the UBIT situation with them. What are your thoughts, Chris?
Wrapping up these two episodes, my thought process it’s similar to a lot of people. If you can start putting money away in these accounts, even the littlest amount, I strongly recommend it. There’s definitely plenty of options for you. I don’t think it matters what age it is. My feedback would make sure you talk to somebody who understands your specific situation. We’re going to be having people on in the future who can talk more about the specifics of these and who you could have a conversation with, that’s part one. The second is with a retirement account. Some people get the sense that they need to take on risk sometimes in the sense of when I invest in mine, “I bought my first notes because it’s my retirement account. I can lose that money.” Remember, it’s still your money.
A lot of people have that thought process because you hear about a lot of scams and stuff and people are like, “It’s my IRA money or whatever.” It’s still your money and it’s more powerful than your cash because the benefit of it growing tax-deferred. Any investment that you go into, make sure you do your proper due diligence on it from that perspective. The power of IRAs is very strong, especially in real estate because it gives people an avenue where they can invest in real estate. Whereas in other opportunities they may not have been able to.
The JV who kicked off this whole thing by being my JV who was a flipper and was making some nice chunks of change and everything was not doing anything inside of a retirement account. He’s kicking himself like he has done 1031 exchanges, which do save you on taxes in the here and now. Eventually, the day of reckoning comes on those. We’ve put a lot of emphasis as early as possible. Don’t feel terrible like you’ve missed the boat if you are not 30 anymore. Starting at the beginning of your life. See things like the examples we’ve given show things can happen quickly in these accounts. You can’t predict when you’re going to get a windfall or something’s going to go incredibly well. The important thing is to be in the game, to have the accounts set up, to be starting to do transactions, to be learning more and more about it and stretching your wings. Anyone who does a lot of deals is inevitably going to have those special moments that we all celebrate where something went well. There was a big slow into the account. You’re never too old for that.
You’re also going to have those special occasions like we talked about on our Open Mic Night where things may not go as well.
I talked about how I lost $11,000 on a deal in my inherited IRA. I’ve been in that deal for years. That’s part of the reason I lost money was because the borrower drags things out for so long. This happens to be in an area where the taxes are high and the interest and penalties on all of these code enforcement liens that he had accrued over the year. That’s the stuff that kills you and that’s the stuff I wasn’t paying enough attention to. In the two-plus years it took me to get a hold of this property, all my profits went away and then some additional $11,000 went away. If that had happened to me early in my investing career, it would’ve been a devastating loss. That IRA has done so well. It’s not something I would want to experience often, but it’s not a big deal. That’s where you want to get to be. There’s been enough growth that I can withstand some setbacks. I’m not on the ledge as they say.
Gail, do you have any other final thoughts?
I want to say we have to return to our format of what happened because I am missing that. This was a good talk. A couple of shows. I hope people got a lot out of it. I hope the main takeaway certainly came through. Go get yourself a self-directed something and make it a Roth. If you already have an IRA that is not self-directed or a Roth, you can convert it on both accounts. The main thing is to go talk to professionals as quickly as possible. Get yourself positioned for major success.
As always, go out and do some good deeds.
- episode – IRA 101: Everything You Need to Know About Self-Directed IRAs episode
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