However, for the vast majority of people, it’s difficult to get access to the same types of “cheap stock” or “partnership interests” discussed in that strategy.
That’s why today, we’re going to focus on one of the more practical ideas for simply getting more of your money into tax-advantaged accounts in the first place.
Let’s dive in,
-Jake Hoffberg
P.S. Interested in using your retirement accounts to invest in deals listed on Equifund?
Chances are, your current IRA custodian – especially if held with larger firms like Fidelity, Vanguard, T. Rowe Price, or Charles Schwab – does not allow you to own private securities.
This means you will need to open something called a Self-Directed IRA (SDIRA), transfer assets into that SDIRA, create an account on Equifund using that SDIRA, and then make an investment from that account.
If you already have an SDIRA opened, and you need help getting your account set up, please email me directly at [email protected], and simply tell me the name of your custodian.
If you DO NOT have an SDIRA, while we don’t endorse any SDIRA custodian in particular, many of our members use AltoIRA as our platform already has a built-in integration.
And now for the legal disclaimer…
Investing in private investments may involve a high degree of risk, including the potential loss of some, or all, of the principal invested. If you are considering allocating a portion of your retirement assets to these investments, you may want to discuss it with your personal financial advisor.
How Insiders and Elites Use Retirement Accounts to Build Tax-Advantaged Fortunes
Quick recap: There are two types of retirement plans – Defined Benefit (DB) plans and Defined Contribution (DC) plans.
- DB plans provide eligible employees with guaranteed income for life when they retire. Employers guarantee a specific retirement benefit amount for each participant, based on factors such as the employee’s salary and years of service.
- A DC plan does not promise a specific amount of benefit at retirement. The employee will ultimately receive the balance in their account – which is determined based on contributions and the performance of the investments in the participant’s individual account, minus any fees and taxes.
Examples of DC plans include 401(k) plans, 403(b) plans, Traditional IRA, Roth IRA, SIMPLE IRA, and SEP-IRA.
Let’s start with the retirement accounts the majority of people have access to – DC Plans.
As a general consideration, the two major factors with DC plans are the annual contribution limit and the required minimum distributions (RMDs).
On October 21, 2022, the IRS announced an increase in how much individuals can contribute to DC plans.
- The contribution limit for employees who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan was increased to $22,500, up from $20,500.
- The combined limit on annual contributions to an IRA increased to $6,500, up from $6,000.
In addition, for those that are 50 years or older, you can contribute an additional $1,000 “catch up” contribution each year.
For clarification, if you have both a Traditional IRA and a Roth IRA, this doesn’t mean $6,500 per account you have open – but rather, the total you can contribute to all IRAs in your name, in that calendar year.
With that said, married couples filing jointly can each make the maximum contribution to an IRA, as long as their combined income exceeds the amount they’re contributing, even if one spouse doesn’t meet the income requirement (and even if they are a “stay-at-home” spouse).
Also, don’t forget about the kids; for 2023, anyone can contribute to a Roth IRA for a minor, as long as the total amount doesn’t exceed the child’s taxable compensation that year, or $6,500, whichever amount is less.
However, the limit on contributions to Roth IRAs begins to phase out after a certain level of modified adjusted gross income (MAGI).
In addition, for individuals covered by a workplace retirement plan (like a 401k), that can also impact your ability to contribute to a Traditional IRA at certain MAGI ranges.
While many employees have access to 401(k) plans, and substantially everyone can set up a Traditional IRA or Roth IRA…
As usual, the best tax breaks tend to be reserved for business owners and the self-employed.
According to the Bureau of Labor, nearly 16.2m people – roughly 10% of the population – are self-employed.
Many also create jobs for other workers, on the order of about 30 million in recent years – or roughly 30% of the U.S. workforce.
Interestingly enough, most self-employed workers (62%) say they are extremely or very satisfied with their job, compared with 51% of those who are not self-employed. They also express higher levels of enjoyment and fulfillment with their job.
Maybe it’s because of the enhanced wealth-building opportunities given to – as my dad likes to say – those who “sign the front of the paycheck, not the back.”
- SEP IRA: Unlike other workplace retirement plans, any employee enrolled in a SEP IRA does not make contributions themselves. Instead, the employer makes contributions for them directly.
For 2023, the employer can contribute up to 25% of an employee’s salary or $66,000, whichever is less (but with no catch-up provision).
- SIMPLE IRA: This plan allows both the employee and the small business owner or sole proprietor to make contributions.
For 2023, the contribution limit is $15,500, with a catch-up contribution limit of $3,500 for those over 50 (for a total of $19,000).
Last, but most definitely not least…
- Solo 401(k): This is a 401(k) plan for business owners who have no employees (however, spouses can also be included). As the employer, you can contribute up to 25% of compensation up to the annual dollar maximum of $66,000 for 2023.
Even better, as the employee, you can choose how you want to take the tax deduction – either as a Traditional Solo 401(k) (pre-tax contribution), or as a Roth Solo 401(k) (after-tax contribution).
Again, it is beyond the scope of this particular article to help you determine which of these plans is right for you…
The important thing to know is that every single one of these can be turned into a Self-Directed version of that plan – effectively “unlocking” your retirement funds for investments in the alternative assets you may be interested in.
Personally, I am a huge fan of the Roth IRA, for two simple reasons…
- You can withdraw any money you’ve contributed, at any time, with no penalty. I love this “savings account” feature of the Roth. It makes it psychologically easier to contribute my annual maximum to the account, knowing I can take it back out should I ever really need it.
- No RMD (until after the death of the owner). Thanks to the recently passed SECURE 2.0 Act, beginning in 2024, RMDs are eliminated for Roth 401(k)s as well.
But if you REALLY want to turbocharge your retirement savings plan – and you are also a business owner – you can combine a DC plan with a DB plan to save up to an additional $341,000 per year, with the ability to accumulate a maximum balance of $3.4 million in tax-advantaged retirement savings!
How is this possible?
Cash Balance Plans: The Ultimate Retirement Savings “Hack”
If you happen to be a business owner who is nearing retirement, you can combine a 401(k) profit-sharing plan with something called a Cash Balance Plan – which blends the features of a traditional pension plan with the look and feel of a 401(k)/profit-sharing plan – to squeeze twenty years of retirement savings into ten.
Cash balance plans, often referred to as hybrid retirement plans, are defined benefit plans that in many ways resemble defined contribution plans.
The number of active cash balance plans (those without zero participants) rose 70% between 2008 and 2012, and those plans held more than $800 billion in assets in 2012.
Professional practices currently account for the majority of cash balance plans, with the highest concentration in the medical field.
Cash balance plans are especially appealing to this demographic (e.g., doctors, dentists, lawyers, and accountants) because these professionals often earn much-higher-than-average annual salaries and get a later start in accumulating personal retirement savings.
Generally speaking, outside of the incredible tax deductions you can get from real estate, Cash Balance Plans provide one of the most extraordinary retirement savings “hacks” I’ve ever seen.
When a participant becomes entitled to receive benefits under a cash balance plan, the benefits that are received are defined in terms of an account balance.
For example, assume that a participant has an account balance of $100,000 when he or she reaches age 65. If the participant decides to retire at that time, he or she would have the right to an annuity based on that account balance.
Such an annuity might be approximately $8500 per year for life. In many cash balance plans, however, the participant could instead choose (with consent from his or her spouse) to take a lump sum benefit equal to the $100,000 account balance.
If a participant receives a lump sum distribution, that distribution generally can be rolled over into an IRA or to another employer’s plan if that plan accepts rollovers.
But if you want to make this strategy even juicer, you can also include a life insurance policy inside of the Cash Balance Plan.
Because the life insurance premiums are paid with funds from inside the qualified plan, they are tax deductible by the company.
Structurally speaking, the Cash Balance Plan itself becomes the owner of the insurance policy and the participant becomes the insured party. In addition, the participant can name a beneficiary (often the spouse or the children of the plan participant).
Why would you do this? According to Emparion:
- Personal cash flow is improved: The employee doesn’t have to use personal out-of-pocket dollars to pay premiums
- Tax efficiency is increased: Premiums are paid with pre-tax dollars; efficiency is increased if the employee’s health is poor or the policy is rated
- The employee doesn’t have to administer the policy: The plan trustee must administer it
- The employee can obtain the desired life insurance coverage without worrying about the premium cost
In addition, according to McHenry Advisors, it winds up costing up to 79% more to pay insurance premiums outside of the plan.
However, because premiums are paid using pretax dollars, the participant must recognize the economic benefit received as taxable income.
While there are, of course, notable downsides to putting a life insurance policy inside of a plan – namely, a life insurance policy cannot remain in a plan past the plan participant’s retirement – when structured correctly, it can serve as a useful retirement planning tool.
The key to all of this is understanding how the cash value of that life insurance policy works.
For example, If you die prematurely, your beneficiaries receive the death benefit (less any cash value in the policy) free of income taxes.
However, any taxable economic benefit paid by the participant while still alive can be recovered tax-free from the cash value. The remaining cash value can be held in the plan, or be taxed as a qualified plan distribution.
If you decide to retire, or the plan is terminated, you can still do some interesting things to take advantage of the accumulated cash value.
For example, the policy could be purchased by and transferred to an irrevocable life insurance trust. If properly structured, the death benefit will remain free of income and estate taxes.
Final Thoughts: Minimizing Tax Burdens Requires Long-Term, Forward-Looking Planning
As a general consideration, all of the very best investment returns require compounding interest over a long period of time.
For those who are interested in implementing any of these strategies to reduce their lifetime tax burden, it inevitably requires you to do what most people tend to struggle with…
Create a long-term plan and stick to it!
In essence, it means transitioning your mindset from a short-term-focused “retail” investor, who is very focused on “money now” concerns…
To a long-term-focused “institutional” investor, who is more concerned with building generational wealth, and solving “money later” concerns for the benefit of future generations.
However, the big challenge you’ll inevitably have to face is that – should you choose to go down this “Insider” route – you will be responsible for the investment decisions that need to be made within the context of these plans.
Obviously, we would have a clear conflict of interest at Equifund if we suggested that you tap into your retirement savings to invest in one of the offerings listed on our portal (of which early stage investments should be considered high risk and speculative in nature)…
Yet, it’s no secret that institutional investors choose private market investments for one simple reason: their historical track record of outperforming public market securities.
As always, please talk to a qualified financial advisor and/or estate planning attorney to discuss your individual needs.
In many cases, you’ll benefit from having a professional construct a financial model to help you understand the cost implications of these strategies…
And whether or not it “pencils out” to better returns for the added administrative burden.
