Revving Up Your Retirement Accounts
October 07, 2022
By Daniel Gibson
As you accumulate assets in your retirement accounts, have you ever wished you could utilize these accounts more effectively? Here are three strategies that could help you do just that.
Self-Directed IRAs (“SDIRAs”)
SDIRAs are a type of IRA that can hold a variety of alternative investments normally prohibited from regular IRAs. Although the account is administered by a custodian or trustee, it's directly managed by the account holder—hence the name "self-directed." Thus, the SDIRA gives you more control over your retirement savings.
Investment options in these accounts are almost unlimited, provided you meet certain guidelines. Some of the diverse alternative investments available via the SDIRA are:
- Crypto currency
- Precious metals such as gold, silver and palladium
- Private notes and loans
- Private stock offerings
- Raw land
- Residential, farmland and commercial real estate
- Tax certificates; tax liens
- Trust deeds, mortgage and mortgage pools
Most banks and financial institutions tend to limit your retirement account options to bonds, mutual funds, ETFs or stocks not because they are limited to these investments, but because they have no financial interest in allowing account holders to invest in the aforementioned alternative investments.
The SDIRA is either a traditional IRA (to which you make tax-deductible contributions) or a Roth IRA (from which you take tax-free distributions). Self-directed IRAs are best suited for savvy investors who already understand alternative investments and want to diversify in a tax-advantaged account.
Here’s how to create an SDIRA:
- Open a self-directed IRA account and identify a qualified SDIRA custodian.
- Fund the account. Transfer funds from an existing retirement account and make contributions to your newly formed SDIRA.
- Identify investments.
- Determine ways to fund the purchase of investments. Instruct the SDIRA custodian to purchase the investments. This can get expensive and time consuming because the custodian will normally charge transaction fees and needs to approve investments. Alternatively, form a single-member limited liability company (“SMLLC”) with the SDIRA as the owner. Designate the beneficiary (you) as the manager of the SMLLC and its checkbook. Have the IRA custodian fund the SMLLC. Then you, as the manager, are free to make investments through the SMLLC that is owned by the SDIRA.
There are strict rules that need to be adhered to when working this strategy. Running afoul of these rules could have a catastrophic effect on your retirement accounts.
HSA – Super IRA
A Health Savings Account (“HSA”) is a funding account for those with high-deductible health plans (“HDHP”). For 2022, HDHPs are defined as health insurance policies that have annual deductibles of at least $1,400 (individuals) and $2,800 (families), with maximum out-of-pocket limits of $7,050 (individuals) and $14,100 (families) per year. Out-of-pocket costs can include deductibles, copayment and coinsurance but do not include premiums.
The HSA is sometimes referred to as a medical IRA on steroids. Taxpayers can deduct the contribution to the HSA but distributions, if made for qualified medical expenses, are free from any penalties or taxes. Some utilize the account to fund current medical expenses. Others avoid distributions during their working years to have an account they can tap into during their senior years when income streams are fixed. They can either reimburse themselves for medical expenses paid for during their working years or pay for current medical expenses in their senior years. It is crucial to keep receipts for these medical expenses to support HSA disbursements. You can contribute to your HSA if you are an eligible individual and have not enrolled in Medicare Part A, B or D. If you turn age 65 and are still working and are not enrolled in Medicare, you are still eligible to contribute to your HSA.
The Mega-Backdoor Roth Conversion
For most employees, the limit on elective contributions to an employer-sponsored retirement plan is $20,500 (plus an additional $6,500 for those age 50 or older) for 2022, which is the amount one can contribute to a traditional 401(k) or Roth 401(k). But for those with employer-sponsored plans that allow it, employees can make after-tax, non-Roth contributions to fully fund their 401(k) account up to $61,000 ($67,500 for those age 50 or older) for 2022. Then, the employee can either convert those dollars to a Roth 401(k) or, if available, take an in-service distribution from the plan and roll over the money into a Roth IRA. This strategy has become known as the mega-backdoor Roth conversion, because after-tax dollars are used and the tax consequences are minimal.
If viable, consider a backdoor Roth IRA conversion. However, keep in mind that this may not be done totally tax-free because of the pro rata rule that essentially prevents individuals, who already have traditional IRAs, from being able to choose whether to withdraw pre-tax or only after-tax money by mandating distributions be partially taxable based on a pro-rata formula.
Fortunately, for mega-backdoor Roth 401(k) converters, the pro-rata rule does not apply if the employer holds separate accounts for pre-tax money and after-tax money. Therefore, the taxable portion of any conversion or distribution would only be on any pre-tax earnings that existed in the after-tax contribution account. Thus, converting money held in the after-tax account to a Roth account should occur shortly after contributing the after-tax funds to avoid a build-up of pre-tax earnings.
It is highly suggested that you consult with a qualified tax professional prior to implementing any of the above strategies.