Your Retirement Plan And Your Wealth Strategy
Last week I shared the different types of capital that can help get you started on your wealth building.
One of the most popular questions I receive during these monthly coaching teleconferences is:
I want to use the money in my retirement plan for a specific investment. Should I make the investment inside my retirement plan or should I distribute the money from my plan and make the investment outside of my retirement plan?
My answer? It depends! It depends on several factors.
A Few Basics
Before sharing some of these factors, let's review a few basics.
First, the term "retirement plan" covers a huge range of plans - each of which has their own specific set of rules. You will first want to determine what your investment options are in your retirement plan. Some retirement plans, like an employer sponsored plan, such as a company 401(k), limit your investment options. Other plans, such as a self-directed IRA, provide a broader range of investment options.
Second, while the rules vary by the specific type of retirement plan, in general, if money is distributed from a plan early, meaning before the date allowed by the government and/or employer rules, then the distribution will most likely be subject to penalties.
Finally, depending on the type of plan or when the distribution is taken, retirement plan distributions may be subject to income tax.
It's important to understand how these basics apply to your particular retirement plan. Once you understand the basics, then consider the specific factors that may impact your decision.
Here are just a few factors to consider.
Your Personal Situation
Many factors are specific to each person. For example:
Is your tax bracket low or high?
When can you take distributions from your plan without penalty?
What is your expected return on investment inside of your plan?
What is your expected return on investment outside of your plan?
What will you do with the investment long term?
Type of Income
What type of income will your investment produce? Investments can produce different types of income including ordinary income, interest income, dividend income, rental income and capital gain. Some income types work very well inside a retirement plan, and others may cause your plan to pay tax.
Leverage
Does your investment involve leverage (debt)? If your investment strategy involves debt, then this is a critical factor to understand.
The tax implications of a retirement plan owner guaranteeing a loan made to his or her plan are so costly that it makes no sense for an owner to do this. Many lenders, however, are not willing to make a loan to a plan without the guarantee. Lenders who are willing to lend to a retirement plan without a guarantee are usually not willing to lend as much as they would if there were a guarantee.
It is extremely important to understand your leverage options inside and outside of your plan before moving forward with your investment.
Tax Benefits
While retirement plans are often viewed as a great tax deferral vehicle, many tax benefits can be lost in retirement plans.
For example, if a distribution is taxable from a retirement plan, it is taxable at ordinary income tax rates. This is true even if the income inside the plan was capital gain income - which outside of a retirement plan has lower preferred tax rates. The tax benefit of the lower rate is lost.
Another example is investments that create losses. Some investments, like rental real estate or oil and gas, often create losses for tax purposes even though they generate positive cash flow. Losses inside a plan are typically lost because the retirement plan usually doesn't have any tax for the losses to offset.
by: Tom Wheelwright
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