The Complete Guide to IRAs and IRA Investing: Wealth-Building Strategies Revealed

THE COMPLETE GUIDE TO

IRAS & IRA INVESTING: WEALTH-BUILDING STRATEGIES REVEALED

by Martha Maeda

The Complete Guide to IRAs & IRA Investing: Wealth-Building Strategies Revealed

Copyright © 2010 Atlantic Publishing Group, Inc.

1210 SW 23rd Place • Ocala, Florida 34471 • Phone 800-814-1132 • Fax 352-622-1875

Web site: www.atlantic-pub.com • E-mail: sales@atlantic-pub.com

SAN Number: 268-1250

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without the prior written permission of the Publisher. Requests to the Publisher for permission should be sent to Atlantic Publishing Group, Inc., 1210 SW 23rd Place, Ocala, Florida 34471.

Library of Congress Cataloging-in-Publication Data

Maeda, Martha, 1953-

The complete guide to IRAs and IRA investing : wealth building strategies revealed / Martha Maeda.

p. cm.

Includes bibliographical references and index.

ISBN-13: 978-1-60138-202-3 (alk. paper)

ISBN-10: 1-60138-202-2 (alk. paper)

1. Individual retirement accounts--United States. 2. Retirement income--United States. I. Title.

HG1660.U5M34 2009

332.024’01450973--dc22

2009039465

LIMIT OF LIABILITY/DISCLAIMER OF WARRANTY: The publisher and the author make no representations or warranties with respect to the accuracy or completeness of the contents of this work and specifically disclaim all warranties, including without limitation warranties of fitness for a particular purpose. No warranty may be created or extended by sales or promotional materials. The advice and strategies contained herein may not be suitable for every situation. This work is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional services. If professional assistance is required, the services of a competent professional should be sought. Neither the publisher nor the author shall be liable for damages arising herefrom. The fact that an organization or Web site is referred to in this work as a citation and/or a potential source of further information does not mean that the author or the publisher endorses the information the organization or Web site may provide or recommendations it may make. Further, readers should be aware that Internet Web sites listed in this work may have changed or disappeared between when this work was written and when it is read.

A few years back we lost our beloved pet dog Bear, who was not only our best and dearest friend but also the Vice President of Sunshine here at Atlantic Publishing. He did not receive a salary but worked tirelessly 24 hours a day to please his parents.

Bear was a rescue dog who turned around and showered myself, my wife, Sherri, his grandparents Jean, Bob, and Nancy, and every person and animal he met (well, maybe not rabbits) with friendship and love. He made a lot of people smile every day.

We wanted you to know a portion of the profits of this book will be donated in Bear’s memory to local animal shelters, parks, conservation organizations, and other individuals and nonprofit organizations in need of assistance.

– Douglas and Sherri Brown

PS: We have since adopted two more rescue dogs: first Scout, and the following year, Ginger. They were both mixed golden retrievers who needed a home.

Want to help animals and the world? Here are a dozen easy suggestions you and your family can implement today:

•  Adopt and rescue a pet from a local shelter.

•  Support local and no-kill animal shelters.

•  Plant a tree to honor someone you love.

•  Be a developer — put up some birdhouses.

•  Buy live, potted Christmas trees and replant them.

•  Make sure you spend time with your animals each day.

•  Save natural resources by recycling and buying recycled products.

•  Drink tap water, or filter your own water at home.

•  Whenever possible, limit your use of or do not use pesticides.

•  If you eat seafood, make sustainable choices.

•  Support your local farmers market.

•  Get outside. Visit a park, volunteer, walk your dog, or ride your bike.

Five years ago, Atlantic Publishing signed the Green Press Initiative. These guidelines promote environmentally friendly practices, such as using recycled stock and vegetable-based inks, avoiding waste, choosing energy-efficient resources, and promoting a no-pulping policy. We now use 100-percent recycled stock on all our books. The results: in one year, switching to post-consumer recycled stock saved 24 mature trees, 5,000 gallons of water, the equivalent of the total energy used for one home in a year, and the equivalent of the greenhouse gases from one car driven for a year.

Trademark Disclaimer

All trademarks, trade names, or logos mentioned or used are the property of their respective owners and are used only to directly describe the products being provided. Every effort has been made to properly capitalize, punctuate, identify, and attribute trademarks and trade names to their respective owners, including the use of ® and ™ wherever possible and practical. Atlantic Publishing Group, Inc. is not a partner, affiliate, or licensee with the holders of said trademarks.

The Yahoo!™ name and logo is a trademark and property of Yahoo!™.

The T. Rowe Price™ name and logo is a trademark and property of T. Rowe Price™.

The Capital One™ name and logo is a trademark and property of Capital One™.

The Quicken™ name and logo is a trademark and property of Quicken™.

The information included in this book is from the IRS Web site and is accurate as of September 2009.

Dedication

This book is dedicated to all the men and women who have devoted themselves to making sure that economic opportunity exists for everyone and not just a privileged few.

Table of Contents

Foreword

Introduction

Chapter 1: What is an IRA?

Chapter 2: Traditional IRAs

Chapter 3: Roth IRAs

Chapter 4: IRAs, 401(k)s, and Other Retirement Plans

Chapter 5: How to Set Up an IRA

Chapter 6: Your Portfolio

Chapter 7: Self-Directed IRAs

Chapter 8: Early Withdrawals

Chapter 9: Required Minimum Distributions (RMD)

Chapter 10: IRAs and Your Taxes

Chapter 11: Planning for Your Beneficiaries

Chapter 12: When You Inherit an IRA

Chapter 13: Special Circumstances

Chapter 14: Your IRA and the Economic Crisis of 2008 – 2009

Appendix A: Acronyms

Appendix B: Glossary

Appendix C: Useful Web Sites

Appendix D: Federal Government Publications and Forms

Appendix E: Lifetime Expectancy Tables

Bibliography

Author Biography

Foreword

In the early ’90s, one of the last things on investors’ minds was saving for retirement. With the stock market soaring, market dabblers and hard-core players alike were too busy enjoying the sweet fruits of their financial labors. Pre-millennial investors were much more inclined to pick up a second home in Aspen than a book on IRAs.

But times have changed. More often than not, tax-deferred accounts in the past were seen as an added bonus — nice, but not necessary. Now, the special status given to IRAs can mean the difference between having a satisfactory retirement and having any retirement at all.

Whether individuals consider themselves investors or not, today’s citizens need as much information as possible in order to navigate the world — oftentimes, alien world — of retirement accounts. There are Roths, SEPs, SIMPLEs, 401(k)s, self-directed IRAs, and many more vehicles to choose from. Just deciding which account to open can be difficult enough, let alone understanding what investments are available to each account, how they work, what fees and taxes may be involved, and what profits could be made.

Furthermore, baby boomers leaving the workplace in record numbers will soon have to make a decision about their 401(k)s and other corporate-sponsored retirement accounts: keep them linked to their former employer’s plan (if given that option) or roll them into their own IRAs. Most financial experts agree that one of the best ways to aggressively grow a retirement account is to roll one’s 401(K) into a personal IRA after terminating employment. However, after investing for years in company stock or simply choosing a conservative, modest, or aggressive portfolio, most adults are neither prepared to make independent investment decisions nor make them in the wisest way.

For these reasons, and many more, Martha Maeda’s The Complete Guide to IRAs and IRA Investing is essential first-aid for any American looking forward to a happy retirement. This, quite frankly, is one of the most thorough books available on Individual Retirement Accounts.

Other than a few specialty books on purchasing alternative investments with IRA money, I have been hard-pressed to find a book that addresses both traditional and non-traditional investments available to an IRA. Thankfully, this book does. Surprisingly few people know that they can invest in real estate with their IRA, or that they can build their nest egg by making private loans (even small ones) with the money they have in their account. The fact that the average American is unaware of these kinds of options is what bars most people from realizing their full earning potential within their IRAs.

As the CEO of a leading, truly self-directed IRA services provider, I have seen firsthand the significant benefits a truly diversified retirement account can provide. One of my favorite proverbs has always been, Don’t put all your eggs in one basket. Along with that, I have also preached, Look before you leap. Ms. Maeda sees these two cautionary adages as necessary keys to wisely managing one’s IRA, and she offers excellent commentary on the need for both broad diversification and an understanding of one’s personal risk tolerance.

Having the flexibility to move IRA funds from one investment to another is an absolute necessity in today’s fluctuating market. But to do so intelligently requires the kinds of insight and guidance only a strong comprehension of IRAs and IRA investments can provide. From knowing what a stock is to understanding prohibited transactions for IRA investments in real estate, The Complete Guide to IRAs and IRA Investing provides an excellent reference no matter what direction an investor decides to go.

There is a familiar saying in the retirement industry: No one cares about your retirement account as much as you do. Judging by her carefully researched and conscientiously written book, however, it would appear that Ms. Maeda is running a close second.

David Nilssen

CEO, Guidant Financial Group™

www.guidantfinancial.com

888.472.4455

info@guidantfinancial.com

Foreword Author Biography

David Nilssen is the CEO and co-founder of Guidant Financial Group™. Guidant structures customized accounts that allow individuals to personally direct their retirement monies into traditional (stocks, bonds, mutual funds) and non-traditional (real estate, tax liens, personal loans, etc.) investments. A strong believer in broad diversification and hands-on investing, Nilssen is regularly invited to speak at top venues throughout the country as a leading expert in the creative utilization of self-directed IRAs.

Nilssen pioneered the concept of one-stop shopping within the self-directed industry. Under his leadership, Guidant developed an innovative service that includes all rollover steps, customized account structuring, discounted custodial fees, checkbook control, outside attorney consultations and lifetime customer service. The concept has made Guidant one of the fastest growing companies within the industry, and its success has earned it top national and regional recognition, including U.S. Chamber of Commerce Blue Ribbon Small Business; Washington CEO Magazine Best Companies to Work For; and U.S. Chamber of Commerce Northwest Regional Small Business of the Year. In 2007, the SBA named Nilssen the co-recipient of the national Young Entrepreneur of the Year award and, in 2008, he was named an Ernst & Young Entrepreneur of the Year Award Finalist for the Pacific Northwest.

An avid investor himself, Nilssen has purchased millions of dollars in real estate and was instrumental in the development of a national sales team with a production of more than $250 million in gross revenue. He has also helped to initiate many businesses within the service industry, including a real estate agency/property management firm and real estate development company. Nilssen has been highlighted in such publications as Fortune Magazine, the Chicago Tribune, the Los Angeles Times, TheStreet.com and The Wall Street Journal.

Table of Contents

Introduction

Americans are becoming increasingly responsible for funding their own retirement and old age through personal savings. Today, only 25 percent of U.S. companies have structured pension plans for their employees. Social security and Medicare benefits, though helpful, are not adequate to support a comfortable retirement, and many question whether they will even exist in a few decades. To encourage individuals to save for retirement, the U.S. government has created a number of tax-advantaged plans for working people, including traditional IRAs, Roth IRAs, and qualified retirement plans such as 401(k)s and 403(b)s.

These plans allow workers to delay paying taxes on a portion of their income that goes into an investment account, where it stays for the rest of their working life, growing at a steady pace. The tax deferment means that an eligible individual can have an additional 15 to 25 percent of his or her savings available to invest over those decades. An experienced investor knows that this extra investment, compounded over several decades, means a significant increase in the balance of a retirement account.

According to a study by the Investment Company Institute, The Role of IRAs in U.S. Households’ Saving for Retirement 2008, only four out of ten U.S. households, or 47.3 million households, held some type of IRA account in 2008, up from 46.2 million in 2007 and 38 million in 2000. Most of these accounts were either employer-sponsored IRAs or rollovers from 401(k) plans. It is alarming that only 14 percent of eligible households made a contribution to any type of IRA in the 2007 tax year. This indicates that, unless they are participating in some kind of employer-sponsored plan, most families are not inclined to put aside savings for retirement. The study also showed that families with higher incomes were more likely to make an annual contribution to an IRA. Retirement savings are a low priority for a family making barely enough to pay for basic needs, school expenses, or a down payment on a house. Many people tend to think that they can begin saving for retirement later on, when their financial circumstances improve. The number of people saving for retirement increases with age. In 2007, households in which the financial decision maker(s) was older than 45 owned two-thirds of all IRAs.

The 2007 Retirement Confidence Survey by the Employee Benefit Research Institute (EBRI) and Matthew Greenwald & Associates reported that half of workers between the ages of 35 and 44 and a third of workers aged 45 and older had less than $25,000 in savings, but 27 percent of all workers still felt very confident that they would have enough to live on after retirement. By 2008, that number had dropped to 18 percent, a healthy sign that Americans are waking up to reality. The crisis that is developing now will burst upon us in 20 years, when destitute retirees will be forced to turn to their children or rely on welfare for their basic needs. You will not be among them because you are reading this book today. You will learn how to calculate your future needs and how to initiate a savings plan that will allow you to make regular contributions to IRAs and other investment and savings accounts. You will learn how to make the most of the tax benefits IRAs offer, and how to avoid pitfalls that may cause you to lose large chunks of your retirement savings to taxes. Later chapters will explain how you can increase your wealth by judicious management of the investments in your IRA, and how you can ensure your surviving spouse and heirs derive the maximum benefit from your hard-earned savings.

You do not have to be a financial genius to retire wealthy; all you need is an understanding of the rules governing IRAs and some basic principles of investing. You can set a plan in motion, then sit back and let it run with only occasional attention until the day you need to begin withdrawing money. You can choose to manage your own IRA, or you can place your investments in the hands of a capable financial advisor, bank, or investment company. You can even use the funds in your IRA to invest in real estate or to purchase a business that you manage yourself. This book will help you recognize when you might need professional assistance from a lawyer or a tax specialist to deal with special circumstances or plan your estate. Start today to take charge of your finances and plan for a comfortable and enjoyable future.

, you will find an important tip. These tips, found throughout the book, offer helpful information on a wide variety of topics. However, this book is intended only as a starting point to help you understand the opportunities IRAs offer and the pitfalls that may arise as a result of the IRS rules governing them. When you have identified your priorities, you will probably want to seek more information or professional advice. Some of the topics covered in the chapters of this book are complex enough to merit entire books of their own. References throughout the book and a list of useful Web sites at the end will help you to carry out your own research. It is my hope that this book will enable you to succeed, no matter what your income or your financial circumstances, in achieving your goals.

Important Tip

Wherever you see a box like this, you will find an important tip. These tips, found throughout the book, offer helpful information on a wide variety of topics.

Table of Contents

Chapter 1: What is an IRA?

Your Ticket to a Secure Financial Future

An Individual Retirement Arrangement (IRA) is a special type of savings and investment account that increases the amount of money available to an individual in retirement by means of certain tax advantages. The U.S. Internal Revenue Service (IRS) strictly regulates these accounts to ensure they are not used for the wrong purpose by limiting annual contributions, imposing penalties for early withdrawal, and mandating yearly withdrawals after retirement age. The rules governing IRA accounts change frequently and are sometimes altered to compensate for the effects of specific events such as 9/11, Hurricane Katrina, and the economic crisis of 2008 - 2009.

There are several types of IRAs, including employer-sponsored plans, individual accounts, plans for owners of small businesses, and even accounts for education savings. Most banks and financial institutions offer IRAs with specific investment choices, but an IRA can hold other types of financial instruments, such as real estate and tax liens. Holders of IRAs may manage the investments themselves or follow an investment plan a financial institution offers. An IRA is designed to fund an individual’s retirement and old age, but any balance remaining after the account holder’s death can be maintained in a tax-advantaged account by his or her heirs.

History of IRAs

The concept of an individual retirement account is relatively new. It was not until the 1970s, when the average life expectancy had increased dramatically and many corporations realized their employee pension plans would not be able to continue funding promised retirement benefits, that the idea of having individuals contribute to their own retirement savings plans came into prominence. In 1974, Congress introduced tax-advantaged retirement savings accounts for individuals. It is only during the past decade that the first long-term IRAs have matured, demonstrating the power of tax-deferred savings.

Pension Plans in the United States

The numbers of retired workers in the United States began to increase at the beginning of the 20th century after the Pension Act of 1890 granted old-age pensions to all veterans over the age of 65 who had served in the Union army during the Civil War. Confederate states provided more moderate pensions for Confederate veterans. Early in the 20th century, state and municipal governments began providing pensions for their employees, firemen, and police officers. In 1916, 33 states offered pension for retired teachers; by 1934, 28 states provided support for the elderly indigent.

The American Express Company set up the first formal private pension plan in the United States in 1875. Railroads began offering pensions to employees who retired after 30 years of service, and other private companies saw pensions as a means of encouraging employee loyalty. Employers completely financed early pension plans and these plans were either funded — meaning an investment account accumulated a balance from which employee payments were eventually drawn — or unfunded — meaning the company made guaranteed payments from its current cash. In a funded plan, balances were typically placed in safe investments that produced a dependable return. These types of pension plans are also called defined benefit plans because they define a specific benefit for the employee at the occurrence of a specific life event such as retirement, disability, or death.

The 1926 Revenue Act further encouraged the establishment of pension plans by excluding income earned in pension trusts from taxation. Labor unions began organizing pay-as-you-go pension plans for workers in smaller companies that did not have retirement plans. These and other unfunded plans did not survive the Great Depression, but many independently funded private plans continued. The Social Security Act of 1935 extended benefits to those not covered by private pension plans. Even as social security expanded, private pension programs continued to grow. When wages were frozen during World War II, private pension plans became an incentive to attract workers in a tight labor market and a tax shelter from high wartime taxation rates. By 1960, 23 million people — nearly 30 percent of the nation’s workers — were covered by private pension plans. In 1963, Keogh, or H.R.10, plans were established to allow self-employed individuals to save for retirement.

During the 1970s, many corporate entities realized that their plans would eventually become bankrupt and that they would be unable to provide retirement benefits. As average life expectancy increased, employers who chose to continue funding pension plans bore the risk that retired employees would outlive the funds allocated to them and the employer would have to make up the difference. The inability to quantify such a risk proved unacceptable to many businesses, and they began to look for ways to change the pension system. Congress began searching for solutions that would help businesses while protecting employees who had been promised a pension.

Social security may become insolvent.

Social security resembles a defined benefit plan. Beneficiaries receive payments from funds that currently active businesses and employees contribute to. Social security benefits are an important source of retirement income for many Americans, particularly in low-income, elderly households, but there is a real danger that the program will become insolvent. As baby boomers approach retirement, there will be more benefits being paid out than money coming in, and additional sources of funding will have to be found for the program to continue. Today’s workers cannot rely on social security for a secure future.

Over the last three decades, employers shifted the risk that a pension fund might perform poorly in the stock market and be inadequate for workers’ needs by moving from defined benefit plans to defined contribution plans, in which the employer contributes a specified amount to a pension fund on behalf of an employee but does not guarantee the outcome. Plans such as the 401(k) in which an employee makes tax-deductible contributions — sometimes with matching funds from the employer — and is given a selection of investments to choose from are now popular.

Employee Retirement Income Security Act (ERISA)

In 1974 the Employee Retirement Income Security Act (ERISA) was enacted, requiring employers to follow funding requirements and to insure against unexpected events that could cause the insolvency of their pension plans. ERISA also introduced IRAs to encourage employees to save for their own retirements. A tax incentive allowed workers to reduce their taxable income by the amount they contributed to their IRAs, up to an annual limit. Workers could contribute whichever was less, $1,500 or 15