Chaim Frishman’s bank had sent him a brochure offering access to a tax-preferred individual retirement account (IRA). This advertisement surprised him because December 31 had just passed and it was too late to defer taxable income. He knew that people used IRAs to buy mutual funds with pre-tax dollars, but he’d never seriously considered using one. As a real estate investor, he didn’t want to tie up his capital until retirement or invest in mutual funds. Anyway, since IRAs seemed to have an annual deposit limit of just a few thousand per person, the whole thing looked like too much of a bother.
Is Chaim’s view on IRAs correct?
He got zero out of four right.
Chaim is wrong on each one of his assumptions; a retirement account is definitely something he should look into. In fact, because he is a highly taxed investor, he has more to gain from the fantastic flexibility available through the wide variety of tax-busting IRAs. Almost anyone with savings available to invest should discuss with their accountant or financial advisor how they can take advantage of one of the best loopholes in the tax code. Let’s clear up Chaim’s misconceptions one by one.
IRA myth #1: Retirement accounts are for small money.
While the average IRA balance is about $150,000, Senator Mitt Romney is the most significant proof that IRAs are definitely for rich people too. In 2012, as a presidential candidate, Romney disclosed ownership of an IRA worth as much as $100 million! How did he accumulate so vast a sum when the annual IRA contribution limit is merely a few thousand dollars? While regular IRAs’ maximums are indeed modest (for 2023, $6,500 per person under age 50 or $7,500 over 50), there are other types of IRAs that enable putting away tens of thousands of dollars a year, tax-deferred (for example, SEP IRAs and SIMPLE IRAs, as well as 401(k) plans). Those with even more to invest can add a pension plan to their tax strategy, which enables much larger annual deferrals in specific scenarios. If IRAs are good for people like Romney, perhaps Chaim should take another look.
IRA Myth #2: IRAs only invest in mutual funds.
The Wall Street Journal estimated that even if Romney maximized his IRA contributions, the amount he’d have deposited would equal a few million tops. The way the savvy investor really maximized his tax deferral was by placing his IRA money into private investment funds managed by his company, Bain Capital. These exclusive opportunities enjoyed double-digit returns, and, unhindered by taxation, Romney’s savings multiplied manifold. Chaim can also use certain types of retirement accounts (self-directed IRAs or 401(k)s) to invest in real estate, small businesses, gold, tax liens, notes, or virtually any venture. The tax-deferred structure of IRAs is actually most useful for investments with significant cash flow, high growth, and resulting outsized tax burdens, such as real estate flipping or notes versus mutual funds, which are relatively tax-efficient anyway. Self-directed retirement accounts do have certain restrictions—you can’t lend the money to your son or use it to buy yourself a vacation home, for example.
IRA Myth #3: IRA money is locked up until retirement.
Early withdrawals (made before age 59.5) from a traditional IRA are taxed and also penalized with a 10% added charge. Especially in regard to more substantial sums, it’s understandable that Chaim doesn’t want to lock up his money until retirement. However, if he deposits after-tax money into a Roth IRA (directly or via a backdoor loophole), he can remove the principal at any time, penalty and tax-free. There are also penalty exemptions for money withdrawn for excessive medical bills or to cover qualified higher-education expenses for children or grandchildren. If his son attends BMG’s kollel, Chaim can even pay for some of his rent and sefarim from his retirement accounts, penalty free! Because many mosdos are eligible (at the beis midrash and seminary level), even the profits within retirement accounts aren’t nearly as locked as Chaim imagines.
(Keep in mind, though, that a 529 college plan is more advantageous taxwise for education expenses than retirement accounts.)
IRA Myth #4: IRA time is until December 31.
Deciding which type of IRA to use and how much to put in each (you can have more than one) can be a bit complicated. Realistically, many people don’t decide to fund an IRA account until they are advised to do so at tax time. The good news is that you can make your past year’s (2023) IRA contributions until your tax-filing deadline in the current year (2024), even though for all other aspects the books are sealed. This rule enables you to seek your tax advisor’s input before deciding how much to contribute to an IRA. The result is that even within a traditional IRA (not the SEP, solo, or 401[k]), Chaim can make deposits equal to four times the annual limit in early 2024, consisting of 2023 and 2024 contributions for him, and the same for his wife (in an IRA opened in her name). It’s hard to make a living, but using the tax advantages of IRAs can make it a bit easier.
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