Self Directing Your Retirement Plan

Rethinking Your "Retirement Plan"

2009-11-22T02:28:00Z

America is Clearly Transitioning toward a New Paradigm for Retirement

I read an online article at a blog called " GoToRetirement " this week that really got me thinking about what it means to have a "Retirement Plan” and a better understanding of planning for retirement. I encourage my readers to review this blog entry and consider how the points raised apply to each individuals current situation.

The sad fact is that most people between the ages of 50 and 60 still do not have a formal retirement plan. Recent economic events have impacted this age group more than almost any other, since most in this group have been hit with a double whammy of declining home equity and declines in the value of traditional securities investments in a 401k or other qualified pension plan, if they have an employer that still offers one (or still have a job). They are also the same group of people that has been setting records for consumption, borrowing and spending for years. Now they are a key target group for employers seeking to cut costs and pension liabilities as many are highly compensated (or better compensated because of seniority) and nearer to retirement.

For people under 50 the recession has reinforced the need to give more thought to what it means to have a formal, written "Retirement Plan". This is a good thing since most Americans devote less time to planning for retirement than they do to plan for annual vacations. I know it is far more fun to think about and plan for travel fun and games than to devote time to thinking about an uncertain future, but at the same time people of all ages should at least consider the hard facts of retirement in the United States. Take a look at a chart I have used before, which reflects data from before the start of the recent recession (the good old days).

This information is even more important for people under 50 because they must become more involved in planning for their own retirement, in order to have one.

In the "good old days" of retirement, only 2% of retirees were self sustaining and I suspect that most of those were people who had earned far more than they needed to spend plus those who knew how to invest. Given recent events, a very high percentage of people currently between 50 and 60 are probably facing the reality of working well into their 70's in order to build retirement reserves to reasonable levels. They will also have to spend far less and save much more than they ever did. This means a lower standard of living now in return for a better standard of living later. This will be the toughest financial challenge the Baby Boomers and Echo Boomers will ever face.

What Ever Happened to Self Reliance?
Several generations born after 1950 have relied on Corporate “generosity” or on the mistaken belief that a benevolent government would continuously increase the benefits available to retirees through Social Security and somehow guarantee those benefits in the face of a declining workforce and an ever increasing base of retirees who are living longer than ever after retirement. In both cases Americans are in for a huge shock.

The Corporate retirement promises made to employees (when America was the dominant and most profitable industrial power in the world) have already been broken (think Enron, WorldCom and now the struggling U.S. Automakers or Airlines). Ridiculous actuarial assumptions of unsustainable corporate contribution levels, investment results and continuous growth of new employees to backstop promises to old employees have fallen far short of reality. Today profit margins for U.S. industry must be competitive with global competitors. Global labor rates are often below our poverty levels and offering fewer (if any) benefits. This means that less domestic corporate profits are available to fund pension liabilities for past and future employees of U.S Industry. The general decline of U.S. manufacturing jobs means less new funding for existing plans that were designed to need ever more new funding from a growing, young work force.

Government Retirement Plans are Unsustainable
Those who have been part of State and Federal retirement programs who have retired or will retire in the next few years can expect to receive pension benefits that far exceed the contributions they made. This is especially true given the actual investment results obtained by pension managers. Fortunately for these employees, the failure of the pensions they participate in is backstopped by taxpayers who will never receive a dime of benefits from the plans they will be forced to backstop through new taxes. In California the $50 Billion of recent financial losses in the CalPers pension program is a perfect example of this scenario. Promises of 100% of salary at retirement, with Cost of living increases and full medical coverage will probably be met, but at what cost to taxpayers who are not participants in state pension plans? Clearly new hires coming to work for a cash strapped state governments will eventually have to make concessions in the structure of their pension plans to accommodate financial realities, if they are even offered a pension plan.

Of course anyone who is qualified or interested has (or had) the option of going to work for the government in order to obtain the benefits of long term employment by the government. But what about the taxpayers and entrepreneurial business owners who do not work for the government who will have to pay more taxes to fund government pension liabilities that could go to fund their own retirement goals? How far will “free market” business people go to financially support the pension miscalculations and investment mistakes of government retirement plans?

In recent years, government employment has skyrocketed, but not all jobs include benefits at “grandfathered” levels and many positions (e.g. postal employees) are being offered on a contract basis with no benefits. Have you noticed too that the Government calculations for Cost of Living Adjustments conveniently show that there is no need for an increase in current payouts? Somehow the calculations have the result of saving the government hundreds of millions, perhaps billions of dollars in Cost of Living adjustments. Have you also noticed that most products and services for retail consumers are more costly than ever?

So what about those of us who have been most affected by the recent harsh recession or those of us who recognize the necessity of facing harsh facts about our age and financial position? The bottom line is that we must start investing time in a true plan for retirement in order to have resources for a reasonably comfortable retirement or any retirement at all.

Are IRA Assets Protected From Creditors?

2009-09-01T19:58:00Z

Protection Varies by State and Type of Plan

Most people assume that the assets in an IRA are 100% protected from Creditors. Almost everyone remembers that the NFL Pension assets of accused murderer and ex-football star O.J. Simpson were protected against a civil action by the family of his ex-wife. His plan was a Qualifed Plan and not an IRA and the pension assets he had accumulated as a player were protected from garnishment in that suit. Your legal and/or tax professionals should be familiar or get familiar with State statutes that may override Federal protections in certain, limited situations.

Asset protection of pensions includes some gray areas of the law and the treatment of retirement assets is affected by several factors. The Bankruptcy Reform Act of 2005 provided a good deal of clarification regarding access to assets in both Qualified and Non-Qualified Plans. There is also a useful discussion of asset protection in various plans at: http://www.petershannonco.com/timely_tax_topics2.htm .

The two primary considerations are:
1. If the plan is a Qualified Plan, subject to Federal ERISA rules
2. The treatment of Non-Qualified Plans (IRA's and Roth IRA's) is subject to the interperetation by the State Government where the IRA plan holder lives.

In California, information on the treatment of plan assets can be found at: http://www.journalofaccountancy.com/Issues/2006/Jan/ProtectRetirementAssets.htm . The chart below summarizes the treatment of plan assets under federal and state law. Please note that there are exceptions to exemptions for QDROS and other situations.

While the Bankruptcy Reform Act of 2005 did clarify and appears to have improved the asset protection for Non-Qualified Plans, the protection is not absolute.

Budgeting for Pension Contributions

2009-08-03T16:44:00Z

Anyone Can Save to Make Pension Contributions to a Self Directed Retirement Plan

If they really want to, any working person can find a way to save for the future in the form of tax deductible contributions to an IRA, or for the self employed, an Individual (k) plan or other Self Directed Retirement Plan (SDRP). After many presentations on SDRP's I get audience members pulling me aside to tell me that what I am saying makes sense, but that they don't make enough or are simply unable to save for retirement.

Because I already know the answer, I always ask them a direct question; "Do you have a written monthly budget that you update weekly?" 99% of the time, they say, "no I do not, or I've been meaning to do that" or something similar. Since there are 52 weeks in a year, if you find $50 of fluff somewhere in your budget you can make a $2600.00 contribution to your IRA and do it. Once you have established an account, most IRA Administrators/Custodians will gladly accept a monthly check with a notation on the check "Current Year IRA Contribution". You do not need to accumulate a lump sum before sending it in, just send it as you get it.

Almost anyone how invests time in creating and maintaining a budget starts to save money. Of course before you send money, you have to find it. One way to do that is to create a simple budget. Take a look at the Webinar I recently recorded at SustainedAbundance.com on Personal Budgeting and decide what type of retirement you really want.

Frequently Asked Questions: Real Estate Purchase in an IRA

2009-07-29T01:10:00Z

More answers to your many questions on Purchasing Real Estate in an IRA!

The response to my entry on the direct purchase of Real Estate using IRA assets was amazing. There were so many good questions that I decided to share some questions and answers. Let me know if you have more questions. Please note, we will use the word IRA, but many other types of Self Directed Retirement Plans (SDRP's) allow the direct purchase of Real Estate.

Q: We are getting ready to purchase some investment rental properties with our self directed IRA’s. Can we discuss the following questions about our new self direct IRA?

A: Yes, but remember I cannot help you with tax, legal or investment advice as I am not not a professional advisor, simply an educator. If your current professionals do not know the answers, refer them to me and I can help them find that information or you can find new advisors. In this Blog, I do not recommend or point to any investments or advisors.

When real estate sales people invite me to speak about Real Estate in SDRP's, they generally do not want me to go deeply into rules on a leveraged purchase or Prohibited Transactionsand limit my time at the podium. When working with any vendor or sponsor of any investment, you should be doing your own due diligence on all parties involved. You should research any vendor or sponsor you are considering investing with. I have written an article on personal due diligence that you should read and consider before investing with anyone.

You can download more FAQ’s on Real Estate in an IRA and there is a decent article on UBIT at http://www.investorsinsight.com/blogs/retirement_watch/archive/2009/04/03/dos-and-don-ts-of-ira-investing.aspx

Q: If we purchase investment rental property, I know you mentioned that the IRA requires a 35% down payment for a loan, is there a requirement on how many years the loan documents are for (15 or 30 years)?

A: It is not the IRA that requires 35% down, but the commercial lenders who do the non-recourse loans required in an IRA or other SDRP. The lenders set the terms and conditions for the loan and I am aware of two larger lenders in this niche. You can see their websites at http://www.iralending.com/ and at http://firstwesternfederal.com/IRA_Lending.aspx . There are frequently asked questions and a podcast available for you at www.iralending.com . I do not sell these loans or profit from them and you deal directly with the institutions. The loans are currently 30 years, fixed or variable.(around 8.25%) There are a number of fees associated with the loans.

If you find a private lender (which can be another IRA) who is not a broker,you can negotiate your own terms, including points, rate, term, down payment percentage, minimum loan etc. Currently the range of interest rates on this type of loan is 10-14% with 3-5 points (3-5% of loan amount) plus document fees and the duration of these loans are usually much shorter (2-5 years), but an individual (or their IRA) can choose to loan you the money for as long as they wish on whatever terms they wish. Finding the private lender is the problem. I do not connect borrowers and lenders for legal reasons and we do not service this type of loan. The best way to find this type of lender is by word of mouth.

Q: When we purchase rental from the IRA whose name needs to be on the loan documents?

A: Any asset paid for by the IRA is titled in the name of the IRA, through your TPA/Custodian. For example, the vesting would be something like: ABC Administration, Inc. FBO John Doe IRA # 12345. The vesting on loan documents would be the same as well as the escrow documents. When documents come to you from escrow, you will have to initial each page before sending them to your Custodian/TPA for execution.

Q: Whose name should the insurance policy and property management agreement be written in?

A: Always the name of the IRA when the property is held directly in the IRA. Your name should not be on anything connected with property owned directly by your IRA. This is an "Arms Length" transaction.

Q: Are the payments for the property taxes and insurance required to be in an escrow account paid through the IRA with the real estate loan?

A: Generally yes, but each lender has their own requirements, so you will have to check with each. Generally they require a 6 month PITI pad, which makes sense because you need a pad in the IRA in case the property is empty for an extended period, since the payments must come from assets in the IRA or new contributions.

Q: How is the rent check redeposited into the IRA, especially when property managers are collecting rent? Where is the rent check sent to?

A; A copy of “property management contract” is generally required to be sent to your TPA/Custodian, if you utilize a property manager on the property. Monthly statements are also generally required by a TPA/Custodian. Ask the property manager to make the net income check payable to your IRA as vested and be sure to have them reference the property address on the memo field.

Q: If there is a positive cash flow on the property does the full payment go back into IRA or can we use the positive cash flow to pay down the loan?

A: Remember this is full self direction, so you choose what to do with the excess cash flow from your property within the IRA. You can invest it somewhere else in something else or use it to pay down the loan, but don’t forget to accrue money for repairs, replacement of water heaters, furnaces, appliances, roof etc. New contributions to the IRA can be used to cover new expenses as well, but you need earned income to make contributions. If you take the profit as a distribution to pay bills you would have to pay applicable penalties and taxes and report the distribution to the IRS.

Q: Are purchases or down payment on rental/investment properties from Self Directed IRA’s with a positive cash flow considered to be debt-financed income property which maybe taxable by the IRS as UBIT (unrelated business income tax) or are purchases from self direct IRA exempt from these rules?

A: IRA’s are not exempt from UBIT. I have mentioned that there are rules for a real estate purchase in an IRA and UBIT does apply to the leveraged portion of an IRA purchase once the taxable income exceeds the IRS threshold ( I believe this is $1000, but check with your CPA). As I said, in an IRA, the leveraged portion of the purchase is subject to UBIT. This is not true for Purchase Money in an Individual (k) plan.

There is technical information on UBIT in IRS Publication 598. Just remember the key is that the IRS allows you to borrow money that you never earned and use it to leverage a real estate purchase in your IRA (that you may not otherwise purchase). In return, they tax the net return on only the leveraged portion and you keep the net gains after the tax, working tax deferred in the IRA. When you must file and pay UBIT taxes your CPA will probably use the 990-T form.

Q: What are the steps we need to take to start purchasing property from our self directed IRA?

A: While I cannot speak for the specific rules at each TPA/Custodian, I can outline the general steps in the process:

Steps to Buy Real Estate held directly in a Self Directed Retirement Plan (Real Estate Purchases inside an LLC or other entity will be handled differently)

1. a.Open an Self Directed IRA or Qualified Plan (401k, SEP, SIMPLE) Plan that allows Real Estate and other Alternative Investments. b.Transfer funds from another Custodian or fund with new contributions. You will be given an account number, make sure you write it down. Remember you should not make offers or earnest money deposits from personal funds on a property you want to purchase in your IRA. Get your account open and funded, then start buying.

2. Locate an investment Property

3. Make offer on the property in the name of your plan. (Earnest Money Deposit must come from Plan assets, not personal assets)

4. If offer is accepted complete a buy direction letter for your Real Estate, describing the purchase in detail, with a copy of the purchase contract. You will initial each page of your escrow documents before sending them to your TPA/Custodian for execution. Your TPA/Custodian signs the contract on behalf of your IRA and forwards it as specified to your Real Estate Broker/Escrow/Title companies - Once your TPA/Custodian receives documents for a purchase or sale, they will review the documents within a few business days. After the documents have been reviewed in the time frame outlined, they will contact all appropriate parties (client, title/escrow officer, sales team, attorney, etc.) for any corrections that may be needed. If there are no corrections, they will fund the transaction a few business days of receipt of the investment documents. If you need to expedite your transaction be prepared to pay rush or special handling fees to your TPA/Custodian.

5. At Closing, you read and approve all documents from title and escrow.

6. Title company sends approved docs to administrator who signs them on behalf of your plan (continued on page 2)

7. Rental or lease agreements must be assigned by the seller to the plan. New agreements made in the name of the plan. Property Management agreements are signed between the plan and the property manager.

8. TPA/Custodian sends funds to title/escrow

9. Deed is recorded in the name of the TPA/Custodian FBO the IRA or QP and the deed is sent to your TPA/Custodian

10. All income is sent to Admin All expenses paid from plan in direct proportion to ownership

The process is not all that different than a personal purchase, just keep thinking of your IRA as a separate person from yourself and you will do just fine!

Getting Started with Self Directed Retirement Plans

2009-07-09T02:00:00Z

On Demand Webinar "Getting Started with Self Directed Retirement Plans"

Many of my readers have suggested that I find a way to include recordings of my webinars on my site. This recent webinar on Self Directed Retirement Plans includes a discussion of basic plan features and a couple of speakers on alternative investments in Real Estate and Structured Settlement Annuities. To download and play the entire webinar you will need Windows Media Player. You can click on the link below to download the .wmv file.

As always, I welcome your feedback and questions or suggestions for new topics.

Getting Started with Self Directed Retirement Plans. 5 minutes of the full 1 hr+ pre-recorded webinar available for download and viewing with Windows Media Player

http://selfdirectioncentral.com/2009/07/08/getting-started-with-self-directed-retirement-plans.aspx

Bernie Madoff Gets 150 Year Prison Sentence, but Who Really Pays?

2009-07-01T16:47:00Z

Everyone Pays for What Bernie did if the same thing happens again...

They said that people in the courtroom cheered when the 150 year sentence was announced on the "Day of Reckoning" for Mr. Madoff. Since Bernie is 71, this is a life sentence. He will lose his lavish lifestyle on Park Avenue in trade for a small prison cell where he is still guaranteed a free room, 3 square meals a day and the best of free health care. There are more than 48 million Americans who do not have the "luxury" of health care benefits, and I would guess that many of those have no free room are not guaranteed 3 squares a day, so to that extent Bernie is still ahead of many Americans.

Who Else Loses?

Of course the innocent members of his family (there must be some) will be reduced from a fairy tale lifestyle to something far more pedestrian, but at this point there is still great personal wealth in the Madoff family that cannot be attached if no wrongdoing can be proven by family members. The "victims" of the Ponzi scheme will suffer to varying degrees, but many were mega wealthy to begin with and were diversified in their holdings. Those who did not diversify and based their entire financial life on the inflated returns promised are ruined. There are those who will truly suffer from the financial consequences of their losses.

I doubt that there will ever be a substantial recovery of the missing funds. Anyone smart enough to game the system for $Billions over 20 years is certainly smart enough to bury their ill gotten gains deep in the global electronic financial system (or gold in the ground somewhere), freshly washed and accessible to those in the know. So what lessons can be learned? How can we make sure we don't put our trust in a Bernie Madoff?

One of the easiest ways to accomplish this is by taking direct personal responsibility for the investment decisions you make, do your own due diligence and more specifically, buy hard assets like real estate or gold that you can drive by and check on. The use of a fully Self Directed Retirement Plan will allow you to do this. It means you will have to be directly involved in the process and some part of your free time will have to be re-directed to planning for your comfortable retirement.

Would you sleep better knowing exactly where your money is and who is managing it (you)? Can you trust yourself to work in your own best interests? Who else can you think of that is more concerned about the conservation and growth of your assets than you?

By establishing a Self Directed Retirement Plan for at least a portion of your retirement assets, you can change your life and create a better, more stable retirement. If you want to learn more, join my next Webinar on July 7th at 6PM PST or email me at lance@selfdirectioncentral.com .

Did You Know You Can Buy Bank Owned REO Investment Properties in your IRA?

2009-05-19T22:26:14Z

Buy Deeply Discounted Cash Flow Real Estate in your Self Directed Retirement Plan

Everyone has heard about the exceptional values in the real estate marketplace represented by Bank Owned, "Real Estate Owned Properties" (REO). Banks which have foreclosed on properties are marketing them through retail channels that include Brokers and Agents that specialize in REO properties. These brokers and agents in particular are familiar with the processes and procedures used when dealing with the Asset Managers and Loan Servicers who control the sale of these deeply discounted properties. On a daily basis, investors are buying properties that yield very competitive cash on cash returns in California and many other states and there is the possibility of future appreciation over time on top of monthly returns.

Not everyone is aware that you can make Alternative Investments in a Self Directed Retirement Plan including the purchase of REO real estate for investment.

The process of making offers and having them accepted on REO properties is different from the traditional Owner Occupied Real Estate Residential Purchase and working with a Broker or Agent who is familiar with the process can make the difference between getting the property and not getting the property from the servicer/lender/bank that owns it.

The time frames and conditions for REO purchases make the possibility of an all cash offer using funds from a Self Directed IRA or other Self Directed Retirement Plan very attractive for investors and banks, since there are no financing contingencies. Asset managers love to see offers of this type and respond favorably when they know the deal will get done. If needed, a non-recourse loan can be used for properties over $100,000.00 in price. These loans do not use personal credit and are based on the cash flow of the property, but do require 6 months expenses to be available in the IRA after the earnest money and down payment are made.

When using a Third Party Administrator (TPA) for record keeping in the Self Directed Plan, the process and documentation used in a Real Estate purchase with IRA money is nearly identical to a personal purchase, except that all of the documentation is made out in the name of the Self Directed Plan and Title is held "For the Benefit Of" your IRA or other Self Directed Plan.

Needless to say, careful due diligence of the properties is important and the prospective buyer should consider paying for an inspection especially since REO properties are sold "As-Is". It is best to know if repairs are necessary, since the costs for repairs must come from assets in the plan or new contributions to the plan and not from personal assets of the IRA owner. You should also do careful calculations on the potential return on your real estate investment.

IRA and other Self Directed Plan owners can also combine funds from multiple plans and plan types to make real estate purchases as Tenants In Common or using specially constructed LLC's that are funded from plan assets. Before you can make any offers or buy any real estate, you need to open and fund a Self Directed Plan. When transferring assets from an orphan IRA or an old 401(k), 403(b) or TSA plan, you need to allow at least 4 weeks for the funds to transfer after opening an account with a truly self directed plan administrator or custodian. So if you are interested in a purchase at todays low prices, get started today.

If you are interested in learning more about this type of investing or participating in a webinar, send an email to lance@selfdirectioncentral.com

"Buyer Beware" is Not Just a Saying

2009-05-09T18:40:00Z

Due Diligence in your Self Directed Retirement Plan

Recently I have had a number of calls from clients and readers who have lost money in alternative investments they selected for their own self directed plan. My first question when I get a call like this is, "what Due Diligence did you do to determine if the investment sponsor was legitimate and what calculations did you base your decision on?" In almost every case, the decision to buy was made in the heat of a selling event and almost no Due Diligence was conducted prior to the purchase. The purchase of local hard assets, like real estate you can physically see, touch and inspect is one way to avoid an investment fiasco.

We are in tough times and tough times often bring out the best in human nature, but also nuture the worst. People under financial pressure will do and say just about anything to make a commission. It is our responsibility as investors to know who we are doing business with and how they are doing business.

People have endured brutal and perhaps insurmountable financial losses in their corporate 401k plans, which were invested primarily in stocks and mutual funds. Now they are in pain and realize that their retirement dreams have been changed, or realize they may never be able to fully retire. As a result, many people are opening Self Directed Retirement Plans and then investing in schemes that promise to quickly return the monies lost in the stock market through very high, "safe" compounded yields and the promise of near term appreciation. All with little or no effort and little or no risk on the part of the investor. Passive investing with stellar results. Sounds like a Bernie Maddoff pitch to me.

So many people have bought into these schemes that I have categorized these types of investments as "TOHOR" investments, which stands for "Triumph of Hope Over Reason". People need to realize that unscrupulous promoters know the mental state of their marks very well and design their sales pitch to appeal to emotion over reason.

SDRP investing can be tremendously successful and the best SDRP investors will retire with dignity, but the best investors are characterized by an almost obsessive need to understand what they are investing in, what it costs now and will cost in the future, who they are buying from and they have a plan for the duration of the investment.

What Should Your Custodian/Administrator Do regarding Due Diligence?

The primary function of a Self Directed Retirement Plan (SDRP) custodian or administrator, other than providing Administration and Record keeping for your SDRP Assets, is to help educate their clients on the best ways to maximize their results from Self Direction.

SDRP custodians and or administrators do not give tax, legal or investment advice or help clients select investments or investment sponsors, but they do want clients to make sound investments and they benefit when client investments increase in value. Since they cannot give advice on specific investments or recommend investment sponsors, I think it is imperative to let my clients know how important it that they thoroughly research the background of referral sources, individual sponsors and the investments that they sell. This process is commonly referred to as “Due Diligence” in the investment world.

As Americans, we have become very trusting of financial advice given by providers who earn commissions on every transaction they make. Of course people need to get paid for their work, but it is ultimately up to you as an investor to see that they have earned the commissions you pay and you have a right to ask what those commissions are and how they are paid.

Every investor should do much more than rely on the representations made by sales people and their sponsors. The logic for this is simple, the people selling you an investment rely on the income from that sale to make their living and times are tough. This makes it very hard for them to be objective about the true value and future prospects of whatever they may be selling. You need to do your homework to the fullest to avoid losing your hard earned pension money in bad investments and consult with your tax and legal professionals before committing more than just a few percent of your assets to any one investment.

To do this fully can be complicated and time consuming, but at a bare minimum, consider doing the following:
For any investment, whether in Real Estate, Precious Metals, Notes, Tax Liens etc., take time away from the heat of the moment (just after a presentation promising exceptional results from an investment). Go home, sit down at your computer and go to sites like these to check on the investment sponsor. After asking the sponsor what legal structure they operate under request copies of all documents relevant to the offering.

1. Better Business Bureau – www.bbb.org – look at the national site, not just locally for complaints against the investment sponsor and the organization that referred them to you.
2. Rip Off Report – www.ripoffreport.com - look for the names of sponsor companies, the names of principals of the companies and the organization that referred you.
3. Google Search – www.google.com – Do multiple searches with search terms including the name of investment sponsors, the organization that referred you and add search terms to help complete your due diligence for example “John Doe Investment Club, lawsuits” or Jane Doe Properties, fraud claims” Legal complaints, fraud alerts, consumer complaints and as many other search terms as you can think of.
4. The department of Real Estate in your state will have status of licences and complaints against Brokers or Agents
5. The Department of Corporations in your state should be checked to determine if a Corporation is in good standing and if there are any complaints.
5. The Securities and Exchange Commission – www.sec.gov – help@sec.gov Phone (202) 942-7040. It also pays to do a search for any SEC litigation under the name of Principals of any company you are considering investing with to see if there is any history with the of litigation with the SEC. A history of litigation does not necessarily indicate any current wrongdoing, but should be considered carefully in evaluating the company you are considering doing business with and the people who run it. The link to research SEC litigation is at http://www.sec.gov/litigation.shtml
6. The Insurance Department in your state can be contacted to check the licences of Agents or Brokers and to see if there are any complaints.

Other Red Flags
• A company that has only been in business for a short time (less than two years) offering very high compounded returns (over 10%)with little or no risk
• Any company that says they cannot provide referrals from existing clients
• Sponsors who say they work because they love to help people
• Complex investment structures without direct control of an investment (Private Placements, Small Syndications
• Inability to see and touch your investment before buying
• Pressure to make a decision in a narrow time frame “today only”, “price will increase tomorrow”
• Little or no documentation of cash flows
• No paperwork you can take home
• LLC's should have ready access to copies of operating agreements for your review and for your files
• Corporations soliciting investments in shares should have a Share Purchase agreement or similiar instrument for your review and such documents should be reviewed by your tax and legal counsel before execution of the investment.
• No discussion of Exit Strategies, no liquidity, high fees to exit an investment, high ongoing fees for management that impact net returns
• Where out of state Real Estate involves outside management for the collection of rents be sure to research the management company. One way to do this is to call large local real estate offices in the area you are buying and ask if they know the firm being recommended. If the management firm also does real estate, check with the state regulatory agency for Real Estate transactions.
• Any company that suggests a specific rate of return but says they are not offering a security. If real estate is involved be sure to run your own calculations for returns using different occupancy rates. At some point, any real estate can be un-occupied and certain types of real estate, (for example, blue collar residential real estate) can have high vacancy rates due to economic conditions. Remember to research the overall employment factors in the areas where you are considering a purchase.

If everything checks out to your satisfaction and the answers to your questions are acceptable to you and your tax and legal professionals, you can move forward with the knowledge that you did not act in haste. Remember that your grandparents always said “haste makes waste”.

Watch for an upcoming webinar on Due Diligence my site at www.botbseminars.com .

Having Time to Test the Tests of Time

2009-04-09T15:50:00Z

Or, if I only knew then what I know now...

Recently while surfing the net I came across a well written blog by a "thirtysomething" on "Financial Commandments for Your Thirties" that brings home to me the slow spread of a new paradigm among younger generations about money. Namely that there are good reasons to carefully manage it and to save it for the future and specifically that "Debt is not Wealth".

As a Baby Boomer I was very happy to see this viewpoint expressed and I realize that younger generations may have a better grasp of financial reality than mine at that age. This realization was reinforced when I recently held an open house (one of my hats is as a Realtor in CA for a Broker specializing in Bank owned (REO) properties). A group of young people came in to see an REO property in a popular suburban development featuring a man made lake. Properties in the area had a high pricing premium before the bubble burst and a have a high monthly Home Owners Association (HOA) fee for the privilege of living there now.

The property I was showing was close to $800k at the peak of the CA bubble and is currently listed at closer to $500k by the bank that owns it. The home fills the lot with about 8-10 feet on either side, an alley in the back for access to the garage with no driveway and a postage stamp lawn in a courtyard like front yard. It is a nicely finished, 2600sf home, but the young people (engineers and professionals) did not stay long and commented that even at $500k the house was way overpriced and they were seeking to pay cash and get something with real value and without the ongoing HOA fees. Although they did not buy my property, I was happy to witness the intensity of their belief and welcome the rebirth of thrift in younger Americans.

One topic that was not mentioned in the Financial Commandments was tax deferred savings in a Self Directed IRA, so I made the following comment on the Blog:

While you described a traditional IRA well, you forgot to mention the growing use of truly Self Directed retirement plans. As far as IRA’s are concerned, the IRS only excludes investments in Collectibles like art and fine wine, life insurance contracts and shares in an S Corp from an IRA account. The traditional investment community limits the investments in IRA’s they offer to the products they earn a commission on. Most of the time, this rules out investments in anything other than stocks, bonds and insurance in various forms. The plan documents approved by the IRS for a truly Self Directed IRA include the options for investments in real estate of all kinds, precious metals, tax liens and both secured and unsecured notes. One place you can get oodles of free information on this type of IRA is at http://www.cencal.entrustcalifornia.com/. You should do a follow up post to your readers and make them aware of this option!

If you are in your thirties, you have time to really accumulate assets in a Self Directed IRA or other Self Directed retirement vehicle. In the current financial environment, savvy mature investors are loading up on hard assets like real estate and precious metals. Many view the purchase of a small investment property at the right price as something they can control directly without fear of market manipulation and with stable, predictable returns.

Going Down with the Joneses

2009-03-03T19:23:00Z

Dealing with the New Realities in Middle Class America

In a recent entry on one of my other blogs at http://unsustainabubble.com in an entry called "Going Down with the Joneses", I wrote about the paradigm shift that is taking place in the American Middle Class. Specifically the difficult, disruptive and very painful adjustments that are being made in saving, spending and consumption and over all life styles, accelerated by the current economic crisis and rapidly expanding unemployment. In a future article I want to discuss the key factors in our financial history that have brought us to this point and the strategies we can use going forward to best create sustained abundance, regardless of the external environment.

One of the ways people will begin to rebuild wealth once they have dealt with their debt and created an emergency fund, will be to increase the amount of contributions they make to their retirement plans. As you will see in my article, Americans are woefully unprepared for a self sufficient retirement. Less than 2% of retirees will be independent. Everyone else will either continue to work, depend on children or the charity of strangers, or live below the poverty level on a shaky Social Security Check.

Since this is a longer article with charts, I have made the full document available and if you click on this link http://www.box.net/shared/cfje9z2vpv you can view it and download it to share with others.

As always, I welcome your feedback, negative or positive and encourage you to share your thoughts with me.

More Broken Pension Promises to Come

2009-01-25T00:08:00Z

Why Self Direction of Pension Funds Should Replace the Broken Promises of Corporate Plans

It's not bad enough that the value of shares in many Corporate 401k plans have been slammed by the sell off of securities in 2008, but there is another unintended consequence of the sell off in securities that will likely impact earnings on shares of companies with an active Defined Benefit Plan for many years to come. The best short discussion I have seen on these issues is about a likely $409 Billion hole in Pensions that is likely to reduce U.S. corporate earnings for a long time.

"Defined Benefit " (DB plans have largely been replaced at many corporations with "Defined Contribution" ( DC, or 401k ) plans. This process is part of a massive transfer of the financial responsibility for pension benefits to workers from corporations. This transfer has taken place because of the long term liability created by Defined Benefit plans to the corporations that still have them (similarly more and more of the costs of health care insurance have been shifted to employees rather than increase costs of health benefits to corporations).

These long term pension liabilities have been created because the financial assumptions used to calculate the annual contribution of the corporations have been faulty. This is primarily because they assumed a higher annual rate of return from the stock market than could actually be sustained (except for short periods in a bull market). The faulty assumptions may have also included higher mortality rates ( betting that retirees would die sooner than they actually have in real life). This means that retirees who draw benefits after the date of their projected death have created financial pressure on the entire system. (Darn those pesky Octogenarians!) The mortality rate in the U.S. has been steadily increasing since WWII.

Many corporations layoff and settle with older higher paid employees getting close to retirement to reduce unfunded liabilities in the future.

There has been a moral hazard for Pension Actuaries (mathematicians for investment funds and insurance companies) since they were paid extremely well to calculate favorable numbers for major corporate pension plans, much like bond rating agencies were paid very well to assign high investment ratings to bundles of Sub-Prime Mortgage Loans. Pension actuaries earn several hundred thousand dollars per year in salaries that are not connected to the results of their calculations. They lose nothing financially by underestimating contributions needed to adequately fund pensions.

One result is that for some companies, like U.S. auto manufacturers facing a shortfall of pension funds to meet commitments, more corporate earnings must be allocated to pension obligations. This means less money will be available to pay bills, improve plants and grow for the future. If they cannot grow and they must contribute to underfunded pensions from revenue, dividends will be cut.

One way that auto manufacturers have offset these obligations is to include the costs of unfunded pension liabilities in the cost of each auto sold to consumers. Included in the price of one U.S. manufacturer is about $1400.00 that goes to fund DB plans in place for existing retirees still covered by the DB plan. New employees are not covered by the DB plan in place for retirees and must make contributions to a 401k plan that may or may not have matching from the employer. Many employers have reduced or eliminated matching contributions to 401k plans. This same method is being used by other manufacturers in the same predicament, making them less competitive in pricing to foreign companies that do not have the same liabilities.

In part this mess is an unintended consequence of Globalization, since many high paying union jobs with DB Plans were sent to low paying markets that did not have pension liabilities and higher profits that resulted were not used to better fund the existing pension plan liabilities from jobs that were exported. The accounting for pensions is extremely complicated and over time has allowed corporations to create shadow earnings that relate to returns in pension plans and use those earnings to prop up balance sheets and pump up the payouts to key executives to astronomical levels.

Where is the Bottom Line?

For a really long time, individuals have looked to their Corporation or to the Government to take care of their future financial needs. All of these promises will be broken as they must be, since they cannot be met.

Wherever possible and by any legal means possible, corporations will shirk their moral duty to meet the promises they made by going bankrupt and destroying existing plans. Think of all the broken promises at Enron where contributions to the pensions of hard working and honest employees were made in Enron stock. The people may be retired, but without the benefits they were promised and the half-assed provisions for them to make up for what they lost mostly consist of ways for them to defer taxes on current earnings. Ask anyone that worked for Enron if they are satisfied with what is left of their Enron pension promises.

This means that starting today and going forward, we must each be responsible for the ultimate results of our pension planning. This can be done by using the simple mechanism of a Self Directed Retirement Plan for rollovers and especially for Small business owners with no full time (1000 hours or less per year) employees.

A Call to Action

Anyone that agrees with me that Corporations will do as little as they can to secure a dignified retirement for loyal employees, or that Social Security is unlikely to provide for a dignified retirement must start making plans to create their own Sustained Abundance for the future.

I know this will not be easy or fun. Either you can live below your means and save more, or you can find ways to make more. Either option will be difficult and reduce your current lifestyle or take away from your free time.

If you are interested in learning more, take a look at the Webinars and Seminars offered at www.botbseminars.com or contact me at lance@selfdirectioncentral.com .

The Importance of Self Reliance

2008-11-22T03:18:00Z

Get Ready, Because History Will Repeat Itself

Back in 1870 the U.S. resembled the China of today in many ways. Most of our citizens were still in the country, living near or working on family farms (this is the case in China today). Poor, disabled or ill and elderly people were taken care of by family or friends or through local religious groups in the local community. There was no health or disability insurance and no company pension to count on, only the hard assets that were saved or purchased or inherited. Today we are closer than ever to being back in the same situation we were in back in 1870.

From 1870 on as we became an Industrialized nation, people left the farms for the cities and gave up the social network that protected them for the lure of higher pay in the cities. The burden of caring for people in need fell on the people themselves or in many cases the sweatshops they worked for. Conditions in the slums around Steel Mills, Coal Mills and other manufacturing sites were harsh and the Poor Houses and Debtors Prisons were a form of slavery. Local religious groups provided some relief too.

Gradually conditions improved somewhat as cities and states took on some of the social costs for the elderly and displaced in the cities and Unions gained some power to create livable wages and working conditions. The crash of 1929 resulted in an unemployment rate of 25% and with so many losing their life savings, created the need for centralized Federal systems to address nationwide problems.

After (or because of) the Great Depression our Government created and funded many important Social Programs, including Social Security in 1935. The idea behind Social Security was to create a safety net for working people in an industrialized economy in case they outlived their savings. If you look a the original provisions of Social Security, the age for eligibility was 65 at a time when average life expectancy was 67!

If you read a " History of Social Security " written by CPA's you will begin to understand the problems that will force government to cut benefits and increase the age for SS eligibility, or bring down the system. From the very beginning, the benefits paid out had a negative correlation to the money paid in by workers. Reading the Federal Government " Historical Background and Development of Social Security " will give you the clear understanding that all of us need to prepare for our own retirement without counting on Social Security to protect us in the future.

In 2008, U.S. life expectancy has increased to age 78. It was 70 in 1950 and as I said, 67 in 1935. Social Security was and is not designed to handle benefits for such longevity. New medical advances are expected to increase U.S. Life expectancy. By the way, don't get too excited by the current U.S. life expectancy as 41 other countries have a higher life expectancy than we do. Perhaps this is because we work more and have less access to medical care than many others, even though we spend 40% of the world budget for healtcare in this country. There are many reasons for this mess. One obvious one is the bloated profits of pharmaceutical companies.

Contrary to what most Americans believe, the Government does not invest our SSI contributions to fund our future benefits. In fact, the last several U.S. Presidents have raided Social Security surplus accounts by borrowing them to balance the national budget. What everyone needs to understand is that the money comes in through current taxes and is paid out to beneficiaries. Right now there is still more coming in than going out. That will not be the case in 10 years or so.

The original intention of Social Security was not to replace saving for retirement, but that is what Social Security has become. Some 30% of Baby Boomers will rely 100% on Social Security for their full retirement income, which will put them below the current poverty level in America.

This means that every rational American has to take full responsibility for the quality of their retirement. Based on the reliance of the Boomer Generation on Corporations or the Federal Government, subsequent generations will have the pain of seeing what failure to plan really means by simply seeing how most Boomers will live after retirement.

Wishing and hoping will not solve our individual financial problems, only good planning and investing in hard assets which return solid profits will. A Self Directed Retirement plan will help those willing to take responsibility and control for helping themselves.

It's high time we all learned to fish again.

No Surprises Here

2008-11-01T18:25:00Z

63% of Americans Have Stopped Making Pension Contributions!

Given the difficult financial times so many are facing, I was not surprised to see some shocking statistics like the one above in an article titled "Four Ways to Protect Your Retirement From the Ongoing Financial Crisis at:
http://www.moneymorning.com/2008/10/29/retirement-assets/ . But it really got me thinking about what so many of us have not done about planning for the future.

There is really no reason to be surprised by this statistic, considering that most Americans have lived well beyond their means for years (peaking at 113% of income in 2005) and most stopped saving for the future in 1985. For more than 23 years we have lived primarily for the moment, expecting that the future would take care of itself. Why not when our political leaders and consumer companies keep telling us that it is OK to spend?

Almost all of us have a friend or a relative with a friend or acquaintance whose working life consisted of working for the post office or being a fireman or carpenter or perhaps a clerk in a big corporation for their entire career.

This is the friend (or couple) who started buying Gold Coins systematically in the '70's and was buying small houses in Northern California or out in the desert. or out in the midwest somewhere when they were still $30,000 or less. Perhaps the carpenter or fireman bought burned out houses and did the rehabbing themselves and then rented them out (creating sweat equity weekend after weekend while peers were gambling in Vegas), taking the positive cash flow and buying other properties or paying of the mortgage early.

This is the friend that people laughed at because they drove an old car and wore less chic clothes, lived in a modest house in a less desirable neighborhood with modest furnishings and stayed in the same job with the same company or the government for years, even if the position was not exciting or glamorous, even if they detested the people they worked with or the job they were doing. This friend did not throw lavish catered parties on credit or hiring a petting zoo for a childs birthday party to impress the neighbors.

In the blink of an eye, 20 or 30 years have passed and all of a sudden, this boring friend owns 2, 3, 5 or more paid for income properties (including the same modest home they always lived in) and has a full pension, with cost of living adjustments and health care for life, because they stayed the course).

This friend is the topic of discussion among people who are still working to make payments on a home that looks good, in a great area with 25 years of payments remaining on a mortgage held by a 50 year old person who wanted to retire at 62! The house is upside down in value and still dropping. The "owner" has not made meaningful contributions to a pension or done any systematic investing or created any sweat equity, but has had a new leased car every 2 years and some swell vacations too, on credit. Their closets are jammed with stuff and they have a self storage unit, full of more stuff, that costs $135 a month to maintain, or more than $16,000, plus lost interest over 10 years). They also have 250 channels or more on their premium cable service for $160.00 per month.

Now "all of a sudden" the boring friend has retired on full pay, plus the income from their rentals and Social Security and has the time and the money to do as they please and is not at all worried about the stock market gyrations because they truly own "free and clear" hard assets that are generating passive income, either personally or in Self Directed Retirement Plans. So who is laughing now?

Of course we all know exceptional people who made their fortune by building their own business, but they are the exception and a small percentage of the 37% of us who are still making pension contributions. We can learn much from these successful people, but far more from the regular, systematic savers and investors. We also know people who inherit money or win the lottery too.

Let's face it, when people who have not saved anywhere else but their 401k plan (and only did that because there was company matching of contributions) find themselves upside down on their Home Equity and over limit on their credit cards and out of work due to the recession, the first place they go for money (if their family has none) is to their 401k assets or to assets that have been rolled over into an IRA from a 401k at a previous employer.

It does not matter if there is a penalty or not or if current taxes must be paid. This money is accessible when all other sources are not.

The problem is that in most cases, funds distributed now from a pension will almost never be replaced and the younger the person is taking the distribution, the more the lost funds will cost over time (due to loss of compounding tax deferred). The older the person is taking the distribution, the less income they will have from their private pension to supplement Social Security after retirement. It has been said that more than 25% of Baby Boomers will live entirely on Social Security. This means an income below the current Poverty Level.

My point is this, now is not the time to stop saving for retirement. In fact, most of us need to buckle down and save even more, even if it means less channels on cable, fewer parties and fewer vacations on credit.

Self Directed investments in Notes secured by real estate or tax liens can compound at rates well above 12% annually with tremendous safety and security. Careful investments of in real estate can have similar cash flows with potential for appreciation. In these times, Real Estate investors must look for fundamental value at the right price and this is hard work. No one is going to do the heavy lifting and all of the footwork to direct you to a high yield investment without taking a fair commission for doing the hard work. Once the commission is paid, the yield will be reduced to reflect the work that was done.

The more work that you do for yourself in selecting good investments in a Self Directed Plan, the better the yields that you will achieve and investments in correctly priced hard assets will be much safer in a recession or even a depression.

Unfortunately you cannot use sweat equity in an IRA to make improvements to a piece of real property, nor can you use money from your IRA to pay for courses in investing in Real Estate for related investments. The sweat equity you invest is in good education that you pay for with money that would otherwise go to Cable TV or $300.00 shoes that will be out of style next year.

Next time you look at those $300.00 shoes, think about your friend who is free to do as they please and after many years of planning and saving, has the means to do just that.

More on IRA's and Prohibited Transactions

2008-10-18T16:12:00Z

Why Tempt Fate?

As a businessman and investor I can relate to clients, prospects and students who contact me with personal financial problems that they hope to solve using IRA money, without taking a taxable distribution. Many times, they are looking for solutions to current problems in their personal or family finances, using assets currently in a Self Directed IRA account. Frequently the solutions they seek to implement are based on "self dealing" with "disqualified" parties and so constitute "prohibited transactions" (sometimes called PT's) in an IRA. In a recent response to a client concerning some potential investments, I made the following comments, which I have paraphrased here for the benefit of others:

From our perspective as people working self directed retirement plans(who do not provide legal, accounting or investment advice), the loan you propose to make to a spouse or lineal family member and the investment in a siblings existing business venture are transactions that would probably be viewed by the IRS as prohibited (self-dealing) and if you proceed with these transactions, the entire assets of your IRA may be deemed distributed to you as of January 1st of the tax year in which the transactions were made, if discovered and reported. The financial penalties for a forced distribution like this are in my view, severe and not worth the risk.

Some CPA’s or other advisers take the view that a specific, individual transaction is unlikely to ever be discovered by the IRS. If you accept this idea and do a transaction of this nature, you are playing a form of tax roulette.

I keep thinking of the actor Wesley Snipes possibly serving time in prison because his advisers told him paying income tax is unconstitutional and therefore unnecessary. Do you think he is happy today with that decision, even though he had the use of the money that should have gone to taxes? http://www.cnn.com/2008/CRIME/04/24/snipes.sentencing/

You may be better served if you are in need of money and have no other source, to take a taxable distribution now from your IRA. If you make risky transactions and are audited, you may end up on an ongoing, never ending merry-go-round with the IRS. You have to ask yourself whether this is something you really want, or must have. You also need to understand that it is very difficult or may be impossible to replace this money in the IRA through contributions in the future.

In my experience with clients who cannot get a loan from any other source because their income or assets are insufficient to support the loan or their current debt service is too high to be sustainable, even if they could legally borrow from their IRA (which you cannot legally do per Section 408 of the IRS code available at:www.irs.gov/pub/irs-tege/irc408.pdf), they are not truly capable of making the payments to service the additional debt. This may not be the case for you, but I wanted to share my experience.

Recently, I have seen a parade of clients in deep financial distress and great economic and emotional pain and strain. 19 of 20 are looking for a solution to their pain that does not involve any risk or additional pain or any reduction to their current lifestyle or any additional cost. For those 19 who find a short term, “painless” solution (painless = very expensive in current/future costs or interest rates) to a current economic problem, typically an unsustainable debt load and diminishing income (or no income) to service it, they are back in deep distress in a year or less, with the additional burdens created by the “painless solution” they took in the first place.

The 1 in 20 who take the time and honest effort to review every aspect of their finances and credit and who adjust life style and budget to a sustainable level have less stress, more peace of mind and a simpler life style they can maintain in the future. The other 19 are merely living for the moment and putting off the inevitable…

If you make an investment with IRA money from your Self Directed IRA, all returns on the investment must go back into the IRA as they come in, for the exclusive benefit of the IRA. You cannot have the personal use of the plan assets for a while and then put them back into the IRA at your convenience.

I certainly understand the temptation, but the facts are not in your favor when you tempt fate by forcing a prohibited transaction using IRA assets. My advice to friends, family and clients is the same.

Do not tempt fate or you will most likely regret it.

Exeptional Secured Returns from Private Money Lending

2008-10-08T18:41:00Z

From "Hard Money" to "Private Money" Lending, Using Pension Assets

What follows is a discussion explaining why I think “Private Money Lending” will become "The New Sub-Prime" resource for lending on many Single Family Residential (1-4 Unit SFR) loans in America and many other types of properties as well. The opportunity for you is to use money from Self Directed Retirement Plans, secured by real estate and other types of collateral. The returns from these “Private Money” loans will help you reach or exceed your retirement plan goals much faster, with control and real security.

Historically Private Money Lending (PML) was called "Hard Money" or sometimes "Equity Lending" or "Asset Based Lending" (ABL). Each loan was made based on a much lower "Loan to Value" (LTV) than "Conventional" loans from a Bank or Savings and Loan. Hard Money Loans have had a maximum LTV between 50 and 65% of the carefully appraised value on each property (the collateral for the loan). Hard Money meant higher fees and interest rates than the loans available to more "credit worthy" borrowers. The pricing of these loans reflected the risk to the lender and often included a risk premium. This is because the mindset of a Private Money Lender is conservative and capital preservation is a primary objective.

Since the real security for each of these loans is in the underlying property value, if the borrower could or would not make the payments, the lender had to come back to the property to recover his investment. This is still true today and represents the major difference between a PML loan and a Sub-Prime loan based on highly leveraged, cheap money and impersonal computerized underwriting.
Historically, the rates, terms and conditions of "Hard Money" loans varied widely and there were abuses. In more recent years, legal limitations were placed on the practices of this type of lender that limited fees and rates within a narrower range. Federal Regulations were implemented, but "Hard Money" Lending remained relatively expensive.

Another innovation in the middle 1980's was the creation of tools that enabled traditional "Hard Money" Lenders to pool their loans and thereby spread risk from a single property loan to a pool of loans. This change, in combination with regulation marks the transition of "Hard Money" Lenders into Private Money Lenders.
These "new" pools were similar to the pooled mortgages we read so much about today, but with major structural differences that make them a much stronger and more viable financing structure for borrowers and investors. Another benefit of participation in a pool is the risk in any one loan being shared or spread with the other loans in a pool.

Keep in mind that for each loan in a Private Money Pool, the focus of underwriting is always on the strength of the collateral. An experienced lender thoroughly reviews the capacity of the borrower to repay and uses credit history primarily to price the loan. There is little or no leverage in this type of pool and a great deal of cushion for dramatic price changes since the LTV of any loan cannot exceed 65%. The insurance in this type of pool is the value in the properties, cushioned by the maximum LTV. The other cushion is the experience of the Underwriters for the pool. Even during the periods of the highest appreciation a PML underwriter is looking to preserve his capital and maximize his returns.

Most of us remember the Savings and Loan Crisis in the late '80's. That bailout cost U.S. taxpayers in the neighborhood of $320 Billion Dollars.

At that time many loans were originated and held in the portfolios of regional and local Banks and Savings and Loans. In California and similar markets, a large component of that mess was due to thinly capitalized institutions that had originated and held more loans than they could effectively keep when prices went down.
Once the real estate market started to turn down bank regulators demanded that financial institutions mark down the value of the real estate assets collateralizing existing loans to their current market values. All but the strongest lenders could not survive the volume of failed loans that occurred as a result of "marking the loans to the market", because the loan balances outstanding were higher than the current value of many properties and there was not enough capital to cover the paper losses. The phrase "jingle mail" was invented to describe the phenomenon of more than 20,000 California homeowners who walked away from their loans and simply mailed their keys to the lender.

Securitization of loans, rather than holding loans in a portfolio, was the answer that Wall Street devised to avoid similar problems for the future and politicians who did not want another scandal or Federal bailout supported the new methodology. (Which is what we got anyway in 2008, a $700 Billion bailout of supposedly infallible securitized loans.)

Asking loan servicers and trustees or the few remaining portfolio lenders to mark down the value of loan assets in the current market is not something that the regulators have requested.

The continued use of Qualified Special Purpose Entities (QPSE's) by financial institutions to isolate thinly traded mortgage backed securities and illiquid assets from hitting the corporate balance sheets (anyone remember Enron?) is probably not sustainable. Investment banks have scrambled to keep losses in portfolios from the light of day, using accounting practices reminiscent of Enron and there is pressure on the Federal Accounting Standards Board to eliminate the QPSE concept. This will mean more losses and more fire sales of assets to shore up balance sheets at the affected financial institutions, regulated or not.

Current Market Issues

The failure of so many securitized Sub-Prime pools in the current market is a result of too much leverage and very high LTV's (some loans were written for 103% to even 125% of appraised value) on poorly underwritten loans in the pools. From day one, this has been a recipe for disaster. Because of leverage, there simply was never enough collateral or liquidity to reflect the real risk in many of these pools. At the extremes some structures using Credit Default Swaps (CDS) controlled 500 dollars or more of loan assets with less than one dollar of actual cash reserves.

Insurance in various forms was purchased to supplement cash reserves, but as we have seen in the news, the capital strength of the insurers is a concern to many. When the Real Estate market turned down many mortgage pools controlled by servicers/trustees saw increased rates of default. Requests for loan originators to take back bad loans fell on deaf ears, since many originators declared bankruptcy due to excessive liabilities and poor capital. The financial geniuses that created the concepts and did the original calculations believed that the cash reserves and insurance/bonding safeguards were adequate and did not foresee the events that have happened. As of June 2008, two of the largest publicly traded bond issuers have just $75Billion in deflating assets to back up about $1Trillion in Municipal and Corporate Bonds. The "level 3" assets (hard to price, nearly impossible to sell) of 5 of the top Investment Banks on Wall Street (including assets of Bear Stearns) averaged 227.4% of capital and large banks and insurers are not far behind (Source: www.agorafinancial.com )

Because of the readily available loans in the emerging "Sub-Prime" market from 1990-2000, Private Money Lenders became "lenders of last resort" and the business contracted but did not disappear.
Some changed their business model and originated and sold loans just like everyone else. In large part, this was because of the increased use of underwriting standards based on credit scores and mathematical models and the pooling of mortgages with different risk characteristics into securities, theoretically eliminating the risk from Sub-Prime and lower rated borrowers.

Once the system was in place for originators to sell off loans to securitizers, the historical checks and balances in mortgage lending (like verification of employment and assets) began to fail, in part because there was minimal risk retained by the originators (or so it was believed) and because the up-front fees and commissions for these loans represented huge short term profits for everyone involved. Good Private money lenders kept the best performing loans they originated for themselves to the limits of their capital, but they could not compete (and did not want to compete) with a market place awash in capital and the availability of "Liar Loans" with LTV's that went as high as 103% of property values. The old timers saw the handwriting on the wall.

Supported by the artificially low interest rates that were in place, the Boom real estate market expanded and originations of more and more exotic, highly leveraged mortgage instruments increased. Even Private Money Lenders felt the pressure created by the overall easy money environment and many increased the LTV's offered on their loans from historically safe levels of 50-65% to 70% or above, or expanded their offerings to include equity lines at high rates. Many of these lenders have failed or will fail and many were companies that did not develop long term experience by having survived multiple real estate cycles. For most, the lure of quick profits overcame common sense and prudent business practices.

Fundamentals, like a meaningful correlation between income and the cost of properties were abandoned as the market expanded and prices ballooned. Everything was great until the system reached a tipping point in 2005-2006. As Bennet Sedacca of Atlantic Advisors has said "Debt must be serviced, repaid or refinanced or go into default". Ignoring the facts has never changed the facts, so here we are today...

The Sub-Prime Market has Turned Full Circle

Who has not heard daily about the Sub-Prime mortgage meltdown? We are bombarded with daily updates on which mortgage company has now closed and which large bank, brokerage house or insurance company is announcing losses of double or triple initial estimates on investments in Sub-Prime mortgages. There is a popular website at ml-implode.com/ that has tracked the failures of more than 256 lenders since late 2006. Some of these lenders were huge.
Many large individual investors in seemingly safe financial institutions have lost their shirt on stocks held for investment or investments in mortgage related securities. A few have profited enormously from the declines of these securities.

A top hedge fund manager for a fund betting against various Sub-Prime instruments made a heady $3.7 Billion in personal compensation for 2007. His top fund returned over 500% to individual investors (after costs) for the year. Many hedge funds holding the same securities for the long term lost everything or went bankrupt before losing everything. Several large pension funds held long term positions in the mortgage securities that went down. Only time will show the effects of those losses to pensioners.

The Federal Government has gone to previously unheard of lengths to prevent further damage to the finance/mortgage industry and the interlocked dealings between Wall Street, the Mega Bankers and mortgage originators of every stripe, including opening the discount window to investment banks.

On top of the new bailouts for AIG and the rest of Wall Street, taxpayers are already on the hook for a Federal $39 Billion dollar, non-recourse loan made to secure the purchase of Bear Stearns at an initial price of $2 per share. Since the stock traded for $30 per share the Friday before the bailout/purchase on the following Monday, this may well represent the deal of the century for the buyers a valuation of 10-12 dollars would still be a bargain.
Bear Stearns was at the heart of an intricate web of cross collateralized and highly leveraged exotic mortgage instruments whose failures could have collapsed our financial system. If $39 Billion were the true ultimate cost of this bailout, it would be cheap. Now of course, every investment banker that profited from the run up of the bubble sees the Fed (translation=Taxpayers) as the low cost financial solution to a decade of previous highly leveraged financial excess. Why act responsibly when there is no downside, little chance of prosecution for misdeeds and a federal bailout around the corner?

We have seen the selective bailouts and nationalization of some companies with many more to follow.

Apparently the Federal bailouts will not extend to individual borrowers who either cynically manipulated the system in an out of control market or who were incapable of understanding the financial commitment they made to a lender. Of course this will impact every borrower in between these extremes. The ripple effect of these mortgages is very likely to affect properties and borrowers with good credit in the next 2 years.
Current political initiatives (like the S 2636 Foreclosure Prevention Act) to help borrowers with Adjustable Rate Mortgages (ARM’s) or Option ARM’s, are a political football and consumer advocates like the "Center for Responsible Lending" are supporting legislation to help a broader cross section of borrowers than earlier anemic initiatives (see the article "Earlier Subprime Rescue Falters" online.wsj.com/public/article/SB120285480915463431.html?mod=yahoo_free). Any such legislation will be gutted before passing or be vetoed by the current administration.

Another initiative that has passed into law is HR 3221, which will help some distressed homeowners with Adjustable Rate Mortgages. A good article on this bill is at: http://www.wxyz.com/content/news/dwym/story.aspx?content_id=C75E9CAF-77C7-4000-B7F4-1A9B0D22D522&gsa=true

Meaningful Change will be Difficult and Painful

The deep pockets of the financial industry, their lobbyists and the politicians that are beholden to their financial industry patrons, would seem to make meaningful legislation in this area all but impossible. Too much money has been made by too many people for too long with no consequences for any misdeeds and incredible payouts to insiders.

If you listen to talk radio on the topic of borrower bailouts you hear the outraged cries of former mortgage brokers and real estate industry insiders who do not want any kind of bailout for borrowers, in particular the unqualified speculators that abused "Liar Loans" to flip properties and boost the bubble in real estate prices. These callers seem to overlook their own contributions, in league with appraisers and lenders and brokers that contributed greatly to the bubble. I keep thinking of a quote from author Sinclair Lewis who said something like "It’s hard to get a man to understand something when his salary depends on his not understanding it".
These same outraged callers are also forgetting the interlocking relationships between speculators and regular homeowners who qualified for the best financing and put 10% or more down on their properties.

If a "free market" approach had been allowed to take place, a real estate crash would have undoubtedly occurred on a scale hard to imagine. Americans are also incredibly lucky that foreign investors bought so much of our mortgage securities and the losses related to them. Imagine if all of the $250 Billion of write downs related to Sub-Prime loans were taken by American financial institutions alone! Remember by several estimates there is another $750 billion of bad paper still to be written down. The so called "Secondary Market" for mortgage securities is all but closed for business and may never recover.
As disgusting and one sided (in favor of the financial industry) as the current bailouts seem for many people, they have slowed down the overall rate of foreclosures and may prove to be a brilliant solution to the crisis. Of course history has proven that any market cycle that is artificially extended on the upside, experiences a longer and harsher downturn and resolution on the downside. This market cycle is not immune to history, just different in form.

While there is no doubt that responsible borrowers and savers are adversely affected by the actions of the irresponsible, most Americans simply do not realize the enormity of the problem. A good discussion of the potential mayhem for equity values and eroding tax bases is at: www.responsiblelending.org/issues/mortgage/research/subprime-spillover.html .
Estimating Long Term Costs

In a 2006 article published online by the Federal Reserve Bank of Chicago, GMAC-RFC, Americas largest private issuer of mortgage backed securities and a leading warehouse lender, estimated that it loses $50,000 per foreclosed home (a cost that would likely accelerate in a rapid downturn). The entire article can be viewed at: www.chicagofed.org/community_development/files/02_2006_foreclosure_alt.pdf.

The system in place today has created a bias toward foreclosure as the path of least resistance for a servicer or trustee, because of the contractual limitations/difficulties and potential liabilities related to any attempt at modifying terms on any loan in almost any securitized structure. (Email me if you want to read my article on this topic). The percentage of successful loan modifications is very small as is the percentage of successful short sales by borrowers in trouble. We will see if market conditions force lenders to modify more loans or accept more short sales, but right now foreclosure is the easiest option.

There is little doubt that too many foreclosures will force financial institutions to change tactics as many are very thinly capitalized and they do not want to take back properties on a mass scale. A possible wild card would be mandatory federal guidelines for handling problem loans, but financial institutions are likely to fight the tough measures necessary to resolve the problems mass foreclosures would create and politicians in an election year are hyper-sensitive to Governmental solutions that would be overtly recognized by voters as taxpayer funded.
Of course for individual borrowers making legal claims against originators that have failed or are in bankruptcy there is little hope of legal remedy and it is likely that their house will be long gone before a class action type of lawsuit might produce results.

Everyone needs to realize that the well we all drink from has been thoroughly poisoned. Just how far the poison will spread is the real issue, not whether thousands or even hundreds of thousands of small speculators will be bailed out of ARM type loans and into federally subsidized, fixed rate loans. Most of these speculators who have not already walked away will be ruined financially even if they are able to negotiate temporary modifications directly with their lender, or if there are more Federal programs to convert their loans from variable to fixed rate loans. Since most paid a speculative premium, the fundamentals are not there to sustain a long term investment.
If the underlying values have dropped sufficiently, these investors are likely to keep only those properties that cash flow enough to make sense as an investment. Just about everyone in America knows that in most areas, speculation on Single Family Residential properties is dead for the foreseeable future. We are definitely back to basic "buy and hold" fundamental strategies for average investors or more bulk purchases for the wealthy like the recent sale of 11,000 new homes in 8 states from a national home builder to various hedge funds at 40 cents on the dollar.

Americans also need to understand the longer term social costs to every taxpayer when borrowers in inner city and lower income neighborhoods who were deceived in this Sub-Prime mess lose their homes as a consequence of the deception. This is due both to the ripple effects on surrounding homes and the long term social costs to the nation in the affected neighborhoods. All borrowers would be well served by a rational and logical bailout of this sector as near term direct costs will be far less than any well structured alternative.

Out of Disaster, a new Opportunity

If you haven't seen the investment opportunity yet let me spell it out for you.
It will take years for all of the systemic problems we are seeing to be resolved. In the meantime, existing or new mechanisms must expand to fill the void. It is hard to say how large financial institutions will respond in the future and if securitized structures will be redesigned for sustainability in the mass marketplace. Perhaps the deep thinkers in other countries affected by the same issues, like England, Ireland, France, Germany or Australia will come up with a viable structure, while financial institutions here continue to resist the inevitable changes to an unsustainable system. The demand for loans is still out there and originators can process loans all day and night, but if the loans cannot be sold into a secondary market place, this system is finished as currently structured. We must also structure a system with much less leverage than we have seen in the past few years and regulate or dissolve the shadow banking system that has contributed so materially to this crisis.

For the foreseeable future, the opportunity is for private investors to begin aggressively funding Private Mortgage Lenders who underwrite their current loan pools and individual loans (or participations of multiple investors in “fractionalized notes”) based on low LTV's and the strength of the underlying collateral and with the use very little or no leverage. The low LTV's provide downside protection for investors along with the additional collateral that is often used to secure these loans.

Experienced managers of these types of pools will be able to demonstrate a track record of limited losses to investors with excellent potential returns. Of course this type of investment is illiquid by nature and suitable primarily for Qualified Fixed Income investors to diversify and find very attractive returns from monies allocated to longer term (5 year) investments.

Pooled investments typically require more complex, regulated legal structures and have a minimum investment of $25,000 or much more. For investors with smaller amounts to invest, or pension monies to invest conservatively, small individual notes or participations in notes can be found with exceptional short term (as short as 60 days) returns.

If you would like to share your thoughts or questions on this opportunity, Email me directly at lance@selfdirectioncentral.com.

Please note: The opinions expressed in this piece are not intended as either tax, investment or legal advice or opinions. The use of properly trained, licensed and insured professional tax, legal and other appropriate investment professionals to evaluate each investment you make is highly recommended.

Potential Advantages of 401(k) Plans for Sole Practitioners and Sole Proprietors

2008-08-22T16:23:00Z

Advantages Self Directed 401(k) plans for Sole Proprietors can have over Self Directed IRA LLC’s*

Please note that 401(k) plans designed for Sole Proprietors or Self Employed Couples are called by various names like Individual (k) or Solo (k). Different plan sponsors may have different names for similar 401(k) plans designed for the same market. Please note that these plans are designed for Sole Proprietors that have no employees working more than 500 hours per year. Employers with employees working at least 1000 hours per year (or 500 hours if they leave service and are subsequently rehired) must include all eligible employees in any qualified plan, including those that offer self direction by plan participants.

1. Tax Deferred or Tax Free Growth based on your allocation of contributions into the Tax Deferred or Tax Free components in a 401(k) (An Individual (k) includes a Roth tax free component). An IRA LLC Does not have a Roth (after tax contributions, tax free distributions) component (although you can set up a Checkbook Control, Self Directed Roth IRA).

2. Asset protection in a Single Member LLC is more marketing myth than legal fact. Consult your legal professional for information on your state laws.

3. Asset protection in an IRA is governed by State Statutes and varies from state to state with some states mirroring federal statutes and others allowing attachment of assets in an IRA under various circumstances. Asset protection in a Solo (K) may not be the same as the protection afforded 401 (k) plans that fully comply with ERISA provisions. Check with your legal professional before assuming that assets in your Individual (k) are fully protected from creditors. There is a good CPA article on this at http://www.petershannonco.com/timely_tax_topics2.htm

4. In a 401(k), an LLC is not required for Checkbook Control or Asset Protection- therefore there are no annual Franchise Tax Fees to maintain the LLC ($800 annually in CA)

5. In a 401(k) you can have Check Writing privileges acting as Trustee for the 401 k plan
6. Ability to purchase Life Insurance with pre-tax dollars in a 401(k).

7. No total distribution of all plan assets for Prohibited Transactions in a 401(k) (this reason alone is enough to justify the k plan). If you accidentally make a prohibited transaction in an IRA all of the assets in the IRA will be considered distributed and the IRS will tax you on all of the assets in the IRA and will penalize you if you are under age 59 1/2.

8. Ability to borrow from a properly designed 401 k plan up to the lesser of $50,000 or 50% of assets (you cannot borrow from your IRA).

9. Legal Distributions which begin at age 55, not age 59 ½, can save you paying the 10% IRS penalty associated with Distributions before 59 ½ and/or allow you to retire earlier.

10. A 401(k) plan has much higher annual contribution limits than any IRA (deductible contribution limits for an incorporated couple under 50 are over $45,000 in 2009 including profit sharing, with no income restrictions (IRA and Roth IRA’s have income limits for deductibility of contributions).

11. Ability to purchase leveraged real estate in a 401(k) without generating the same income taxes created by profits on leveraged Real Estate in an IRA because of Unrelated Debt Financed Income (UDFI). This applies to purchase money only.

12. In a 401(k) you have the ability to purchase shares in S-Corp stocks that is specifically excluded in an IRA (along with the purchase of Life Insurance and “Collectibles”).

*Not all Self Directed 401(k) plans or IRA’s offer Debit Cards/Checkbook Control. Availability of all legally available features in a 401(k) plan or IRA is dependent on the design and construction of the plan documents by the plan sponsor. Some plan sponsors elect to draft a plan that does not include all legally available features in order to control plan holder options for the benefit of the sponsor. Before you select a plan sponsor, create a check list of the features you want to have included in your plan design and compare the list to the options offered by a prospective plan sponsor. Checkbook control may not be suitable for individuals who are not familiar with regular book keeping and tax forms and who do not balance their check book. Third Party administration and book keeping may better serve you if you are not good at keeping your own records.

What to do with your Pension when you Change Jobs

2008-08-15T06:03:00Z

Job Changes and Pension Rollover Options

At the time of a job change, thinking about your pension options may not be your highest priority, but the decisions you make (or do not make) can have repercussions throughout your working career and into your retirement.

A common way people handle pension assets in a 401(k) during a job transition is to leave the money in their old employers plan. Typically an ex-employer will allow this if the amount in the plan is more than $5,000.00. If the amount is $5,000.00 or less, normally an employer will distribute the money in the form of a check to the ex-employee that will become a taxable distribution to the recipient if it is not placed (as an indirect rollover) with another retirement plan custodian in 60 days or less.

There may be advantages to leaving funds in your old plan if that plan has multiple high performing investment options and the assets will continue to grow tax deferred by leaving it there. About 5% of 401(k)plans have a loan provision which you may be able to use if your plan includes it. You will not be able to make new contributions to your old plan, but you can always move your balance at a later date.

A direct custodian to custodian transfer will have no tax implications and maintain the tax deferred status of your accounts. (Note: Plans can have different types of administrators which can be Custodians, Trustees or Third Party Administrators (TPA's) or a combination. It pays to know the differences between each for the new plan you select. To keep things simple, I will generically describe them all as custodians for this entry.)

If the amount is over $5,000.00 your employer will ask you to complete a form that identifies your choice to make a rollover or transfer to a new custodian or to take a taxable distribution. If you elect a distribution there will be withholding from your distribution check for taxes and penalties if they apply.

If you are over 59 ½ years of age, and you cash the check rather than roll it over into a new plan, you will be liable for income taxes on the entire amount in the current tax year at a rate based on your current tax bracket, which may be higher than the amount withheld by the custodian. If you are under 59 ½ and cash the distribution check, you will pay a 10% penalty imposed by the IRS in addition to the current taxes due.

Some people elect to take a lump-sum distribution and pay taxes and penalties in order to have immediate and unrestricted access to their funds, but depending on your age, this could cost you up to 1/3 of your current assets and much, much more in the long run. Consider this alternative very carefully and avoid it if you can. Remember you are giving up tax deferral on these assets forever on what could be significant earnings and if you liquidate at the wrong time, you may realize current losses in your portfolio.

The worst effect of this option is that you may drastically reduce your income at retirement. For example, If you were able to earn 12% compounded on your assets, the “Rule of 72” says that your assets would double every 6 years. If you have $50,000 and are 18 years from retirement at 65, this would mean trading about $35,000 today (after taxes and penalties) for what could have become $400,000.00 through tax deferred growth by age 65. In effect you would be paying $365,000 dollars of retirement funds to spend $35,000 today.

If your old plan had limited investment options, or was not performing well, you may want to consider moving the assets in that plan into a plan with more options, but there are several things to think about. If you leave or are severed from an employer with a 401(k) plan and do not get a new job with a traditional employer you have options:

1. A Rollover into a Individual Retirement Plan (which can be self directed, with nearly unlimited investment options) and low contribution limits or:

2. If you are self employed and generating income from your business, consider starting a 401(k) sponsored by your business (which can also be self directed). A properly drafted 401(k) plan can include legal distributions at age 55 and a loan provision in addition to much higher contribution limits than an IRA. (See the entry on Solo K Plans for more information on these features)

3. If you are Self Employed you can also consider a Simplified Employee Pension Plan (SEP) which has benefits in certain situations but does not offer the flexibility of a Solo K.

If your income is high enough, you can make tax deductible and/or after tax contributions to a Qualified plan and make non-deductible contributions to an IRA as well to get tax deferred growth from the IRA.

Rollover to an IRA

By rolling over 401(k) assets into an IRA you keep the tax deferred status of your funds, but you will be moving from a “Qualified Plan” in to an IRA, which is a “Non-Qualified Plan”. There are limitations imposed on any IRA because of the distribution rules that apply to “prohibited transactions” in all IRA’s, which are applied differently to a Qualified Plan (401(k), 403(b), 457). IRA’s do not have a loan provision. You cannot take a personal loan from your IRA, period. You can take a personal loan from a properly drafted 401(k). You could split your rollover into several IRA’s for asset protection or to test your ability to self direct by rolling over a portion of your assets into a self directed plan.

If you do not start your own business after a job loss/job change and are not happy with the 401(k) plan at your old employer, a rollover into an IRA can at least offer control of your investments through self direction. Once you start your own business, you can always sponsor a 401(k) and rollover all or part of the assets in any existing IRA you may have into your personal 401(k).

If you find a new job right away, you can elect to rollover the money from your old employers 401(k) into your new employers 401(k) or you still have the option of rolling over the assets in your old plan into an IRA and start a fresh 401(k) or other Qualified Plan (403(b) or 457) with your new employer.

Other Options

One of the options offered to employees at the time of severance is to rollover 401(k) assets into a “Qualified Annuity”. Annuities can provide a fixed income at retirement with capital preservation and “Equity Indexed Annuities” can offer upside potential in addition to capital preservation. The assets are transferred and maintain tax deferred status until distributions are taken.

This is a tempting option for many, since an annuity offers fixed payments that you cannot outlive. If you consider this option, do some serious due-diligence and comparison shopping. These types of products can have higher costs with heavy back end commissions paid for through “surrender charges” and may have state taxes on the premiums. A transfer into a Qualified Annuity is an irrevocable decision.

Note: For the purposes of this entry I have used the term “Rollover” for the movement of assets from one pension plan to another through a check to the plan holder. In some scenarios, a direct transfer of funds occurs from custodian to custodian and is called a transfer rather than a rollover. A rollover occurs when there is a distribution direct to a plan holder, who then may place the funds with a new Trustee/Custodian/TPA or takes the current tax hit if the rollover does not occur within 60 days of the distribution.

All distributions are reported to the IRS for tax purposes. Direct transfers (existing Trustee/Custodian/TPA to new Trustee/Custodian/TPA) are not reported to the IRS. Depending on your situation, there are times when a distribution by check to a plan holder is faster than a custodian to custodian transfer. If you are planning to rollover your proceeds and have identified your new Trustee/Custodian/TPA, you can request a check to the new custodian "FBO" for the benefit of (YOU). You have 60 days to get the check to the new custodian without tax consequences.

There are many nuances to Pension Rollovers and this entry is not intended to be either tax, legal or investment advice, but rather as information to help you avoid the most common problems associated with pensions and job changes. It is not an all inclusive summary of your options. Before you do anything with pension funds between jobs, do your own due diligence and homework and ask lots of questions of anyone you are considering transferring your hard earned assets to.