The answer is — it depends.

An investor needs to know where they want to go with their investments. What they hope to achieve. When an investor knows what they hope to accomplish they have a personal set of guidelines for what makes a good investment for them.

The BawldGuy talks a lot about Purposeful Planning. A Purposeful Plan starts with knowing what you want out of your investments. An investor’s goals or plan can be very simple or complex, but it should be well thought out.

For many investors real estate is a way to build wealth for retirement. For others real estate is a way to quit their day jobs. Some want to be actively involved in their investments. Others need investments that can almost run themselves.

For someone looking to build a solid retirement, current year returns become less important. The goal becomes maximizing the income that can be used in the retirement years. Market trends become far more important. Potential appreciation becomes more important. It becomes increasingly more important that a property be well built as to minimize repairs and maintenance issues.

Investors who have little time for their investments will need solid advisors. It becomes important to insure that your advisors know your goals and have the expertise and knowledge to meet your goals.

Once you know where you want to go you’ll find that there are many ways to get there. Finding solid real estate that you can hold onto forever is one way of getting there. Finding properties that you might want to hold for 3 – 5 years, another approach. Some choose to find properties that have potential for forced appreciation.

Knowing where you are going helps you as an investor to make better choices and clarifies what is a good investment.

Again, we are talking about comparing these plans for a self-employed individual with NO employees, an individual who is either a sole proprietor or incorporated under some entity (e.g., c-corp, s-corp, LLC). The second consideration in comparing the two plans is the common theme that the individual wishes to self-direct his/her retirement funds.

That being said, let’s first look at the 401K and examine its pro’s and con’s.

Pros can be many but, on the surface, can be identified as follows:

- Greater flexibility in contributions vs. other plans;
- Employees can contribute more to these plans than with, for example, an IRA (Traditional, Roth or SIMPLE);
- The 401K is a good plan for any sponsoring business that may have cash-flow issues;
- 401K plans have flexibility in offering both loan provisions and hardship withdrawals;
- Employees can contribute up to $17,000 with an additional “catch-up” contribution of $5,500 for employees over 50 years of age;
- Employers can contribute the lesser of 25% of compensation OR $50,000, whichever is less on top of the employee deferral (assuming, of course, the employee qualifies for such); and,
- The 401K allows for both Employee deferral and Employer match. This provides the option for both to make contributions on a tax-friendly basis.

Cons with the 401K may be viewed as:

- Possible higher administrative costs under more basic arrangements;
- Preparation of an annual Form 5500;
- Requirements to conduct non-discriminating testing so that discrimination is not occurring with a company’s more highly compensated employees; and,
- Additional administrative burdens and costs associated with hardship withdrawals and loan provisions.

Now, remember, we are talking about a self-employed individual who is both the employer and employee of the plan. So, if we were talking about a 401K plan for a company with multiple employees (2 and above), the aforementioned cons would be serious considerations.

However, with an individual 401K plan with NO employees, the following cons are satisfactorily addressed:

- There should be not be higher administrative expenses for the plan for a self-directed individual 401K vs. any IRA. In fact, annual costs can either be eliminated or greatly reduced;
- Provided assets of the plan are under $250,000, there is NO requirement for any reporting of the plans assets, including the Form 5500. Once assets surpass the $250,000 threshold, the individual only has to prepare Form 5500EZ. The Form 5500EZ is the much simpler and prettier cousin of the dreaded Form 5500. It is only two pages long, and the individual or his/her tax preparer can simply prepare this document;
- There is NO non-discrimination testing as, again, the individual is both the employer and employee; and,
- Any hardship withdrawals or loans are executed by the Trustee of the plan…again, typically, the self-employed individual. As such, this does probably not rise to a level of being an administrative burden or cost to the self-directed individual.

So, right now you are probably saying, “Hmm, yes, the 401K is definitely the one to go with…I don’t think I need to read any further.” But, we gotta be fair to the SEP.

So, let’s turn the table and look at the pros and cons of the SEP. Pros of the SEP, can be identified as follows:

- The SEP is easy to set up and operate;
- SEPs have low administrative costs;
- Like the 401K, the SEP has flexible annual contributions…which help with cash-flows issues of a company/sole proprietor; and,
- Employee is vested immediately on the funds contributed on their behalf.

Cons of SEP, could be viewed as:

- The SEP has to fund all employees equally with the same percentage;
- The SEP is an employer funded plan. The employee is not allowed to make contributions nor can they control what the “boss” is doing….the boss sets the contribution limits.

Well, like the 401K, these negatives can be easily addressed by the self-employed individual who has a SEP. Specifically:

- As there is only one employee (typically, just the employer/employee BUT they could also include their spouse), there is not a concern, generally, about funding the contributions in the
same manner as other employees. There are no other employees; and,
- One might say, who cares if the SEP is an employer-funded plan as, again, the employer and employee are the same individual.

Okay, so now you may be leaning a bit more to the SEP. But remember what I said at the beginning. Both plans for a self-employed individual will, on the surface, be very similar to overall benefits and negatives (if you think there are any). However, here are a few very important considerations for our self-employed individual who is desiring to establish either a self-directed SEP OR 401K and is weighing the pros and cons of each.

1) Technically speaking, the 401K (through both employer and employee contributions) can contribute up to $55,500 in total contributions whereas the SEP will be limited to a maximum of $50,000 in employer contributions;

2) Where SEP contributions can ONLY be made in a traditional, pre-tax manner, our self-employed individual can actually make traditional, pre-tax contributions, ROTH contributions or both (if the plan documents allow for such);

3) The 401K plan will allow loan provisions from the plan up to $50,000 or 50% of the account balance, whichever is less. The SEP has no loan provisions.

4) Remember, we are speaking of a self-directed plan. Therefore, as IRAs are mandated by Congress to be “held” by a custodian, our individual who elects a self-directed SEP IRA (or any other IRA) will have annual custodian fees with a self-directed IRA custodian. In contrast, it is possible to establish the 401K plan with minimal or no annual fees. This can result in our individual saving thousands of dollars in fees; and,

5) If our self-directed individual has an IRA that participates in a Prohibited Transaction (one of those IRS “no-no’s”), it is invariably a death sentence as the plan must be distributed and fully taxed and have a 10% excise tax if the event occurred prior to 59 ½. Finally, with what funds are left over that haven’t been taxed or penalized, they are no longer in an asset-protected vehicle such as the IRA.

In contrast to this, the 401K may qualify for much lesser penalties than the IRA. This is due, in part, to the plan being a qualified plan.

So, now, you have probably flip-flopped again, right? As always, this post is not intended and should not be viewed as tax, legal, financial or investment advice. But, you can see that with both plans, you can self-direct, and there are significant benefits to both. However, there may be just enough benefits to the 401K where it should be strongly considered in comparison to the SEP. Again, as mentioned at the beginning of this post, it really boils down to a personal preference and what “fits” best for your situation. I’m pretty sure BawldGuy calls it your ‘comfort zone’.

Do your due diligence and ask questions. Unfortunately, many professionals (even in the world of self-direction) urge their clients to take what they believe to be the path of perceived least resistance…the IRA. However, I think you can see that the 401K is a solid consideration for any self-employed individual….whether they are self-directing their retirement assets or not.

Next? Let’s look at the pros and cons of 401K loans and taking early distributions from your account….again, self-directed or not.

Bonds

This week, bonds took a bit of a beating, largely due to events overseas, and even internal info coming out of the economic sector back here in the States. First off, Greece is adamant about their claims of having reached an agreement with the Euro Nations on their ‘bailout’. It appears that this agreement should be in place by the end of the day, Monday the 20th. While I’m still skeptical, it appears that this might actually happen this time — no, really. If that’s the case, expect a little flurry of investors to start investing some capital into stocks, and thus liquidating some of their safer assets like bonds and mortgage backed securities. This could put a little pressure on the price of bonds and thus raise rates slightly.

At Home

The news on the home front was positive and for the most part in line with the numbers expected. There was a .9% rise in gasoline prices here in the states for January that contributed to pushing the Consumer Price Index to it’s highest level in 4 months. If you take out the more volatile food and energy and look at the core rate of inflation, it rose in line with the experts expectations. One thing definitely worth noting is the core rate of inflation has climbed over the past 12 months, signaling that the rate of inflation may be waking from it’s slumber. Remember, Big Ben has been desperately anticipating inflation to increase, so he may finally get his wish. It is still way too early to tell. This is important to note though, as it may cause the Fed to hold off on moving forward with Quantitative Easing part III, or as we’ll title it QE III — the Fed’s direct purchase of the longer term bonds and mortgage backed securities. If inflation is starting to increase, and it is consistently increasing, there will be no need to enact such a measure.

On to next week. It would be a shortened week for investors at the Wall, starting with Tuesday Wednesday and Thursday, the Fed will be looking to sell off $99 billion in 2, 5 and 7 year notes. If the auctions go well, expect mortgage rates to remain steady, whereby poorly bid auctions could send rates upwards.

We will also get January’s report for existing home sales Wednesday, and on Friday the government will release data for new home sales.

Current Rates:

30-YR. FIXED RATE FOR SFR WITH 20% DOWN WILL GET YOU 5.125%

30-YR. FIXED RATE FOR 2-4 UNITS WITH 25% DOWN WILL GET YOU 4.875 – 5.0%

Everyone have a safe and enjoyable 3-day weekend for those lucky enough to have Monday off.

Some Questions

Turns out they were brothers. They told me to ask ‘em anything, so I proceeded to do just that.

• What’s your current financial picture?

Cash reserves? Available investment capital? Assets convertible to cash without muss ‘n fuss? Gross annual income from work? Any real estate investments? Etc.

• Outside of housing expenses, how much debt do you have?

• Are you currently contributing to a 401k or IRA? How much? Balances?

• When do you want to retire?

• How much income is the minimum for you to feel comfortable?

• How much capital — not touching generous cash reserves — is available for real estate investing?

• How much money, if any, can you comfortably afford to add on a periodic basis to any cash flow toward the goal of debt reduction?

There were many more questions, but you get the gist. Turns out they’re in San Diego visiting their mom, Dad having passed away some time ago. They promised to get in touch once they’ve returned home. One thing they said though, caused me to pause and reflect.

They said the phrase with which I’d begun, Purposeful Planning, gained more meaning as I asked each successive question. One of ‘em put it this way.

Heck, most people make out a plan to retire, even if it’s only in their head. But there’s a difference between planning — and doin’ it with a clearly defined purpose. It’s not like we haven’t had a purpose, we do. But after today, I can see how it makes a big difference when the plan itself is done as deliberately, detailed, and methodically as you’ve suggested.

That’s a loose but accurate paraphrase of his observation. He was so painfully honest, it made me wonder if I’ve underestimated how many out there are truly analagous to a cork floating on the ocean, going wherever the current takes ‘em. Betcha they had retirement plans too.

Take both words in Purposeful Planning literally. Take them that way separately and together. The older you get the more crucially important it becomes that your plans for retirement succeed. The more nebulous your plan’s origins, the more likely it will disappoint.

BawldGuy Takeaway: A detailed, methodically mapped out plan for retirement with a concisely stated end game — read: purpose — will virtually always generate superior results. I see it every day. Find out where you are now, financially, then proceed from that point.

It’s also critical to note that Purpose should always be viewed both as a noun and a verb. It’s one thing to have a purpose when mapping out a plan. It’s quite another to execute that plan ON purpose. Corny? Maybe. But true just the same.

Sure, it gets complicated once you arrive at the ‘how to’ part of the plan. The multiple strategies necessary for complete success must be understood to be executed properly. (Duh) Your retirement will prove far too pivotal in your life to be approached in any other way.

Don’t you agree?

Hey! Let’s agree on something else. You, calling me at 619 889-7100. You’d rather write me? Click on the Contact BawldGuy button at the top of the page. We’ll go into Purposeful Plan mode together. Have a good one.

Negative leverage — Thou shalt not

If the cost of money borrowed in the process of acquisition cost more, in terms of interest rate than the subject property ‘returns’? You’ve entered the land of negative leverage. It’s akin to the guy whose intention was to fill the hole up, only to discover he’s been diggin’ it deeper and deeper. In the end, it never works.

Law: An investment property shall generate a yield greater than the cost of money it took to acquire it.

Appreciation in value

First off, let’s not pretend we don’t adore appreciation. It’s wonderful when your invested dollar turns into two dollars merely due to time’s passing. I’ve enjoyed it the vast majority of my adult life. Buy an income property for $X, and sell it a few years later for $2.3X works every time it’s tried. (Bubbles excepted.) However, when analyzing a property(s) with an eye to buyin’ ‘em, never, as in never ever insert appreciation as an assumption. When we assume the property won’t go up in value, the world of ‘real’ takes over our analysis. Funny how that works. Smoke ‘n mirrors is more reliable than an analysis dependent upon the value rising.

In fact, I’ll go a step further. The property(s) in question should work even if they slide a bit in value. Free ‘n clear properties owned at retirement generate cash flow — regardless of whether their value has fallen. Imagine retiring with $80,000 a year in income, when it shoulda, by all rights been $105,000. Oh, the humanity.

Law: Never, for any reason whatsoever, no matter how rational sounding, imbue any property analysis with the presumption of appreciation. No exceptions.

When it comes to rents

Beginning a serious property analysis without boots on the ground knowledge is worse than wasting your time. In the publishing biz, it’s called fiction. Since the money you’re investing isn’t fictional, it’s been my experience that ensuring the reliability of the analysis’s imputed rent(s) better be nothin’ short of slam dunk.

Put another way — it’s called ‘income property’ for a reason. It’s folly at it’s worst when the analysis of said income property is literally based upon unsubstantiated income. This is done all the time by well meaning investors who’ve ‘surmised’ income by whatever technique with which they’ve become comfortable. My advice? Learn to get comfy with rents which are virtually unassailable.

Law: The rents used in any analysis of investment property must be be reliable to the point of being beyond reproach. Anything else is — without exception — always unacceptable.

Most acceptable is hearing from you. Make it happen by calling 619 889-7100. Rather send me a note? Easy, click the Contact BawldGuy button up top. Either way, let’s make it happen together. Have a good one.

Recently, in a fairly well-hidden bill that was defeated, there was an amendment by lawmakers that tried to eliminate (or greatly reduce) the estate benefits of the Inherited IRA. The defeated proposal would have raised nearly 5 BILLION over a 10 year period by amending and changing some of the rules pertaining to the aforementioned retirement account, and how people actually take distributions on that account.

What’s an Inherited IRA?

You might be asking what exactly is an Inherited IRA and HOW would it raise nearly 5 billion dollars for roads? Well, the Inherited IRA allows heirs of the original account holders of the IRA (before it became inherited) to stretch out the period of time they needed to pay taxes on the Inherited IRA over their expected lifetime. However, the proposed amendment would have required the beneficiary of the account to distribute and pay applicable taxes over a five year period of time. As an example, if an individual aged 45 received an Inherited IRA from their deceased parent and that 45 year old had a life expectancy of age 80, he/she could spread out the required tax bill to Uncle Sam over that time period — vs. — the proposed amendment of 5 years. To say this would be quite an adjustment would be an understatement.

While the amendment was defeated, it is a sign of possible “winds of change” with regard to how much is allowed to go into a retirement plan, taxation amounts, durations, etc. The fact that it was even originally included as a deficit-reducing tool is indeed surprising.
In fairness to the proposal, many view “stretch” related IRA plans to be more of an estate issue that a retirement issue. It is fair to say that lawmakers certainly viewed a tool such as the Inherited IRA more as a way to prolong the government’s ability to receive taxes from a retirement plan that’s intended purpose is to stretch out the benefits over a longer period of time.

As Senator Max Baucus from Montana stated, “IRAs are intended for retirement. They’re being used by some taxpayers to give tax-free benefits to second, third, maybe fourth generations.” Further, Baucus noted, “It’s important to put the R back in IRA. They’re for retirement, not an estate-planning tool.”

While this was a noted surprise as an amendment to the bill, there has not been any recent serious discussion about lawmakers considering further changes to the tax code as it relates to other plans such as IRAs (Traditional and Roth) or 401Ks and the like. But, this is certainly good food for thought.

BawldGuy Here: This very attempt at raiding qualified plans by the House and Senate are what I’ve been warning folks about for several years. It’s yet another solid reason to get out of whatever plan you’re in — and sooner rather than later. Around 4:30 yesterday afternoon would serve you just fine, thank you.

Don’t get me wrong, I believe many financial planners can be quite helpful in building a financial plan and in presenting the investment choices that they know and understand. The wrinkle seems to be that there are so many ways to really invest and planners tend to focus on investments that they are most familiar with and perhaps where they can make the most money. In my opinion real estate can be a great investment, especially if you understand the fundamentals of what makes for a good real estate investment.

A common fallacy that I hear is that cash flow and appreciation are the only elements in a real estate return. It is then further stated that appreciation is unlikely and should not be considered which only leaves cash flow. Reality is that cash flow and appreciation are just two out of the four elements that make up a real estate return.

4 parts to any real estate return

Cash flow – important but not necessarily the most important part of the return

Tax Savings – paper losses can offset ordinary income

Equity Buildup – someone else pays down the principle

Appreciation – something we hope for these days

These four elements do make up any rental properties return, but once again there is much more to investing. Money can be made at the time of purchase. Money can be lost when unforeseen structural or environmental problems are discovered after purchase. Money can be made when after purchase the city council rezones the area.

It’s more than numbers

My point is that there is more to real estate investing than simply numbers. The numbers are very important because they shed light on what you might expect as a return on your investment, but the numbers fail to express the other factors that can impact your return as well.

Do you suppose that population growth in an area might impact real estate returns? What about the job market? Do you suppose that environmental regulations or land use laws might impact real estate? What about zoning, school districts, soil conditions or even weather?

Some things are very much in an investor’s control which is one of the reasons many like to invest in real estate. Quickly clear, is there are some things that are beyond any investor’s control and must be minimized at time of purchase.

BawldGuy Here: I’ll be writing a post this week on how almost any real estate investment woulda been vastly superior to almost anything on Wall Street. I’ll be using the investment period, 1975-2005 as the example period. Nothin’ like using history to demonstrate what’s what.

Now let’s back up a little bit.

So why does this have an impact on mortgage rates you ask? Again, this is a situation that wreaks havoc on our economy. Economically, this is bad news for Europe and for the US economy, as well as all other global economies. Nobody gains any benefit from a country defaulting. This is an extremely uncertain time right now for investors to gauge. And in uncertain times where do investors like to put their money? You guessed it, the safe assets like bonds and mortgage-backed securities. We’re not seeing a huge increase in the price of MBS right now because the price of the mortgage-backed security keeps bumping it’s head on the proverbial “glass ceiling”. The MBS has never been higher, and when you reach the pinnacle, ultimately you are going to have a little resistance. If Greece continues to struggle in their bailout pleas, we may break through this ceiling and we could potentially see rates dip a little more. Time will tell.

I would like to report what Warren Buffet thinks is the right move right now, as he knows a thing or two about this stuff.

“Current rates, however, do not come close to offsetting the purchasing-power risk that investors assume. Right now bonds should come with a warning label.”

In other words, lock ‘em if you got ‘em, or buy now as rates ain’t gonna get a whole lot better. Whomever you decide to believe, I’m following Warren on this one. I’ve said it before and I’ll say it again, “Hogs get fat, pigs get slaughtered!” Get in while the getting’s good!

Ok, on to the important stuff.

Today’s Rates:

Single-family Residence 4.875% with 20% down

2-4 units, are 4.75% with 25% down

Everyone have a great weekend, and we’ll see how this ‘Euro’ thing shakes out next week.

As a matter of note, please be advised that ROTH IRA funds cannot be brought into a 401K plan. But, once we get past the Roth conversation, most other funds from other qualified retirement plans can, generally speaking, be transferred/rolled over into the 401K plan.

However, two very specific plans cannot be transferred/rolled over into a 401K plan. These plans would be:

Inherited IRAs

Roth IRAs

So, this leads to the next question….which of the following plans can be transferred into a 401K plan?

Traditional IRA YES

Simple IRA YES — after two years

SEP IRA YES

457 (government) YES

“Pre-Tax” Qualified Plan* YES

403(b) Plan YES

Designated Roth Account NO
(401K or 403B)

* Qualfied Plans, for example, include Profit Share, 401K, Money Purchase Plans, Defined Benefit Plans.

In the next post, we will examine the pro’s and con’s of a SEP IRA (Self-Employed Pension) compared to a 401K plan. I think you will find that the 401K MAY just be your better option if you are self-employed (without employees).

This blog post is not legal advice. Individuals should seek advice based on their particular circumstances from their own counsel. Nothing in this blog post is intended as tax, legal, financial or investment advice. Moral of the story is to always seek guidance from professionals in those fields.

I am working with a client who sent me an e-mail from another agent who he was working with originally. Before he received this e-mail he was still undecided as to who to work with. The funny thing is he simply asked some questions, good questions, and stated he had talked to another agent.

Here is the first paragraph [with all identifying sections taken out].

“With all due respect, I don’t have the time nor the inclination to attempt to justify our strategies with you if you are going to turn this into a “beauty contest” with other agents or products. I’ve been there, done that and it is a complete waste of time. Our strategies are not up for debate at this point. We could use any insurance company we wanted to but with our experience, we know what is best for the client and that is our one true aim.”

Unfortunately there are many in the financial fields that think like this whether it is insurance, real estate, or investments. For levity I will annotate this for you, but the point is deadly serious. Educate yourself about any product or strategy you are considering, ask questions, expect answers, and never work with someone who thinks they know what is best for you!

With all due respect [You’re a fool that can’t possible understand what I am talking about].

I don’t have the time nor the inclination to attempt to justify our strategies with you if you are going to turn this into a “beauty contest” with other agents or products. [I fear we don’t offer the best product and can’t explain the intricacies of why I think this product is better than others]

I’ve been there, done that and it is a complete waste of time. [Once folks understand how little I know I always lose the sale]

Our strategies are not up for debate at this point. [I can’t debate them because I only offer what I am told and have someone else tell me how to sell the strategy]

We could use any insurance company we wanted to but with our experience, we know what is best for the client and that is our one true aim. [Don’t you worry your little head about this, papa knows best what is good for you.]

This last sentence is the one that get’s me the most. What you want to bet what is good for the client [in their mind] is what is best for their pocketbook?

I know the people reading this will understand to stay away from sales people that think like this. Unfortunately there are far to many folks out there that think like this.

Hope you get as good of laugh as I did when I received this!

BawldGuy Here: First, thanks to Dave for the best written comic relief so far this year. Seriously though, I’m always imploring those calling me never to let me get away with sayin’ something ‘hard ‘n fast’ without backing it up in depth, and in detail, to their satisfaction.

As pros, all the contributors here understand that some answers aren’t the ones the questioner wishes to hear, but, well, the answer’s the answer. Again, thanks to Dave for my giggle of the day.