Only two types of investments are excluded under IRS Codes:

• Life Insurance Contracts
• Collectibles such as works of art, rugs, jewelry, etc.

What are prohibited transactions?

IRC 4975(c) (1), identifies prohibited transactions to include any direct or indirect:

• Selling, exchanging, or leasing, any property between a plan and a disqualified person. For example, your IRA cannot buy property you currently own from you.
• Lending money or other extension of credit between a plan and a disqualified person. For example, you cannot personally guarantee a loan for a real estate purchase by your IRA.
• Furnishing goods, services, or facilities between a plan and a disqualified person. For example, you cannot use personal furniture to furnish your IRAs rental property.
• Transferring or using by or for the benefit of, a disqualified person the income or assets of a plan. For example, your IRA cannot buy a vacation property you or your family intends to use.
• Dealing with income or assets of a plan by a disqualified person who is a fiduciary acting in his own interest or for his own account. For example, you should not loan money to your CPA.
• Receiving any consideration for his or her personal account by a disqualified person who is a fiduciary from any party dealing with the plan in connection with a transaction involving the income or assets of the plan. For example, you cannot pay yourself income from profits generated from your IRAs rental property.

Who are disqualified parties?

A disqualified person (IRC 4975(e) (2)) is defined as:

• The IRA owner
• The IRA owner’s spouse
• Ancestors (Mom, Dad, Grandparents)
• Lineal Descendents (daughters, sons, grandchildren)
• Spouses of Lineal Descendents (son or daughter-in-law)
• Investment advisors
• Fiduciaries – those providing services to the plan
• Any business entity i.e., LLC, Corp, Trust or Partnership in which any of the disqualified persons mentioned above has a 50% or greater interest.

Q: Can I invest in art?

A: Nope, art is a “collectible” and thus explicitly excluded as an allowed investment.

Q: Can my IRA purchase a 4% interest in an LLC that my son also owns a 20% ownership in?

A: As long as you or your son are not drawing any salary or other income outside your capital interest you can. Your son is under the 50% ownership threshhold so it is safe, but tread lightly. You don’t want any self-dealing.

Q: I own a rental house. Can I sell the rental house to my IRA?

A: No. This would be considered “self-dealing”

Q: Can my self-directed IRA’s LLC purchase a 50% interest in a joint-company with my wife’s IRA?

A: No. Your wife would fall in the 50% threshhold of a disqualified person. The IRS would disqualify both your IRA’s and you’d suffer major tax penalties. In your described arrangement it would be easy for the both of you to control the company so as to have personal gain.

Q: I own 25% of a company through my IRA. My son recently got hired through his own merits and I just found out he works for my company now. Will this cause problems?

A: Yes. Since you are part owner, it would be easy for the IRS to assume that your relationship to the investment influenced the hiring decision. You should ask your son to change jobs or divest yourself from this company to protect your IRA from becoming disqualified.

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I spend a great deal of time investing, researching, and creating deals.  What we often neglect is what our money is earning in between deals, in between major purchases, when its sitting in your checking account.  I recently came across a great website – checkingfinder.com.

The website allows you to search for high-yield checking accounts in your area.  Recently I was very close to opening a checking account at a local bank that was paying 4%.  I spotted the offer on a billboard near my wife’s work.  After going to checkingfinder.com I found a bank paying 5.51% or 38% more than what I had found.

Your search will return a list of banks which you can sort by distance or rate.  I did rate.  the highest paying bank paid 5.51%, but was 400+ miles away, no problem in this modern internet banking era.

After you get your list you can click on “learn more” and get more details and restrictions on the offer with a link to the bank’s website.

I highly recommend the website.  Check out Checkingfinder.com for yourself.

**UPDATE:  8/22/2008

Shortly after I posted this, I received an email about a 7.01% checking account.  I thought it would be some offshore bank, but it turned out to be Midwest America Federal Credit Union.  I’m going to be opening an account there.   This bank didn’t show up in checkingfinder.com, but then again there are thousands of banks in the U.S. and all of them don’t have big marketing budgets to get their name out.

There are some caveats:

• 7.01 apy is only for the first $25,000 in deposits.
• Must make 10 debit card transactions for that month
• Must have 1 ACH debit or credit transaction for that month (a bill pay or direct deposit for example)
• Sign up for e-statements.  You should do this anyways to save paper and for security.

These caveats are not too bad.  You could make a series of small debit card transactions quite easily.  Pay a bill and sign up for e-statements.  Not bad.  Considering this account would pay me $62.70 more per month than the 4% account I found locally I can make due with a little bit of extra effort each  month to get this juicy yield.

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Looks like the economic stimulation package is going to pass through Congress. So this may leave you with a few questions: 1. How much do I get? and 2. What am I going to spend it on?

I can’t tell you what to spend it on, but if you want to get an idea of how much you might receive I found this – The Olathe News Tax Rebate Calculator. Unfortunately I’m not receiving anything back. I guess it is fortunate that I’m earning enough to not qualify. In any case it would have been nice. Even if I received the rebate I would still disagree with it.

The stimulus package does more than rebates.

The Package:

• To address the mortgage crisis, the package raises the limit on Federal Housing Administration loans from $362,000 to as high as $729,750 in expensive areas, allowing more subprime mortgage holders to refinance into federally insured loans.
• For consumers, up to $1,200/family
• The package would allow businesses to immediately write off 50 percent of purchases of plants and other capital equipment and permit small businesses to write off additional purchases of equipment.

Notably Absent:

• No extension of unemployment benefits.
• Removal of ability of businesses incurring losses now to reclaim taxes paid in past years.

There are a few things that concern me. The rebate is slated to be 1% of our GDP. Now I really doubt that it will move the economy much. In fact most of our consumption is on foreign goods. Of course our economy is 60% services so a good chunk would get spent on domestic services. In any case I think it to be inefficient.

Another concern I have is the cost – $100 billion. Putting cash in the hands of consumers is not what I consider a stimulus. It is irresponsible at best. What really stimulates the economy is investment in capital goods. The 50% capital equipment writeoff is a good start, but I think more targeted tax cuts would do a better job then giving away cash to consumers. This is a stop-gap measure that at best will have a very short-term effect of delaying a recession or at best provide a few quarters of flat growth.

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A Good Deal?

Looks like a nice offer. “Rates just lowered an average of 30%!” Wow! I better look at this closer. The offer is for a 10 year term life policy on a 27 yr old female. I quickly found a few problems with the affinity “special” offer.

Overpriced

I did a quick search and came across an insurance subsidiary of GE that sold term life. Below are the prices I found.

$100,000 policy – $7.18/month or 25% less than this “special” offer of $9.66/month

Wholesale Coverage at Retail Prices?

Another thing that struck me about this offer is that to go from $50,000 coverage to $100,000 or double coverage, the premium went up by 3x.

There is a baseline cost of doing business or writing an insurance policy. As such, the larget the policy the premium per dollar coverage. With GE I found the premiums to be:

• $100,000 – $7.18/month, 7.18 cents/$1000 coverage
• $250,000 – $10.50/month, 4.20 cents/$1000 coverage
• $500,000 – $16.63/month, 3.33 cents/$1000 coverage
• $1,000,000 – $28.83/month, 2.89 cents/$1000 coverage

Click the image above for the full cost schedule

The above should be the norm. Think of it as wholesale prices. Whether you buy $100K of policy or $1 million, the insurance company has to have an underwriter and agent write your policy and enter it into the system. There is not much difference to the insurance company in costs. Therefore, it is cheaper per dollar coverage for the insurance company. According to this offer it looks like they are offering wholesale coverage at retail prices. That’s not how it normally works.

You’re not so “special”

Affinity offers tend to appeal to an individuals need to feel special. If you are a member of the Bar Association, or the American Kennel Club, or the American Medical Association, or any other association you will likely get an affinity offer. These offers want you to feel special for being in your group. In effect they are banking that you will feel that you received a “special” offer and take the bait. With very little research you can usually find better deals. Sometimes you will find the affinity deals to be better, but do your research before you start feeling special.

This offer did have one thing right – “Send No Money”. Don’t worry, I won’t.

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I am more aggressive with my investments since I day trade in addition to investing in alternative investments. I’m either lucky over 10 years or I’m good. Either way my broker is happy for it.

As an aggressive trader, I always plug away at numbers in my head. I’m almost ashamed to say I have a calculator by my bed. One of the things I always keep my eye on is how fast my money is growing. Also I estimate from time to time how long some of my risk capital will double, triple, or even quadruple. To do so, you don’t have to have 99.99% accuracy. That’s where the “Rules” come in.

The Rule of 72

You may be familiar with the Rule of 72. This formula can be used to estimate how long it will take to double your money based on an interest rate.
Example:

You expect to get an 8% return on your money. How long would it take to double your money based on that interest rate? To estimate, simply divide 72 by 8 and you will get 9 years.

The formula is fairly accurate for estimating.

The formula is most accurate between 5 and 9 percent. Above and below it is less accurate, but still useful for estimation.

The Rule of 114

The Rule of 72 is great for estimating how long it takes to double your money, but what if you are more ambitious and want to triple it? That’s when the Rule of 114 comes in. Divide 114 by your expected interest rate. Using the 8% return figure from the first example, we would calculate it as 114 / 8 = 14.25 years.

The Rule of 144

To estimate how long it will take to quadruple your money, you can use the Rule of 144.

Time Value of Money
These 3 rules underscore the concept of the Time Value of Money. Time value of money simply states that money received today is worth more than the same amount received in the future. The core principle of finance holds that if money can earn interest, an amount of money is worth more the sooner it is received. The current value is called Present Value or Present Discounted Value.

Time Value of Money is useful for financial planning for things such as retirement and college financing. If you remember anything remember, a dollar today is worth more than a dollar tomorrow.

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A penny saved is a penny earned or so Ben Franklin said. Well it is true especially for your next million. If you have ever felt like it takes forever to build up your large nest egg you’re right. It is due to the time value of money. The earlier you save, the better off you are assuming you keep that money working for you. Looking at the above chart, if you saved $1,000/month and earned 10%/year for 22.4 years, you’d have your nest egg grow to $1 million. To get to your next million it would only take 6.4 years.

While 22.4 years may seem like a long time, it shows that it is possible to become a millionaire without inheriting or winning the lotto. If you’re like me you don’t want to wait 22.4 years. So here’s what you need to do now.

• Realize that $1 million 22.4 years from now is not the same as $1 million today. Inflation will bite into your spending power.

• Try to earn more. As you can see earning more interest sooner will get your there faster. For example earning 11% vs 8% will get you to $1 million 3.3 years faster.

• Earn it sooner rather than later. Don’t have a savings plan where you contribute $12K at the end of the year and invest it. Contribute it monthly to your investments or if you can put more up front and defer expenses until later in the year, you’ll be better off. In the above chart one thing is apparent. Your first million works hard for you to get to the second million. The same holds true for the first dollar you save and invest. Save early and invest early.

• Don’t let money sit around. By sitting around, I mean don’t let it sit in an account earning 1% in a checking account. Look around. There are many options such as online money market accounts such as Everbank and HSBC. Direct deposit your paycheck into a high-interest account. If you prefer the convenience of local banks, then just setup an automatic monthly transfer to your brick and mortar bank. That’s what I do.

• Know where you stand. I highly recommend using some personal finance software such as Intuit’s Quicken or MS Money. There are also online tools such as NetworthIQ that help you track your networth and compare against others to see how well you’re doing. They also have good tips on how to achieve your goals.

• Lastly – Believe you can do it and be disciplined. For every person that says you can do it, you will find a hundred that will tell you you can’t, and another thousand that will say you’re crazy. Look at the chart above. It is doable. Keep your eye on your goal and don’t lose sight of it.

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Though full-service brokers charge a lot for their services, they do a good job of marketing their product and educating their potential clients about their financial needs. Before you start planning the future it is important to understand where you stand now. A.G.Edwards has a simple quiz that will give you an idea of your nest egg.

My results were “excellent” which means I’m “done an outstanding job of building your nest egg up to this point in your life”. I always look at what is the max score I can get. On this scale the max is 850. I scored well, but I’m still disappointed I didn’t score higher. My guess is I’d need a much higher income to reach the 800’s.

The results give you an idea of where you stand relative to the National Score and also provides some tips on how to improve your financial situation.

Here are a few canned suggestions I was given:

1. Continue to manage debt. .

2. Maximize your retirement contributions.

3. Consider your other financial goals.

4. Review your investment mix.
5. Create or review your estate plan.

The tips to further improve are quite generic, but are good in general. Each tips has more detail and usually recommends talking to a financial advisor or using some other A.G.Edwards tool. Not surprising since the goal is to get new clients.

Try it out and see where you stand. There are 14 questions and takes a few minutes to complete.

Get your A.G. Edwards Nest Egg Score

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Below is the marginal tax rates for U.S. citizens for 2007.

Tax Year: 2007
Filing Status: Head of Household

If your taxable income is between… Your tax bracket is:
0 and 11,200 10%
11,200 and 42,650 15%
42,650 and 110,100 25%
110,100 and 178,350 28%
178,350 and 349,700 33%
349,700 and Above 35%

To make an example, suppose your taxable income (after deductions and exemptions) was exactly $48,201 in 2007 (avg household income per US Census) and your status was Head of Household; then your tax would be calculated like this:

11,200-0 11,200 x 0.1 = $1,120
42,650-11,200 31,450 x 0.15 = $4,718
48,201-42,650 5,551 x 0.25 = $1,388 <— Their marginal rate is 25%
Total: $23,723

Income?

Take the above household and assume they have $10,000 saved to invest. If they put it in an interest bearing account of some sort where they get a 9% return, they will get $900 interest at the end of each year. After taxes (marginal rate is 25%), the household will get $675 of interest. Their interest would be taxed as ordinary income and their marginal rate would apply.

We will assume the household continues to reinvest the income each year for 5yrs. At the end of 5yrs after taxes, the household will have $13,862 after all taxes.

or Growth?

Now let’s take the same example, but now let’s invest in a financial instrument that will give us long-term capital gain instead of income each year. Our return in this case will be the same at 9%. Our gain will end up being taxed at 15% long-term capital gains, but only when we sell. So we will be taxed once at the end of 5 yrs when we sell.

Our money will grow faster because we will be getting the full 9% compounded. In fact our $10,000 will grow to $14,578 after paying the 15% capital gains tax at the end of year 5.

We end up with $716 more with the investing for growth model or 5.16% more.

Which to Choose?

There are other decision factors when choosing whether to invest for income or growth. You must take your own situation into account.

Why Income?

• You are approaching a period in life where you will be relying on this income for lifestyle maintenance. In this case you wouldn’t be reinvesting your income, but using it.
• You are expecting some potential large expense. For example your car may be on its last leg. It may die tomorrow or maybe even 3 yrs from now. You would like to have the availability of your funds “just in case”
• You feel more secure. Some people down right like the feeling of getting periodic positive feedback from their investments.

Why Growth?

• You want to accumulate wealth by minimizing taxes.
• You don’t need the money for current needs and can wait to reap the benefits.

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The effects

Going to foreclosure puts immense stress the individual and his credit rating for future home purchases. It becomes a cycle where the buyer has to seek out even more complex instruments designed to capture the high-risk individual’s business. This is what the subprime mess is all about. Some nefarious mortgage companies preyed on the lower-credit individual’s desperation.

Avoid it

There are steps you can take to avoid foreclosure. Below is a graphical depiction of the entire time-line of a foreclosure.

The process is quite lengthy. The most important thing is for you to get in touch with the lender and let them know of your difficulty. The earlier you do this in the process the better. Once notices have been sent, you start fighting time.

So here’s what you do:

1. Call the lender and ask to speak to the “loss mitigation” department.
2. Schedule a review of your scenario with the lender. Be sure to indicate that you wish to keep current, but need some flexibility and alternatives.
3. Be aware that your lender is not obligated to change any of your terms, but they also don’t want REO or “real estate owned” on their books. Your bank is in the business of rotating money through loans not holding real estate.

People go through foreclosure for various reasons : illness, divorce, job loss, etc. In most cases it is because they bought a house they couldn’t really afford. They got “cheap” loans that reset at 3,5, sometimes 7 yrs. When those rates reset they couldn’t afford the loans. The best thing to do is to buy a house not only that you can afford, but one that you can easily afford. I have a double-income household, but I plan on buying a house we can afford with one person’s income. I take it a step further and plan on buying a house that we can afford with the lowest income member of our household. This is the strategy that the affluent use.

The worst way to borrow is to let the bank tell you what you can afford to borrow and then borrow that amount. They use stock numbers like 4times income or something similar. If you made $100K, you can afford a $400K house. Should you? The answer is more complicated. The question to ask is “Can I easily afford a $400K house” and “Do I even need a $400K house?”

As in most things planning/preparation in the beginning of the home purchase will yield the maximum benefit. However if you find yourself in the precarious foreclosure scenario, don’t give up. Learn your options and communicate with your bank. Downsizing is not a bad thing if it is the right thing. Be open-minded and know that it is not the end of the world no matter how painful it may seem.

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What is a self-directed IRA?

A self-directed IRA allows you to invest in both “traditional” investments such as stocks, bonds, and mutual funds, as well as “non-traditional” investments, like real estate, mortgages/deeds of trust, private placements, tax liens, and other private placements and limited partnerships. A self-directed IRA enables you to use your investment knowledge and expertise to manage your own investments. It is a common misconception that you can only hold CD’s, stocks, bonds, and mutual funds in your IRA. This is simply not true. A self-directed IRA quite simply is an IRA account that allows you to directly manage and choose which investments to purchase.

How do I set up a self-directed IRA?

As in most things, there are some tricks of the trade. My company DNA Investments can help you maneuver through them. Below are some high-level summaries of available options:

Option 1: Setup a trust

In this option, you setup a trust to hold all your assets. The trust will charge fees for this service. You would direct the trust to buy the assets that you have selected. This can become somewhat cumbersome and expensive as you will typically pay per transaction + a percentage of assets under management.
Option 2: The DNA Investments Passbook Trust

In this option you are given more direct control of your assets. IRS rules prohibit arms reach transactions, but you can still retain close control. You can’t for example purchase a home as an “investment” and then live in it. This would be a violation.

With the Passbook Trust, DNA would setup a trust much the same as Option 1. The difference however is that the trust in turn would purchase stock in a company that we create on your behalf. The company has its own bank account and is able to open its own investment accounts. The company would in turn buy stock, bonds, mutual funds, as well as invest in real estate, and other alternatives previously unavailable to the individual.

It is a manageable process to create the Trust, but the individual must conform to IRS regulations. Properly setup it afford the individual a tremendous investment vehicle to invest.

A Misunderstood Retirement Investment Vehicle

Unfortunately, most investors believe that their only IRA investment options are bank CDs or the stock market and mutual funds, not real estate. If you currently are a successful real estate investor, or are just looking to diversify your retirement portfolio, the combination of real estate and your IRA can be very powerful.

The tremendous advantages a self-directed retirement plan offer the following benefits:

• The power of compound interest
• Reduction of taxable income
• Asset protection – assets in your retirement accounts are protected in lawsuits
• Estate planning

Resources:

• DNA Investments – Setup a DNA Passbook IRA account

• IRS – Resources for Retirement Plan Participant/Employee

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