Is there a way to defer some rental income into some kind of retirement account when retired?
Lets say someone was able to live entirely off savings for a year, could they somehow put their rental income into a deferred (not annuity) retirement account and pay no taxes?
The simplest thing is just to use the income from your rentals to fund your contribution to your IRA. Unfortunately, that's only a few grand per year and is subject to income limitations.
You might look into a Solo 401K and see if you could set up a company that owns rentals and using the income to fund the 401K. The contribution limits are much higher. You do need to watch out for the self-dealing rules. Those probably mean you can't put current rentals into this deal. You already own those, so selling them to a qualified plan of any sort isn't allowed. Solo 401k's don't work for me because I have a regular job, so I've not looked at them in detail.
Jeff S.,
I am thinking that if you took just one rental, financed at 75% - 80% LTV, and rented to produce a positive cash flow, you will have a net passive loss after depreciation. Do a cash flow analysis on a prospective target property and see if you have a positive cash flow AND a tax loss on paper.
In this case, your rental income is already sheltered by the depreciation expense and there is no need to do anything fancy and expensive with an active income business entity.
Dave T,
The key is that through the use of certain retirement plans not all positive earned income is subject to Social Security and medicare. In fact if you can turn it into retirement matching contributions or into a direct pension you can essentially have ZERO positive income.
If you had positive cash flow and a paper loss. Turn it into break even cash flow and a greater paper loss. Does that make sense? Look into Defined Benefit Plans.
The Roth comments came up due to the OP being in a lower tax bracket this year.
Jeff S.,
As for the funds contributed to the pension plan: That money will NEVER be subject to Social Security or Medicare.
As for when the SDIRA for real estate makes sense is when you can finance it as you can take the depreciation.
As for Was talking to a guy (business head) and he acted like I was kind of nuts for even wanting to contribute to retirement since I was old enough to withdraw it. This is a different kind of thought pattern for me. Maybe he is on to something.
This is flawed thinking. If you do not need the money now, why pay the tax on it? You might need those funds 40 years from now and if you earned it at a tax deferred 15% annual return. Those funds will have worked overtime for you. This is the reason I mentioned the ROTH rollovers in order to keep saving and reduce the tax burden from large future gains.
Jeff the big question is do you expect your net worth to increase? What makes the most sense for estate planning purposes at this point. The big thing is what are you major LONG-TERM goals.
-Steven
Thanks Steven Hamilton II for clearing that up, this is good stuff.
I do expect my net worth to increase on a cash basis. If cap rates go to 10, from 4, because of a surge in interest rates then paper net worth will plummet.
Right now working on turning RE investments into more actively managed and profitable (improvements and rent increases) business assets. This will give me something to work on for 6 mo or so.
Getting short-term affairs in order will then allow room for other pursuits. If I feel as ambitious as I do now there won't be much work at all and next year will be even less income than this year.
In 40 years I will need some cash for a cruise around the world for my 100th birthday. We can have a BP meet-up. Plan to jog around the deck every morning.
Maybe I should get a RE license and depreciate the 26k car I bought in 2011. I could go to the office and drink coffee, maybe lose money on paper.
How can I earn 15%?
So you are saying the financed portion of a SDIRA is depreciable?
Let's see what the future holds for tax reform. My guess is there won't be much change for the little guys and gals. SS certainly will go back to what it was though. It is hard to imagine anyone putting a crimp into investors business who are helping fuel the RE recovery.
Jeff S.,
I'm saying you will take standard depreciation and all normal deductions in determining if there is an income to be taxed. in figuring if there is an income. IF you have a gross positive income you then figure any tax based upon the financed percentage.
There is nothing wrong with depreciating part of your car or taking mileage for your rental properties. now based upon the percentage used for RE. This is yet another thing you could do by turning it into an active business.
-Steven
Tim Delp simply holding passive rental property in an S-corporation does not change the nature or taxation of the passive income. No self employment tax will be due on passive rental activity and the income does not become ordinary simply by run it through an S-corp.
If you review a K-1 you'll see that businesses must report ordinary income and passive income along with a host of other things.
You do of course need to have earned income in order to contribute to an IRA or 401K.
I take it that money from a 457 deferred compensation plan, can be rolled into a ROTH (rollover?) with after tax $ without limits, when having left employment and being 59.5. Don't believe age even plays a role in this though.
Is there still a 5 year rule if old enough to withdraw funds?
Jeff S.,
What type of 457 plan is it? No the rule is 5 years or 59.5 whichever comes first.
-Steven
Steven Hamilton II 457b gov't employee (transit) non-qualified. It is little more than a pretax saving acct. No match or anything and not same rules as 401k etc. Can take money upon termination of employment but have to pay income tax when withdrawn. My understanding is it can all (or part) be put into an IRA. Just not sure what kinds of IRAs are allowed. Wonder what kind of SDIRAs qualify, or even if they do.
Jeff S.,
You will be able to contribute that to any type of IRA as well as even roll it over to a 401k if you so chose.
-Steven
Steven Hamilton II wading through the paperwork on this 457 and it says earnings are taxable (not qualified) if not invested in the ROTH for 5 years and need to be 59.5. Why not just remove original investment, a portion equal to earnings if using earnings is the goal? Maybe this is what you were referring to.
Never have understood why someone would roll anything into a 401k when IRAs accomplish everything one could want, correct?
Jeff S.,
The rule is 5 years or 59 1/2 whichever occurs first.
If you convert December 31st 2012, the 5 years starts from January 1st of 2012.
The reasons someone would want to roll over an IRA to a 401k is when you open up a business and want to have a higher 401k balance so you can borrow from it. Also some want to keep all of their retirement funds together.
-Steven
I'm not getting a clear picture of what your situation is.
Your talking about putting rental income into an IRA. The money you bring in from rents could conceivably be put into any IRA, if you have earned income from other sources. Rental income wouldn't be considered earned income.
Your retirement / tax planning should consider all sources of current and future income. Maximizing your tax situation currently may not necessarily be the best long term tax strategy.
Do you have any business income? You mentioned property management but are you managing your own properties (a passive activity that can be very active and much like a business) or are you managing properties for others which is a business that in many states requires a license.
W-2 income, business income where you materially participate, royalties made from your personal efforts all would be considered earned income. Interest income, dividends, rental income and some other forms of income would be considered unearned and would not count in determining what can be contributed to an IRA.
Are you asking about rental income inside an IRA? Nothing wrong with that.
Charles Perkins my situation is I am 59.5 and retired from a W-2 with 3 months job income this year. Chances are, but not positive, that next year will not have earned income.
Having retired in April 2012 will enjoy a year w/o anything new job or business wise while working on existing rentals and researching some new goals going forward.
The property management will be on personally owned properties. This could be expanded in various ways.
On the one hand there is an argument for taking retirement funds and converting them (paying tax) into ROTHs and going in several possible directions (SDIRAs or just investing in stocks and REITS, and/or loans). The other hand would include working on sheltering rental income from taxation and not converting retirement into ROTH and simply trying to reduce taxable income.
One example would be if nothing changed and I did not pursue a job or business income and took one rental and did not want to pay tax on its income, how might that be done?
The original question was regarding whether rental income could be sheltered to possibly drop into a different tax bracket, or just reduce taxes.
Spent at least an hour debating with a C. Schwab guy the benefits or not of converting retirement funds into a Roth.
You could wonder why these plans weren't calculated a long-time ago and part of it has to do with retiring quickly when I found out bus driving was grinding down the cartilage in my back. Went from planning on continuing employment into a decision to retire in an 8 day period. Should have retired sooner, the money isn't worth it, having time is.
That sheds better light on your situation. You'll want to build a financial plan to determine your actual tax situation with the rental properties and what amount of taxable income makes sense to create when converting traditional IRAs to a Roth IRA.
Based on your current rental income, expenses and debt, you should be able to put together a reasonable model of expected cash flows, taxable income and then play with different conversion strategies to determine the tax effect.
You'll also want to consider the impact of social security and when you should start taking social security. Taking a long term look at your retirement picture should give you a better perspective of how to minimize your taxes over the long run.
I would assume higher tax rates in the future.
Feel free to PM if you want more specific help.
Thank-you both Steven Hamilton II and Charles Perkins for your expert information. Like many individuals and businesses we are taking a wait and see attitude.
While tax rates may go up or down, it seems to me the effective tax rate will be what will counts going forward.
If Romney gets elected we could hope for some favorable treatment for owning a small business which could be a catalyst for many of us to get something going.
What seems to make some sense is to pay tax and convert some assets that will have the highest taxable yield and shelter those in a ROTH. If you can earn that tax back quickly then earn tax free for many years...
I agree paying tax today can make a lot of sense over the long haul. You also want to consider managing your taxes. Planning how much you convert to a Roth by looking at the tax brackets and any potential Alternative minimum issues.
Jeff S.,
I'm in agreement with @Charles Perkins in that a wait and see change can result in significant taxable resources. Do a quick estimate of your tax situation and compare to next years prospective rates. You can see that this year is the time to make the right moves. Even if things are extended you still will have taken advantage of the better rates and rules.
-Steven
It sounds like sheltering income at this point makes no sense (can't lower bracket) and possibly reversing some contributions this year via contributing to a ROTH, are potential strategies worth considering.
That kind of bugs me because I could just as soon just let it sit tax deferred. Doing nothing maybe not best though.
The problem is we don't really know if middle income will pay more since requiring that would certainly push us into recession.
Does it matter who will be Pres?
Jeff S.,
I don't want to turn this thread political. Congress is where the tax laws come from.
-Steven
This is really interesting about paying taxes and funding a ROTH as opposed to avoiding taxes as long as possible.
Talking with a neighbor about this and her financial adviser doesn't want her to fund a ROTH from her retirement account. Her accountant wants her to.
Anyone listen to the Ray Lucia show on the radio? He is a CFP with a host of tax attorneys on board. A lady calls in and says she was advised to cash in 40k of her 401k and buy a ROTH. Ray Lucia ran the numbers and advised instead of paying the tax with the 10k she would have to pay in taxes, she should take that money and buy a mutual fund. He showed after 10 years how she would be better off.
Is it really accountants versus financial planners on this issue?
Jeff S.,
In many cases yes it can be. Here is the thing if you are using the funds in the Roth to earn 15% annual in lending. You will be much better off by just paying the taxes now and even further ahead than the mutual fund adviser suggests.
-Steven
I am not sure I would bother although I may not understand the hypothetical... I may take this further into make-believe-land, but here goes... People generally don't "live on their savings" with an objective to "save for retirement." Think about it... I assume you are to the point where you are less concerned about "earning" and more concerned on "positioning" your retirement assets. If my presumption is correct, you should start to plan how you will "use" your retirement funds and non-retirement accounts together. People often forget that certain retirement accounts (i.e. Traditional IRAs) all have to flow through your tax return as income at some point. It all gets taxed. Some retirement funds start to get forced into your earnings through mandatory draws. You should understand all this. You should make sure you know how to appropriately manage all this in your retirement. One way would be to have "after tax" dollars available. I recommend entering retirement with a good deal of liquid assets outside of retirement accounts all together (or at least in after tax retirement accounts). It gives you flexibility to meet your needs and blend the sources of funds in a manner to stay in lower brackets. Hypothetically, if you are making $50K a year on rentals and have $100K in liquid assets (outside retirement accounts) and the typical smattering of retirement accounts.... I would spend some time scheduling your draws from any pre-retirement accounts and understand how you will have to report those earnings. If you have the earned income to move cash to a Roth, then sure; but generally, if you aren't actively pursuing income, you have begun to draw on your nest egg and might ask yourself if you are retired... the time you have deferred income to might be now! You should put some thought toward managing your assets and your taxes through retirement. Consider reporting some income (not deferring it) to convert pre-tax retirement funds to a Roth (or to cash) at least until you fill those precious lower tax brackets.
Remember that your earnings are generally only taxed once (clearly there are the obvious exceptions). Also remember that tax brackets are graduated. That means that your first dollar of income is taxed considerably lower than the incremental dollar you earned when you report $100K. If you are married, your first $71K of taxable income can move through the tax process at 15% or less (Some of that is clearly at a lower rate). When you are nearing retirement, you should want to move pre-tax dollars through the taxation process at the rates you choose (to the extent you can). I would want to take advantage of every bit of that 15% tax bracket, even if I had to take social security early to do it. Above 15%, there may be some value in deferring a couple years, but think about it as tax rates are getting worse. If you are approaching retirement, I would make sure you don't elect to defer more income and burn through your cash only to force yourself to draw a lot of retirement funds the next year only to have some of it taxed at 25% or higher. After all, we spend a lot of time thinking about deferring taxes, but it is likely that at some point your mentality must flip to minimize your taxes (not just deferring them) and sometimes that means if you stop working that you start to move some deferred income through your tax return.
You also have some flexibility to borrow against your properties to smooth out some of your needs in retirements and reduce your payments to Uncle Sam.
Tom, thanks for taking the time to analyze this stuff. Retirement is such an interesting subject and if you are like me, you thought about it a lot when working. That would most likely mean non satisfying employment.
I have, and do spend time thinking about positioning assets. I do understand IRAs and other retirement accounts required distributions at 70.5.
The debate that I come across is whether taking distributions in the form of converting to a ROTH is more profitable then letting the tax portion ride and earn.
Of course not going into the next tax bracket is important and making use of today's lower brackets is to be considered too.
To be concerned with taking distributions at 70.5 would require a significant amount to affect tax brackets when spread out over 27.5 years. I am not that concerned but will most likely start distributing the funds rather than defer more.
The original question asked whether deferring income as long as possible might be a good idea even when retired (and if that is even possible) which would make a larger percentage of income be taxed at 15%, and the fact that money could work tax free possibly in the form of a tax deferred self directed (traditional) IRA.
The reason for considering stashing cash in retirement is the fact that my pension will almost certainly implode. At some point it will collapse and they will pay us off. The proceeds will not be able to generate the returns we have been promised.
So when you say the time I have deferred income to might be now, that is only correct from a possible tax standpoint, not from the standpoint of spending down assets.
BTW welcome to BP, a formidable 2nd post.
Thanks. One question.... If you are pulling down only rental income for a year, and you get your money into a traditional IRA... You know that when you take the money out that it is ALL taxed at your effective tax rate at that time (basis and gains). So my question... Are you planning for your effective tax rate to be 15% at that time?
If you don't get a meaninful tax benefit for "deferring income" today... why not take the income and have the benefit of after tax dollars that grow tax deferred? Let the money grow outside of a retirement account in an index or mutual fund. If you don't sell the investment, the gains that accrue are also deferred until you sell. :-) ALSO your basis is has already been taxed. Only your investment gains are taxed as capital gains (which subject to political interference) will likely have some preferential aspects to them if not merely the ability to determine when you recognize them in your tax return.
Not that you are in this boat, but often people forget that capital gains in a traditional IRA become income (and no longer are treated like capital gains). So I see your question as "is the benefit of lowering my taxes today" worth more than the higher taxes I will pay tomorrow due to higher income and converting capital gains into income through an IRA*.
*Meaning your capital gains become income in an traditional IRA, yet would remain capital gains if you kept them unencumbered by the tax code and liquid.