This month we wrap up our sessions on the Super IRA. In the May issue I explained how an IRA can be invested in real estate, private companies, mortgages, and a wide range of other investments. You learned where to find custodians who will allow such investments in IRAs. You also learned how to increase the investment options and flexibility by creating a limited liability company that is owned by the IRA. Last month we discussed how to maximize the investments and transactions available through an LLC IRA.
Now, let’s look at the high level of asset protection that can be provided by an LLC IRA for people who are concerned about losing everything in a lawsuit.
There is no federal law setting the asset protection provided by an IRA. Each state sets its own rules on the extent to which creditors can tap a debtor’s IRA. In some states, an IRA gets complete protection. Most states, however, offer limited or no protection for IRAs. In those states, creditors can either seize or attach assets in an IRA. The situation is confusing, because annuities and employer pension plans often get complete protection from creditors, but IRAs usually have separate rules.
In California, for example, an IRA’s protection is subjective. It is protected from creditors only if it is necessary to support the debtor and his dependents at retirement, after taking into consideration all the other resources that are likely to be available. A court will review all the financial data and decide how much of the IRA is protected.
In addition, the IRS specifically is allowed to seize an IRA to satisfy tax liabilities. In the past the IRS seemed to have an unofficial policy of not going after IRAs, but it has seized IRAs in recent years.
If you want strong protection from creditors, an IRA isn’t likely to provide it.
A limited liability company provides strong asset protection in most states. Again, each state sets its own rules, but most give their highest level of protection to LLCs.
Suppose an IRA owns a limited liability company, and all the IRA’s investments are made through the LLC. Then, suppose a creditor gets a judgment against the IRA owner. The best the creditor can do in most states is to take control of the IRA and get what is called a “charging order” against the LLC. This allows the creditor to receive or seize any distributions from the LLC. But the creditor cannot get ownership of the LLC, take part in management of the LLC, or seize any of the assets inside the LLC. The IRA owner, or whoever was managing the LLC before, continues to manage it. The LLC is not required to make any distributions. If the LLC management chooses not to make distributions, the creditor never receives anything.
Things actually can get worse for the creditor. The LLC under the tax law is not taxed. All income and gains pass through to the owner of the LLC. The owner pays taxes on all income and gains, whether or not money or property is distributed to the owner. Some advisors believe that when a creditor has won a judgment and seized the IRA assets, the tax law requires the creditor to pay taxes on all income and gains of the LLC even when they never are distributed.
Thus, it could cost a creditor money to win a judgment against an LLC IRA.
The real goal of most asset protection plans is to discourage creditors from aggressively pursuing claims. Instead, a good asset protection plan encourages creditors to settle for a relatively low amount, because they believe the cost of pursuing more would be high and the probability of prevailing would be low.
If asset protection is your concern, consider adding an LLC IRA to your plan.
There are two other issues about the Super IRA we should cover before concluding this series.
The Super IRA still is subject to the required minimum distribution rules for those over age 70 1/2, if it is a traditional IRA and not a Roth IRA. You might get a bit of a break on the RMDs if your IRA invests in assets that aren’t traded publicly, such as real estate, either directly or through an LLC. That’s because the valuation of the asset is a little subjective, and the minimum distributions each year are based on the value of the assets at the end of the prior year. On the other hand, you have to justify the value each year, and that might mean paying for an annual professional valuation.
Those approaching or over age 70 1/2 also must keep in mind that the IRA needs enough liquid assets to make the required distributions. That can be a problem when the IRA invests in illiquid assets, such as real estate.
But keep in mind that the year’s RMD is computed for all IRAs as a group and can be taken from the IRAs in any combination. You can put some of your assets in a Super IRA and the rest in a conventional IRA to make the RMDs.
Another issue relates to annual contribution limits. If your IRA owns an asset such as real estate, that investment might need cash infusions from time to time. A property might need repairs and maintenance, or vacancies might cause the cash receipts to be less than the expenses. Because of the annual contribution limits, you might not be able to contribute additional cash to the IRA to pay for these expenses.
These cash flow issues need to be considered when creating and managing the Super IRA.
You don’t have to be locked into the limits of traditional IRAs. Investment options and asset protection can be increased dramatically with a Super IRA or LLC IRA. It is not for everyone, but those who are looking for different investment strategies in your IRA should consider the Super IRA.