An IRA doesn't have to be asimple retirement savingsaccount that passively accruesinterest earnings. Itcan be invested in real estate, privatecompanies, mortgages, and a widerange of other investments. Throughcareful research, physician-investorscan find custodians who will allow suchso-called "super IRA" investments.They can increase their investmentoptions and flexibility by creating a limitedliability company (LLC) owned bythe super IRA and maximize its availableinvestments and transactions.
Let's take a look at the high level ofasset protection that can be provided byan LLC IRA for investors—particularlyphysicians—who are concerned aboutlosing everything in a lawsuit.
Asset Protection Cap?
There is no federal law setting theasset protection provided by an IRA.Each state sets its own rules on the extentto which creditors can tap a debtor'sIRA. In some states, an IRA gets completeprotection. Most states, however,offer limited or no protection for IRAs.In those states, creditors can either seizeor attack assets in an IRA. The situationis confusing, because annuities andemployer pension plans often get completeprotection from creditors, but IRAsusually have separate rules.
In California, for example, an IRA'sprotection is subjective. It is protectedfrom creditors only if it is necessary tosupport the debtor and their dependentsat retirement, after taking into considerationall the other resources that are likelyto be available. A court will review allthe financial data and decide how muchof the IRA is protected.
In addition, the IRS specifically isallowed to seize an IRA to satisfy taxliabilities. In the past the IRS seemed tohave an unofficial policy of not goingafter IRAs, but it has seized IRAs inrecent years. If you want strong protectionfrom creditors, an IRA isn't likelyto provide it.
A Better Alternative
On the other hand, an LLC providesstrong asset protection in most states.Again, each state sets its own rules, butmost give their highest level of protectionto LLCs. Suppose an IRA owns an LLC,and all the IRA's investments are madethrough that LLC. Then, suppose a creditorgets a judgment against the IRAowner. The best the creditor can do inmost states is take control of the IRA andget what is called a "charging order"against the LLC. This allows the creditorto receive or seize any distributions fromthe LLC. But the creditor cannot get ownershipof the LLC, take part in managementof the LLC, or seize any of the assetsinside the LLC. The IRA owner, or whoeverwas managing the LLC before, continuesto manage it. The LLC is notrequired to make any distributions. If theLLC management chooses not to makedistributions, the creditor never receivesanything.
Bad for Creditors
Things actually can get worse for thecreditor. The LLC under the tax law isnot taxed. All income and gains passthrough to the owner of the LLC. Theowner pays taxes on all income andgains, whether or not money or propertyis distributed to the owner. Some advisorsbelieve that when a creditor has won ajudgment and seized the IRA's assets, thetax law requires the creditor to pay taxeson all income and gains of the LLC, evenwhen they are never distributed. Thus, itcould cost a creditor money to win ajudgment against an LLC IRA.
The real goal of most asset protectionplans is to discourage creditors fromaggressively pursuing claims. A goodasset protection plan encourages creditorsto settle for a relatively low amount,because they believe the cost of pursuingmore would be high and the probabilityof prevailing would be low. If asset protectionis your concern, consider addingan LLC IRA to your plan.
There are two other issues about thissuper IRA that should be considered.First, it is still subject to the required minimumdistribution (RMD) rules for thoseover age 701/2, if it is a traditional IRAand not a Roth IRA. You might get a bitof a break on the RMDs if your IRAinvests in assets that aren't traded publicly,such as real estate, either directly orthrough an LLC. That's because the valuationof the asset is a little subjective, andthe minimum distributions each year arebased on the value of the assets at the endof the prior year. On the other hand, youhave to justify the value each year, andthat might mean paying for an annualprofessional valuation.
Those approaching or over age 701/2must also keep in mind that the IRAneeds enough liquid assets to make therequired distributions. That can be aproblem when the IRA invests in illiquidassets, such as real estate. But keep inmind that the year's RMD is computedfor all IRAs as a group and can be takenfrom the IRAs in any combination. Youcan put some of your assets in a superIRA and the rest in a conventional IRAto make the RMDs.
Another issue relates to annual contributionlimits. If your IRA owns anasset such as real estate, that investmentmight need cash infusions from time totime. A property might need repairs andmaintenance, or vacancies might causethe cash receipts to be less than theexpenses. Because of the annual contributionlimits, you might not be able tocontribute additional cash to the IRA topay for these expenses. These cash flowissues need to be considered when creatingand managing the super IRA.
You don't have to be locked into thelimits of traditional IRAs. Investmentoptions and asset protection can beincreased dramatically with a superIRA. It is not for everyone, but thosewho are looking for different investmentstrategies in their IRA should considerthe super IRA.
Robert C. Carlson is known for
developing savvy, safe retirement
financial strategies. He is an attorney,
accountant, past editor of Tax
Wise Money, author of numerous
books and reports, and an instrument-rated private pilot. His current book, The
New Rules of Retirement (John Wiley & Sons;
2004), will be released this fall. He welcomes questions
or comments at 800-346-0138, or for more
information visit www.retirementwatch.com.