197: Good Deals, Bad Timing, and a Retirement Account Update!
Buck: Welcome back to the show everyone. My guest today on Wealth Formula Podcast is the President, CEO of Total Control Financial Mr. Damion Lupo. Damion has been on the show before, a few times actually. He’s the serial entrepreneur and author along with his position at Total Control Financial and he’s also a master of martial arts. Damion welcome back to Wealth Formula Podcast.
Damion: Good to be here, Buck. Thanks for having me back.
Buck: You bet. So what have you been up to? What have you been up to? Have you been you know cranking along write more books?
Damion: Yeah well we had that that last one Unicornomics that came out and then helping people design their decade here with some new changes that have happened with tax laws and just helping people design a decade and instead of just having in one of these default decades that nobody really likes to look back.
Buck: I hear you. So listen you’ve been on a few times and we’ve talked about a few different things but you the core of what you do in your business has to do with the concept of this EQRP and I know there are some new developments on this and we’re gonna talk about that in a few minutes but I thought we’d use the time to just again you know review the elements of retirement accounts in general and pros and cons if that’s okay with you. So at a root, you know and I’m gonna ask some basic questions because the reality is a lot of times people have basic questions and don’t know basic things and they’re afraid to ask. So at a granular level let’s start with a simple question okay what is the difference between an IRA and a 401k?
Damion: The difference is they’re under different parts of the code so IRAs are under 408 and 401ks are under 401 and basically you’ve got a custodian with an IRA and you can be your own custodian if you will under a 401k and big difference I’m really is that you can put a lot more money into a 401k versus an IRA and you can actually have control and invest in real estate very differently without being taxed in a 401k whereas in an IRA there’s a huge tax that we always like to talk about and most people don’t know is there. That’s a huge difference for people that are really into real estate and want to use those funds.
Buck: You may not know the answer to this, and I don’t expect you would, but why? Why is there such a big difference because ultimately they’re both retirement accounts right so what’s the what why the difference? Why is there a difference in terms of the law here?
Damion: It’s a strange thing I mean back these were both started in the 70s with the ERISA Act and when they started differing the IRA was meant to be just kind of an add-on thing for people to add a few more dollars if they didn’t have a company 401k. And the 401k was meant it was really a giveaway to the companies to stop doing defined benefit plans the pensions so that they could spend less on the future obligations and most people were putting a lot of money into defined benefits and to switch it you had to have a lot of money whereas the IRA wasn’t meant to be like a catch-all for everything and what’s really strange is that over the years a lot of people leave their jobs and they moved their 401ks into IRAs so now there’s more money in IRAs there’s almost 10 trillion dollars in them and so a lot of the focus with IRS and the Congress and I’ll get into this and some of the changes has been on that pool of money because 10 trillion dollars is a lot of money to try to figure out how to tax and make revenue for the government and so that’s really been a target the 401ks are kind of the same thing most of them are in mutual funds so there’s not a lot of changes there other than a couple of things we’re going to talk about but really the the focus has been changing the ways the IRAs are working and and and they’re becoming a bigger animal than the 401ks.
Buck: Okay so as a reminder and again let’s just stick to some basics again to get some you know to make this sort of a well-rounded show because i think people I’ve noticed actually a bunch of new listeners just in terms of downloads. So the taxes that you’re talking about that that you don’t generally get with the 401k but you do with an IRA relate to certain kinds of things specifically as we know them UBIT and UDFI, is that correct?
Damion: Exactly right.
Buck: Explain what those are what are and what are the differences between UBIT and UDFI and what kinds of things constitute that.
Damion: So UDFI is the unrelated debt financed income effectively if you’re making money let’s say your IRA invest in something and it has debt then you’re making profits partially because of your money which is kind of the equity and partially because of the debt and the IRS says well that’s not really fair it’s we should tax you on the money the profits. You’re making from the debt and so that’s where this thing called UBIT the unrelated business income tax hits and it’s this really high tax rate which is 37 percent as the top and so they target that type of thing if you’re using debt. Now for whatever reason in the in a 401 section which is where the EQRP lives there’s an exemption for debt financed and and leveraged real estate and I think that’s because with IRA is what we know is that there’s more money in IRAs and that’s where most people do their real estate investing. So they’re targeting that space and they’re not really going after the 401 which is where the EQRP has the golden chute if you will because it’s exempt.
Buck: So and again basically what we’re talking about is you get your IRA you got your 401k and really what this is what we’re specifically focusing on is the idea hopefully most people know this but you can self direct your IRA. If you don’t know that well now you know it. And the same thing goes for a 401k rather than having to invest in just you know stocks bonds and mutual funds you can self direct, it’s called a solo 401k, if you’re a business owner and you can invest in things like real estate and what Damion is saying is that if it’s an IRA whether it’s a Roth IRA, a regular IRA, that the IRS is saying that hey if you invest and you made you know 30% on your investment we’re gonna pick that apart and say well what percentage of this was from from leverage and the leverage component, correct me if I’m wrong, but the leverage component of that will be taxed at that 30 percent level, is that right?
Damion: That’s exactly right.
Buck: So it’s an interesting idea because I don’t even understand necessarily how they picked that apart but yes somebody must do it. So just to be clear, Damion, what we’re talking about is this is that in an IRA, but not in a 401k, if you make say for example you know 30 percent return on investment in real estate somehow that profit gets picked apart and part of it is determined to be because of leverage and part of it is determined to be not because of leverage and the part that is with leverage is taxed in a pretty meaningful way at about 30 percent, correct?
Damion: Yeah and and it’s just so it’s really clear I think with if a common thing we’ll do we see this happening in somebody has an IRA and invest in a real estate deal maybe they put $100,000 in and that doubles over five years, that $100,000 profit if there was like a 70% mortgage which is very typical their tax would be about $20,000. So when you split it apart that’s about the reality of using an IRA.
Buck: Okay interesting. So it comes out to about 20% you know of the actual returns when you look at it from the standpoint of like a 70/30 you know 70% like a 70% LTV deal.
Damion: That’s exactly right.
Buck: Okay all right. So doesn’t matter if it’s a Roth, by the way and just to review since we’re going down this rabbit hole of you know reviewing all the concepts behind a retirement account, a Roth IRA is essentially the same type of thing you can do with after-tax funds. So you can take money and you know instead of doing tax deferral on the front end you pay the taxes and then you don’t ever pay taxes again. So in that case you would even with the Roth IRA then would you have UBIT in that situation because I thought you weren’t supposed to be taxed on any of that income?
Damion: It’s actually one of the big surprises all IRAs are gonna get taxed on thee on any type of leveraged real estate so it doesn’t matter if it’s deferred or Roth that’s the nightmare but it’s definitely any IRA.
Buck: Okay got it is solo 401k. We know can also be of the Roth variety and in that case you wouldn’t have to worry cuz you didn’t have to worry for it in the first one either in that non differ in the pre-tax one. So and just for pure completeness what is a Backdoor Roth because that’s the last component of the basics I want to cover.
Damion: So basically when someone makes too much income and they want to have a Roth IRA they can’t they get opted out they get exempted out. So effectively what you do is somebody takes money put it into an IRA and then they convert it to a Roth that’s basically what a backdoor Roth is it’s kind of a silly thing because you can only put a small amount of money in but it is how you do it back to our quote unquote act or Roth and we’re gonna maybe share some ideas about a totally different idea.
Buck: We’ll talk about those limits as long as we know just so we can compare and contrast what we can do. So when you say first of all in an IRA just remind us so it’s your you know maximum contribution per year?
Damion: Six thousand and if your age fifty you get a whole thousand-dollar catch-up so seven thousand a year.
Buck: Okay so seven thousand dollars a year and and that’s how you’re gonna do your quote unquote backdoor and seven thousand dollars right. And then with the typical 401k what is a solo 401k with the type of contribution there?
Damion: So it’s fifty seven thousand per person and a couple are you talking about one hundred and fourteen thousand and then if they’re over age 50 it’s another sixty five hundred each. So it could be a hundred and twenty seven thousand per household.
Buck: Got it kind of so that’s actually you know quite a bit more meaningful. Now of course the solo 401k is not typically something that anybody can do because you need to have a business right? So then comes along this thing that you call a QRP so what is a QRP and and you know what makes so we can do this?
Damion: So the idea and there’s a little confusion around this. The QRP stands for qualified retirement plans. This is all of the plans it’s an IRA is the 401k’s what we’ve created is the eQRP and it allows people to have control of their money under the 401 section and there all sorts of businesses are qualified meaning you could have an online business you could have an eBay store it basically anybody that wanted to do something can qualify and it has some unique things that make it far superior to everything in that class. It makes it way better than say a solo 401k we can go into those a little bit.
Buck: Let’s do that because that’s one of the questions I get sometimes and quite honestly, I don’t really know the answer. So why is it better than a solo 401k? Because what you’re saying is I understand it is okay well yeah I mean listen you could devastate low for a 1k you could maybe have your investment business and have a solo 401k why not do that right? So why do a QRP?
Damion: So the reason for setting up an EQRP is is that you’re gonna have two major things one you’re gonna be your to have liability protection because of the way it’s built and typical solo 401ks don’t have the liability protection meaning if you get sued and you have a big pile of money in this thing then the courts are gonna go after you for a judgement and in places like California that’s not a good thing because they tend to go after people a lot. So with an EQRP you’ve got a layer of liability protection that a solo does not have and so that’s a big deal in and of itself and the other thing is that you can’t have employees if you have a solo 401k. EQRP you can have employees you could also hire employees down the road so what we see people doing is they set up a solo 401k and then they end up wanting to hire an employee and then they’re stuck so their plan blows up and that’s a huge problem.
Buck: Got it got it. And to your point now like about the flexibility of this of course every you know a lot of times when when you talk about this everyone’s first question ends up being well why isn’t everybody doing this then? Why is everybody just doing IRAs in self-directed IRAs and stuff like that I mean what’s the catch here?
Damion: The IRAs have been used for the self-directing for a lot longer than the 401k section the four ones have really just always been mutual funds until the last couple of decades. And so what happened is a big industry grew up around the IRAs and that’s where all the marketing is and that’s where people tend to go automatically they think I’m rolling my money out of a company 401k it’s gonna go into an IRA. When the legislation changed back in the early 2000s it allowed some things where you could put 50 plus thousand into an individual 401k and people said oh this is great but there’s the fees are so much less when you’re not being feed for every transaction which you generally are with an IRA. So that’s that’s not a good model for a custodian when they don’t get to feed you all the time that’s really a profitable model. So you’re not gonna see companies saying hey let me give you a model where we make 10 times less money that would be really bad for business.
Buck: Got it. Ok so pretty good reason in and of itself to say I should at least look into this QRP thing by the way if you are interested Damion has a book that he’s made available for anybody and if you want a copy of that you can text 44222 and then just put in QRPbook as one word. 44222 QRPbook and then he’ll send you an actual book that you can read all about it. Now I want to move on here because there was a reason that we specifically wanted to get you on because some of the legislation in this area has changed favorably for people. Do you want to talk about that?
Damion: Yeah there’s something called the secure act that was put into law effective January 1st it was one of those end of the evening right before Christmas events they got signed into law and made effective January 1st and some big things changed. So basically this was a big push by the insurance companies to sell annuities and so that’s why it happened. So if they’re gonna sell a new for 401ks one of the things that Congress always has to figure out to do it like you have to figure out how they’re gonna pay for their legislation. So what they did is there was something called a stretch IRA or basically somebody inherits an IRA and they can keep it and spend it and grow it the rest of their lives they killed that in this legislation so if you inherit an IRA or this is part of a state planning for a lot of folks it’s it’s no longer a lifetime it’s ten years. So somebody inherits it if generally got to spend it or pull it out within ten years that’s how they stay paid for this whole thing so that’s a big deal. Now that was the downside that was the negative. The positive is that they made it so that you can set up a retirement account anytime up to the point that you file your taxes. So for example here we are in 2020 and you go oh my gosh I made too much money I made $200,000 in 2019 but it’s re 2020. Well it used to be that you were stuck but now the new legislation allows you to set up a retirement account an eQRP for the last year and contribute for the last year all the way to the time you file your taxes which April 15th or October 15th. And so what that means if let’s say you made 200,000 and you think oh crap I’m in the thirty two percent tax bracket and I’m not going to get that 20 percent deduction which we got from previous tax legislation basically if you set up a plan like we set up a plan now and then you contribute say fifty seven thousand you’re Max and you’re now you’re in comes down to 143 well now you’re below that threshold so you can get the 20% deduction which means your actual income is going to be like 114. So if you just do the math on setting up a plan it’s gonna save around 20 thousand dollars in taxes and we could never do this before. It only allowed us to do this after the legislation to fix last year so that’s a huge deal for people
Buck: this done a yearly basis now where it will be up to tax day or is it or is it just for this year for the correction of this year?
Damion: The biggest one any time now we can set up a plan in the net in the following year for the previous year and then you can always make your contribution for the previous year up to the time you pay your taxes or you file your taxes
Damion: You file even if you’re extending?
Damion: Yeah absolutely so all the way till October. So it allows you to do some tax planning and not even have to have the cash until towards the end of the year.
Buck: Well that’s really interesting too because the it’s one of the I think one of the problems that I mean I certainly have and I’m sure others do they have no idea how much tax they owe until the following year then you’re like I wish I did that or I wish I know I wish I’d done that. So this is an opportunity for people to kind of sort of the best of both worlds they can actually you know have some additional cash and and pay less taxes and and make that calculation based on you know numbers that are at their fingertips from tax planning.
Damion: That’s a big problem like when you’re talking about getting stuff later people get K1s to get their stuff way into the new year and they literally don’t know so this fixed that problem.
Buck: Yeah like for example depreciation right I mean lots of bonus depreciation particularly in our Investor group with all the real estate and people are getting K1s back and they it’s really hard to know exactly how much bonus depreciation it could be you know forty percent it could be 90 percent you know in that first year and those make a substantial difference to your projection. So this is actually a really good thing to know. Now let me ask you is there anything else we need to know from that before I move on?
Damion: Yeah and the other thing that really they want to get more people the government wants to get more people involved in the 401k system so one of the things they said was our time employees are now going to be required to be covered. So here’s a thing if you’ve got a solo 401k that thing is a bad idea it’s not going to work if you end up having part-time employees and we’re talking people that are working like ten hours a week. So the great thing is an EQRP covers that it covers those part-time or the full-time so this makes the EQRP even better than the solos better than it already was because it covers them. So when you have typically 401ks have employees they have participants with the solo 401k you have a business owner and that’s it. So an EQRP has the ability to cover both the owner and the employees. Solo 401k is not built and set up for employees at all.
Buck: Got it okay cool. Well one other thing I think it’s worth mentioning because I get this question a lot you know in the context of people just learning about what you do and you know full disclosure I don’t do this because I you know I’ve got lots of depreciation so I really haven’t had to luckily focus too much on retirement plans so I’m no expert in this area at all but one of the questions I often get is when people find out well gosh I didn’t know about this UBIT thing or UDFI thing and what can I do about it I mean I’ve already pledged assets you know they already bought or invested in you know a bunch of apartment building with my IRA, is there a way to you know move the ownership to a QRP and then you know hopefully not pay that tax?
Damion: That’s the great thing we can do a rollover and it’s called an in-kind rollover where we move the asset. So you don’t even have to sell the asset it can just be like an apartment syndication you have to be in you happen to be invested in, we can move the asset from the IRA into your EQRP at that moment the tax is gone you are exempt. And so there is a way to solve this and the urgency is making sure you do it sooner than later because if it gets sold the likelihood is you’re gonna have to pay the tax. But you can definitely fix the problem even if it’s invested that’s a huge thing for people to realize they can fix this.
Buck: Even if you’ve already had a distribution like it’s a years gone by about distributions from one you can’t you can still move it?
Damion: Yeah and that’s one of the things that people don’t really they they say well I’m not really subject to this because I’ve had my investment for two or three years and nothing’s happened and I haven’t had to file a 990 T which is what you have to file if there’s UBIT and the reason is because there’s not a positive income of over a thousand bucks so it doesn’t matter if you’ve had distributions you haven’t been subject to UBIT where it’s been a payable event the moment that the property sells or you run out of depreciation you’re going to have that UBIT tax.
Buck: Interesting. Well again if you want to learn more about this you know order Damion’s book just text 44222 and put QRPbook that’s one word. Damion is there anything else we need to know about this topic or subject before we go?
Damion: I think one of the things that’s really valuable is to understand there are uses for it and then there are you the reasons not to use a retirement account. And with a lot of time if you have long term real estate that you’re gonna hold for 30 years probably, not a very useful thing to put that tax shelter in this tax shelter. Our friend Tom Wheelwright says that all the time. And if you’re doing things where you’re maybe going to be in something and then out of it and save three to five years like a lot of syndications this is the tool now the last thing I’ll say is that when you have an EQRP you can convert your money from deferred or Roth and when you do that there are ways to do that without paying taxes so you’ve never pay taxes on that on the money and you’ll never pay taxes on the distributions. And those are some of the strategies that Tom Wheelwright and his clients will work with us on the Roth is one of those great giveaways. I don’t think it’s gonna be here forever. And I guess that the last last thing I’ll say is you are able to pull money out of Roth out of your contributions into a Roth account or conversions at any point tax-free and penalty free that’s a huge thing most people don’t realize you have access to a giant amount of money that you thought was stuck until you’re 60 but you can actually pull it out at any point.
Buck: Pull out the principal.
Damion: Principal or end as well at the conversion so if you have deferred money you can convert it as soon as you’ve converted it you can pull it out tax-free penalty free.
Buck: Got it good stuff man very nuts-and-bolts kind of granular stuff that we can use every day thanks again for being on Wealth Formula Podcast. I know you’re coming out for the event and give us a little no short version of what we talked about today just for people as a reminder, I want to thank you again for being on the show.
Damion: Thanks buck it’s always great to be here, appreciate it.
Buck: We’ll be right back.