There is a worry that nags at many of the millions of American investors who look to their Individual Retirement Account as a source of retirement security. It keeps nagging because, while the worry is well founded, there is nothing obvious to do about it.
An IRA is a tax-free zone for accumulating wealth. Whether it is a traditional IRA (fed by deductible contributions) or a Roth IRA (withdrawals can be tax free), an IRA offers a big growth advantage — earnings compound at a before-tax rate of return, so the value of your IRA grows faster. The result can be far more spendable cash waiting for you at retirement time.
There is now a robust political constituency supporting the generous tax treatment given to IRAs. One element is the 40 million people who have an IRA. A second element is the retail financial industry – banks, brokerage houses, mutual funds and insurance companies – for which those 40 million people add up to big business.
It's a cheery picture: amid the sea of high tax rates and punitive rules there lies an island of tax freedom protected by millions of voters and an army of well paid lobbyists. A tax haven for main street. The worry is that the haven is getting too big for its own good.
The Big Pinata
The total value of IRAs and other tax-favored retirement plans is now counted in the trillions of dollars. For revenue-hungry politicians, that looks like the Big Pinata. Will they make a grab for it?
Doing so would be a politically hazardous move, but the Government needs money, and the money has to come from somewhere. Here are some of the ways it might come from your IRA.
• Mandatory investing. The Government might require your IRA to invest some share of its assets (50%, for example) is U.S. Treasury securities. That would assure the Government a source of low-cost funding for its big deficits but would leave your IRA exposed to inflation or, in extremis, to a "restructuring" of Government debt.
• IRA bonds. Your IRA might be required to invest everything in special Treasury bonds issued for retirement plans only. This would be even worse, since the government would have a free hand to set a low, fixed interest rate and stick to it even when inflation is running wild.
• Green stocks and bonds. It's a political game, so if the politicians make a grab for your IRA, they might try to attract allies by including "green" investing as part of the package. Your IRA would be required to put part of its money into stocks and bonds issued by companies that have been officially designated as environmentally correct.
• Surtax on large IRAs. Congress once passed, and later rescinded, a 15% "excess retirement accumulations excise tax" on large retirement plans. Reviving that tax could bring the Government a lot of money.
• Integration with Social Security. The Government might reduce Social Security payments to people who are receiving distributions from an IRA.
At this point, every one of these worries is just a hypothetical. Don't be surprised if none of them ever becomes a fact. But don't be surprised if the government goes after retirement plans in some other way, something that we haven't yet thought of.
If we knew what new rules were coming, we could plan for them. But we don't. That's why the worry nags. The only way to protect your IRA from a possible future grab is to plan for the unknowable. And that's one of the many uses of a structure called an "Open Opportunity" IRA.
An ordinary IRA is sponsored by a financial institution – a bank, a mutual fund family, a stockbroker or an insurance company. Not surprisingly, it only allows you to use the investments or services the institution wants to promote. You do get the tax deferral that is at the heart of an IRA – a very good thing – but you don't get investment freedom. And the investments your IRA is permitted to buy are left in the hands of the IRA custodian the sponsoring institution has selected.
An Open Opportunity IRA changes all that. It doesn't just stretch the envelope of investment choices, it breaks out of it.
With an Open Opportunity IRA, the custodian you select holds just a single asset -the shares in a limited liability company (LLC) that you manage. You deal with the custodian just once, when you set up the structure and roll your IRA assets into it. From there on, you are in charge.
As Manager of your IRA's LLC, you open a bank account for the company wherever you want. The checkbook sits in your desk draw, and you are the only one who signs. You also can open a brokerage account for the LLC and give the buy and sell orders. But that's only the beginning of the possibilities. Acting as Manager of the IRA's LLC, you can:
• Buy gold coins and store them however you think fit – in safe deposit box at your local bank, in a Swiss depository or in a mayonnaise jar in the back of your refrigerator. You decide.
• Buy real estate, for appreciation or income
• Attend auctions and buy foreclosure property (as Manager of the LLC, you have full power to act quickly)
• Buy and rehabilitate dilapidated houses
• Buy tax liens for high yields
• Lend on well-secured second mortgages – another way to earn high yields
• Go into the equipment-leasing business
• Invest in intellectual property (copyrights, patents, software) and collect royalties
• Buy an apartment in Buenos Aires or a farm in New Zealand
• Own and earn royalties on patents, copyrights and other intellectual property
Because the LLC is inside your IRA, there are a few restrictions on what it can buy, but there aren't many. So the list here is just a list of examples.
Investment freedom (the fatter returns you can earn when your hands aren't tied) is a strong reason for rolling an ordinary IRA into an Open Opportunity IRA. In addition, making that move may be the best way to protect against any surprise change in the rules.
Freedom and Protection
We don't know what the new rules might be, but we do know that out of 40 million IRA owners, only a few tens of thousands have an Open Opportunity IRA. Because this minority is so small, there is an excellent chance that the new rules would be written without considering how Open Opportunity IRAs might slip through.
And the new rules very probably would be aimed at harvesting easy-to-value, easy-to-sell liquid assets (stocks, bonds, cash), because that's the form of 99.9% of all wealth in IRAs. So your Open Opportunity IRA would have another survival advantage by owning difficult-to-value, difficult-to-sell, illiquid assets – such as real estate, equipment, tax liens and private loans.
There is a further safety advantage you can achieve with an Open Opportunity IRA. Regardless of the underlying investments, it is possible to ship all of your IRA's value to another country. I'll cover that topic in Part II – Getting Your IRA Out of Town.