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How To Maximize Your Investments Funds With Partnering

Posted on by Quest Trust Company
Estimated reading time: 3 minutes

It’s no secret that people choose self-directed IRAs because of the many benefits they offer, like reducing taxes and providing options for alternative investments. They are also very powerful accounts for real estate investors, as they allow the possibility for utilizing creative investment strategies. 

What is Partnering? 

One of the great features of self-directed IRAs is that they don’t have to be used only on their own. Self-directed IRAs can work together by using a beneficial strategy called “partnering”. This term is used when one entity (or more) and an IRA come together to put up the funds for an investment. 

In this strategy, all parties have a vested percentage of ownership in the deal. When doing this, the percentage of ownership is decided at the beginning of the investment and must remain the same throughout the life of the investment. This means that any profit the investment receives is returned based on this percentage of ownership. Additionally, the IRA would be responsible for its percentage of any expense associated with the investment, too. 

Who does Partnering work for?

Partnering is a great strategy for a variety of people. For investors who are just getting started, partnering allows the chance to participate. Even having only a small percentage of a total investment allows a small dollar IRA to gradually grow. Oftentimes, Coverdell Education Savings Accounts (ESAs) and other small dollar accounts will partner together to purchase an investment. 

There are also many occasions when a good deal is available, but an investor doesn’t have enough money in their IRA to make up the total cost of the purchase. Being able to partner with another IRA account they may have or another money partner provides the ability to purchase the investment after all. 

It is also beneficial for account holders that have multiple IRAs. For those who want to utilize all of their accounts at once, this is a great way to have all accounts involved in one deal. Over all, partnering provides more possibilities for accounts to be involved in deals when they may not have been able to before.  

Who can your IRA Partner with?

Not only can one or multiple accounts be partnered together on investments, self-directed IRAs can also partner with personal funds. When partnering with personal funds, your IRA has a percentage of ownership and you do, too. This is not to be confused with doing a transaction with yourself. Keep in mind that when partnering with a disqualified person, the percentage of ownership is decided at the time of purchase and must remain the same throughout the life of the investment.

Knowing what you can do is great, but it’s even more important to know what you and your IRA can and cannot do. If you haven’t heard about disqualified people and prohibited transactions, it’s important to know these terms to better understand how partnering is different. Disqualified people are certain people or entities that your IRA is not allowed to transact business with, and it’s important to understand who they are before entering into any deals to avoid doing a prohibited transaction. 

Being able to combine funds with other investors and IRAs opens a door to a whole new world of possibilities, and understanding how to partner accounts will allow more investors to grow their accounts faster. For more information on partnering or how to maximize all of your self-directed IRAs, give an IRA Specialist a call at 855-FUN-IRAs (855.386.4727). To learn more about how to get started investing with a self-directed IRA, schedule a 1-on-1 consultation with an IRA Specialist by clicking HERE.

Paying for Educational Expenses TAX FREE – Comparison of the Coverdell and 529 Plans

Posted on by Quest Trust Company
Estimated reading time: 4 minutes

With the new school season just around the corner, you have probably already started working on your school’s supplies lists. However, the beginning of the year isn’t just the only time you spend money for school. Materials for projects, electronics for homework, maybe even school uniforms and tuition are things that come at all times during the school season. Wouldn’t it be nice if the money used for education costs were exempt from federal income taxes? They can be, and there are investment plans that allow you to do this!

The Coverdell Education Savings Account (ESA) and 529 are similar education savings plans that allow you to save for college and other educational purposes, but their differences can determine which one is best for you. Some plans, like the Coverdell ESA, allow you to diversify your investment portfolio by investing in alternative assets, such as self-directed real estate or notes.

In this article, we’ll cover the main differences and similarities so that you can get a feel for which account may best fit your needs.

The Coverdell and the 529 are both used for education, and this is the most common similarity. What does education cover? The good news is… that answer is very broad. For a Coverdell, educational expenses can cover everything from school supplies like binders and notebooks, to textbooks and even computers if the school program requires it for the class! For a complete list of qualified education expenses, please view IRS Publication 970.

Another important similarity these two accounts share are the tax benefits. For the Coverdell and 529, taxes grow tax-deferred until distribution. If used for qualified educational expenses, these plans offer tax-free growth! It’s important to note that non-qualified expenses that are withdrawn could be subject to federal taxes and a 10% penalty tax.

What can you use these accounts for?

Their differences are where the two accounts are set apart. Though they are both great accounts that can be used for education, one account allows you to begin using it earlier than the other. The Coverdell ESA funds can be used for qualified expenses from Pre-K all the way up to college, whereas the 529 plan funds can be used for qualified college expenses, but has a $10,000 limit if you are using it to cover K-12 expenses. This is something to consider if the funds were needed for secondary school tuition. 

What are the contribution limits?

Another difference is the contribution limits. With a 529 plan, the limit varies by state, whereas the Coverdell ESA remains the same across the board (for 2023 the annual contribution limit is $2,000 per child, per year until the child reaches age 18).

One unique characteristic of the Coverdell ESA is that even though contributions must stop at age 18 (the age of majority), the account can remain in that child’s name until age 30 or it can be passed along to another eligible family member. (Special needs beneficiaries are not affected by the age restrictions.)

In order to contribute to a Coverdell ESA, the adjusted gross income of the depositor must be less than $110,000 if single, or $220,000 if married and with a 529, there are no income limitations.

It is important to note that gift contributions can be made to a Coverdell. This means that if a contributor’s income level was higher than the limit, another person could contribute to his or her place. For example, if a child’s parents made too much, but had grandparents who were under the income limit, they would be able to contribute to the Coverdell if they wanted.

What can you invest in?

The biggest difference is who is in control of the investments. With a Coverdell ESA, the account holder has the option to choose his or her own investment. If you want even more flexibility, you can open a self-directed Coverdell ESA which gives you the option to purchase alternative investments. One investment strategy is to partner the child’s Coverdell account with their parents’ self-directed IRAs to purchase real estate investments and even private loan partnerships. Deciding whether you want to take control of the account or let the state make the investment decisions will be important when picking which education account is best for you.

Coverdell ESA and 529 are both beneficial accounts to have for school savings and qualified educational expenses. However, both come with their own freedoms and restrictions. It’s up to you to decide how much control you want to have over the account and how you anticipate your future spendings. When in doubt, consult with a tax advisor to make sure you are accounting for the expenses properly.

If you would like more information about the Coverdell ESA or have questions about which plan might be right for you, you can speak with an IRA specialist at 855-FUN-IRAS (855-386-4727). To learn more about how to get started investing with a self-directed ESA, schedule a 1-on-1 consultation with an IRA Specialist by clicking HERE.

 

How to Pay for Education Expenses With Tax-Free Dollars

Posted on by Ingrid Chavez

Estimated reading time: 5 minutesMany people are under the mistaken impression that a Roth IRA is the only type of self-directed account from which tax free distributions can be taken. However, distributions from Health Savings Accounts (HSAs) and Coverdell Education Savings Accounts (ESAs) can be tax free if they are for qualified expenses. In this article we will discuss the benefits of the Coverdell Education Savings Account and, more importantly, what investments you can make with a self-directed ESA.

 

Contributions. Contributions to a Coverdell ESA may be made until the designated beneficiary reaches age 18, unless the beneficiary is a special needs beneficiary. The maximum contribution is $2,000 per year per beneficiary (no matter how many different contributors or accounts) and may be made until the contributor’s tax filing deadline, not including extensions (for individuals, generally April 15 of the following year). The contribution is not tax deductible, but distributions can be tax free, as discussed below. Contributions may be made to both a Coverdell ESA and a Qualified Tuition Program (a 529 plan) in the same year for the same beneficiary without penalty.

 

There are limits to who may contribute to a Coverdell ESA. Your eligibility is based on your modified adjusted gross income (MAGI) and tax filing status.

Single filers can contribute to a Coverdell account if their MAGI for the year is less than $110,000. For married couples filing a joint return, the MAGI threshold is $220,000. A trust or corporation can also make contributions to a Coverdell account on behalf of an eligible student.

 

Tax Free Distributions. The good news is that distributions from a Coverdell ESA for “qualified education expenses” are tax free. Qualified education expenses are broadly defined and include qualified elementary and secondary education expenses (K-12) as well as qualified higher education expenses.

 

Qualified elementary and secondary education expenses can include tuition, fees, books, supplies, equipment, academic tutoring and special needs services for special needs beneficiaries. If required or provided by the school, it can also include room and board, uniforms, transportation and supplementary items and services, including extended day programs. Even the purchase of computer technology, equipment or internet access and related services are included if they are to be used by the beneficiary and the beneficiary’s family during any of the years the beneficiary is in elementary or secondary school.

 

Qualified higher education expenses include required expenses for tuition, fees, books, supplies and equipment and special needs services. If the beneficiary is enrolled at least half-time, some room and board may qualify for tax free reimbursement. Most interestingly, a Qualified Tuition Program (a 529 plan) can be considered a qualified education expense. If you believe that contributing to a 529 plan is a good deal, then contributing that money with pre-tax dollars is a great deal!

 

One thing to be aware of is that the money must be distributed by the time the beneficiary reaches age 30. If not previously distributed for qualified education expenses, distributions from the account may be both taxable and subject to a 10% additional tax. Fortunately, if it looks like the money will not be used up or if the child does not attend an eligible educational institution, the money may be rolled over to a member of the beneficiary’s family who is under age 30. For this purpose, the beneficiary’s family includes, among others, the beneficiary’s spouse, children, parents, brothers or sisters, aunts or uncles, and even first cousins.

 

Investment Opportunities. Many people question why a Coverdell ESA is so beneficial when so little can be contributed to it. For one thing, the gift of education is a major improvement over typical gifts given by relatives to children. Over a long period of time, investing a Coverdell ESA in mutual funds or similar investments will certainly help towards paying for the beneficiary’s education. However, clearly the best way to pay for your child’s education is through a self-directed Coverdell ESA.

 

With a self-directed Coverdell ESA, you choose your ESA’s investments. Common investment choices for self-directed accounts of all types include real estate, both domestic and foreign, options, secured and unsecured notes, including first and second liens against real estate, C corporation stock, limited liability companies, limited partnerships, trusts and much more.

 

With the small contribution limits for Coverdell ESAs, you might wonder how these investments can be made. Often these accounts are combined with other self-directed accounts, including Traditional, Roth, SEP and SIMPLE IRAs, Health Savings Accounts (HSAs) and Individual 401(k) plans, to make a single investment. For example, I combined my daughters’ Coverdell ESAs with our Roth IRAs to fund a hard money loan with 2 points up front and 12% interest per year.

 

One client supercharged his daughter’s Coverdell ESA by placing a burned down house under contract in the ESA. The contract price was for $5,500 and the earnest money deposit was $100. Since the ESA was the buyer on the contract, the earnest money came from that account. After depositing the contract with the title company, the client located another investor who specialized in rehabbing burned out houses. The new investor agreed to pay $14,000 for the property. At closing approximately one month later, the ESA received a check for $8,500 on its $100 investment. That is an astounding 8,400% return in only one month! How many people have done that well in the stock market or with a mutual fund?

 

But the story gets even better. Shortly after closing, the client took a TAX FREE distribution of $3,315 to pay for his 10 year old daughter’s private school tuition. Later that same year he took an additional $4,000 distribution. Assuming a marginal tax rate of 28%, this means that the client saved more than $2,048 in taxes. In effect, this is the same thing as achieving a 28% discount on his daughter’s private school tuition which he had to pay anyway!

 

The Coverdell ESA may be analogized to a Roth IRA, but for qualified education expenses only, in that you receive no tax deduction for contributing the money but qualified distributions are tax free forever. Investing through a Coverdell ESA can significantly reduce the effective cost of your child or grandchild’s education. As education costs continue to skyrocket, using the Coverdell ESA as part of your overall investment strategy can be a wise move. With a self-directed ESA (or a self-directed IRA, 401(k) or HSA for that matter), you don’t have to “think outside the box” when it comes to your ESA’s investments. You just have to realize that the investment box is much larger than you think!