While self-directed retirement accounts are becoming more and more common, there are a few ‘alternatives’ that have massive benefits that you need to know about. Specifically, Solo 401K accounts and Health Savings Accounts. Real estate investors and small businesses are in business to build wealth…and keep as much of their income as possible. If you’re not familiar with these very powerful tools…you need to be. Edwin Kelly is the 2015 Winner for the Best Wealth Building Show on FlipNerd.com
Mike: Hey, it’s Mike Hambright at FlipNerd.com. Welcome back for another exciting expert interview, where I interview successful real estate investing experts and entrepreneurs in our industry to help you learn and grow. If you haven’t checked out the all new FlipNerd.com, go check it out, FlipNerd.com. It’s growing rapidly, we have hundreds of properties, hundreds of vendors and it’s turning into a great one-stop destination for real estate investors.
For today’s show, I’m joined by Edwin Kelly. He’s the CEO of specialized IRA services and he’s helping Americans take control of their IRA to attain financial freedom. Edwin’s a leading expert on self-directed retirement accounts. And while we talked about those in the past, today is going to be a little bit unique. We’re going to talk about alternative self-directed accounts like Solo 401(k)’s and health savings accounts. And there’s a lot more to him than you know unless… probably a lot more than you think you know. Before we take a deep dive into this and get started with Edwin, let’s take a moment to recognize our featured sponsors.
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Hey Edwin, welcome the show.
Edwin: Hey, Mike it’s great to be here.
Mike: Yeah, yeah, good to see again. For those that don’t know, Edwin just joined a mastermind group that I’m in, so we actually had dinner together just a few weeks ago. Had some interesting conversations there. It’s interesting, as real estate investor I’ve bought hundreds of houses and we’ve really never utilized self-directed accounts up until this point. But every month that goes by, every time I talk to somebody in a self-directed space or had a chance to talk with you, I just keep kicking myself as to what are we still doing? Why haven’t we done this earlier? This will be one more kick in the butt for me to get out there and do something. I’m glad you’re here today.
Edwin: Yeah, well, I’m so glad to be here. I appreciate it.
Mike: Yeah, yeah. Well, Edwin, before we get started talking about this stuff, why don’t you share to us how you got into this because I know you have a long background in real estate investing, tell us how you got started and how you got to where you are today.
Edwin: Yeah, it’s interesting Mike because I was always interested in money from the time I was young, and I remember in sixth grade I knew at that point in time I was going to be financially successful in life. Didn’t know how I was going to do it, but I knew I wanted to do it. I started doing odd jobs in junior high, middle school, saving money and I decided that I wanted to start investing, believe it or not, in junior high.
So of course being a minor there’s rules around that right? So I opened up what’s called an UGMA account. An UGMA account is a brokerage account that you have a responsible individual or a legal guardian basically who’s over the age of 18 sign up, but it’s for your benefit, for the child’s benefit. So I opened up this account and I put money in it, I put my savings in it. And the very first investment I ever made was I bought a stock in a company called Chuck E. Cheese. Everybody who has kids they know Chuck E. Cheese, right?
Edwin: And I remember I bought that stock…
Mike: And they want to forget it, by the way.
Edwin: Exactly, I have kids of my own now. Thank goodness we’re past those years. Yeah, but the great thing was I bought this stock, Chuck E. Cheese and I bought it at $18 a share. Now, my grandfather was the responsible individual on that account at the time. And so the stock went from $18 a share to $42 a share and so I was excited. I doubled my money, it took about 12 months for that to happen.
And I said, “Okay, now I want to sell it.” And my grandfather said, “No, we can’t sell it.” And I’m like I go, Why not?” He said, “Well, you own stocks for the long run.” I said, “Well I get that, but I’m not going to spend the money, but I want to get out of this stock and I want to look at buying something else because it’s more than double.” He says no, he won’t let me sell it, he says, “You need to stick with it.” And what happened was, Chuck E. Cheese ended up filing for bankruptcy. Now what a lot of people are not aware of in the investing world is that when a company files for bankruptcy… because Chuck E. Cheese is still around we know the company.
This goes back many years, I’m not going to date myself how many years ago this is. But when a company files for bankruptcy the court can allow them, and in this particular case they did, allow them to wipe out all existing share holders. So my $42 investment went to zero. I lost 100% of my investment. They’re still around, they re-emerged, they were able to issue new stock.
Edwin: Right, but I lost all my money, which I didn’t like that very much. I kept on investing, I kept sticking with it and by the time I got into my early 20s, I said, “There’s got to be a better way to do this.” Because the market goes up and the market goes down, you think you make money and then it takes it away the next year. And saw this rollercoaster ride happen over, since I had been investing since I was in junior high, I saw this happen by the time I was in my early 20s and in college, I’d already seen this play out a couple of cycles.
I knew there had to be another way to do this, and so I started looking at alternative ways of investing. I hate to even call them alternative, but they’re alternative to what most people are doing. One of the things I came across is real estate. In fact, the thing that I found out was that the two ways that most people create wealth in this country is through one of two avenues. They own real estate and they invest in real estate, or they own businesses. That’s how the top 1% become the top 1%.
At that point I said, okay, I need to shift my investing strategy and I had three things that I wanted to achieve. I wanted to [achieve] predictability, a high level of certainty and my money coming back, because ROI, there are two types of ROI. Not just return on investment but return of investment. That was the lesson I learned back on Chuck E. Cheese.
The third thing is security. Real estate is an example, I think one of the reasons why you have so many followers and people are implementing what you’re teaching and coaching and sharing with them is because you can achieve all three of those in real estate, certainty and predictability and security. The investment part was one part. But the other part of it is the tax side because the problem once you start making money is you find out very quickly well, who gets paid first? We own our businesses, so in essence we can say we get paid first, but that’s not really the case, right? The government takes their fair share first and then we get what let’s over.
Mike: There’s a difference between what you make and what you keep, right?
Edwin: Right. There’s a huge difference in that. And so what I learned along the way was, we have a choice. A lot of people don’t realize this, but we have a choice. We can pay ourselves or we can pay the government. Well, I’d rather pay myself because even if I do something dumb with the money, I have only myself to blame. Right?
Edwin: I already know the government must do something dumb with my money, I don’t need to give it to them. I started paying a lot of attention to taxes and one of the best ways to reduce, defer, or eliminate taxes is the use of IRAs from retirement accounts, another tax advantage savings account, as we call them. I started looking at these tax protection vehicles as a means of sheltering the taxes and looking at real estate and these other investment strategies as a way of growing and compounding that money and that wealth tax free. And when you bring them both together, that’s really where you hit the sweet spot, and that’s where long-term true wealth is created.
It’s not just long-term, because when we talk about retirement accounts and a lot of people think, “Oh, this is something that’s only going to benefit me in the future.” It’s not true. You will make more money in your pockets today when you know how to use these accounts, and you will also put more money in your pocket in the future. But it’s today and tomorrow, and there’s ways to do both.
Mike: Yeah, I think that’s probably a common misconception is people think, “Well that sounds awesome, but I don’t want to wait till I’m 70 years old to enjoy the fruits of my labor today, when I’m in my 30s or 40s or whatever age people might be at. I know we’re going to talk about Solo 401(k)’s and health savings accounts. Maybe right up front here, give an example or two about how using those vehicles could benefit someone today where they don’t actually have to wait till they’re retired.
Edwin: Okay, so let me start by defining what an IRA is and what a self-directed IRA is and then we’ll talk about that. So what’s an IRA? An IRA is an IRS approved vehicle that allows us to make investments, put money in that account, and grow our money tax deferred or tax free, depending on the type of account [inaudible 00:10:15] okay?
Now to take one step further what is a self-directed IRA? A self-directed IRA is an IRS approved vehicle that allows us to get all those tax benefits. But the big difference between a self directed IRA, and what I call, a plain vanilla IRA which is we get [inaudible 00;10:31], is that a self-directed IRA allows you to have complete control over your money, and invest it in anything that you choose to invest in. So one of the big misconceptions that people have is that they say, “I have it, in fact I hear if you sell it, its fine. I have a self-directed IRA, it’s at Scottrade.”
Okay, that’s not what we mean by self directed. What Scottrade means, when they say, you have a self-directed IRA is that, you can buy any commissionable, we don’t charge commissions, that’s why I can’t say that right. But you can buy any commissionable investment that we offer. Mutual funds, CDs, stocks, bonds. You can pick anything that we “approve,” right? And that’s what they mean by self-directed. That’s not what we mean. When we say self-directed, we mean that you can invest in anything the IRS allows or the government. So there’s a whole realm of options there.
When I tell people that you’re virtually limited to only by your own creativity. So the self-directed IRA gives you complete control over your retirement account and allows you to take full advantage of all these tax protections and other benefits. That’s the baseline.
The question you asked me about was the Solo 401(k). The Solo 401(k), it’s referred to different things if you do some research, an individual K, an individual 401(k). There’s various names that it goes under, but it’s all expectively the same thing. There are a lot of advantages to the Solo (k) over the IRA. And we’re to touch on some of those today, actually, touch on all of them. We’ll touch on some of those benefits, but you’re specific question was to how does that benefit you today?
Let me give you two quick examples and then we can go from there. One advantage is that the 401(k)allows you to put more money in it today. So with the… and I won’t get into the specific contribution limits, they change from time to time. So the best way to find out is you can just contact the office, we can tell you what the current contribution limits are. But just to give you a feel, you can put $50 to $60,000 a year into that Solo 401(k) from a contribution stand point.
And by the way when we say Solo (k)that’s for you Mike, or you and your wife, as an example. You guys are married and you’re working the business together, so one of the things that people will say is, “Well, how do I get around the small contribution that’s on IRAs?” Here’s the way. You can put more money in this year. Between you and your wife you can put, $120,000 in to that 401(k) this year if you wanted to. Right?
Here’s the other nice thing, is that you have complete control over the tax treatment on that money. Meaning if you told me, “Edwin, I want to lower my taxes this year.” We can set it up where you get a $120,000 tax deduction this year. If you say, “I want that money to be like Roth money, tax free, so I never have to pay taxes again. But I have been told I make too much money and I can’t make Roth contributions.”
Guess what? That $120,000 can be all tax free money if you want it. And you say, “Edwin, I want both. I want to deduct some of this, but I want some tax free.” You can do that too.
One of the benefits today is that you can put more money in and regardless of your income limit or level, you can make those contributions tax deductible or tax free. So that’s one quick benefit you get this year when you set one of those plans up.
Here’s a second benefit, one of the challenges I hear from some investors is that they say, “Well the reason why I don’t have a retirement account is because I feel like I don’t put a lot of money into the retirement account, is because I feel like when I put money in, I lose control over it.” Well, I’ll say two things about that. First is that’s true when you have it at a plain vanilla IRA banker or brokerage. You don’t have control, they control it. So that’s a true statement. But when you have a self-directed retirement account, you can do virtually anything in that account, that you can do outside that account. So anything you’re doing right now outside of your account, you can do inside that IRA as well.
Here’s the second answer, and this is another one reason why that Solo 401(k) is superior to the IRA. If you’re not familiar without some of the rules and regulations on how these accounts work, one of the things you need to know about IRAs is that you cannot use that money personally. You can’t do that. But the 401(k)is the only account that allows you to take out a personal loan from it. That loan is tax free and penalty free.
So if you’re 40 years old as an example, and you have $100,000 right now in say, a traditional IRA we can transfer that traditional IRA from the bank of brokerage into a self-directed 401(k). Then you can immediately turn around and borrow $50,000, tax free, penalty free, if you’re using it in your business, if you’re restructuring debts, whatever you want to use that money for, you can use it for any purpose you choose, you can pay that money back, you pay back with interest but who did you borrow that money from? You borrowed from your own account. So you’re basically taking money out of one of your pockets, you’re putting it in the other pocket. Really, is what I refer to as a zero cost of capital. So if the Solo(k) you have access to your money today through tax-free, penalty-free loans, as well as having complete control over that money when it’s in a self-directed Solo(k) and able to invest in anything you want to invest in anyway.
Mike: Yeah and there’s some stipulations too, like you have to have that paid back within a certain period of time, right? You take out a loan from yourself and it has to be paid back within how long?
Edwin: Yeah, so the way the loan provisions work is that it depends on what you’re using the money for. If you’re taking it out for any purpose, it’s a fully amortized loan over five years. Okay? So five years is the payback term. This is all defined in the code by the way. A lot of these things are things that the government says, “Okay, we’ll let you do this but here are the rules you got to go by.” So one of the things you’re going to pay it back over five years.
Now there’s an exception for that rule. If you’re taking the loan out to pay or to purchase a primary residence, that’s when property is not going to work, so it has to be a primary residence, then the way it’s written is that, that could reflect the way that you would normally structure a loan of that type to buy a primary residence. Fifteen years, 20 years something like that. Most people aren’t borrowing money to buy a primary residence. They’re using it to making investments, to maybe do something in their business, to do some education in training, that type of thing. So that’s going to be a five-year payback. Interest rate is prime plus two, generally speaking, so you can live where prime is, you add [inaudible 00:17:30] points to it. Like I said, that’s kind of moot point…
Mike: You’re paying it to yourself.
Edwin: And you’re paying it to yourself anyway. It’s all your money, it doesn’t really matter what it is.
Mike: Well, maybe at a high level, I don’t want to take up too much time talking about this, but one of the beauties that a lot of folks don’t quite understand of generally what a self-directed IRA is, and again I’m not an expert so anything I say that’s wrong here, tell me that I’m wrong because I want you to. Is that those accounts can actually borrow money and effectively lever themselves and I know it has to be a non-recourse loan, typically things like that. But is at the same thing for of a Solo 401(k) as a self-directed IRA?
Edwin: Right. So here you hit on a huge, huge, huge benefit here. So one thing that people are not aware of, is that if you don’t have all the money in a retirement account, IRS rules allow your retirement account to borrow it. So literally I have gentleman, just quick study here for you. He’s a client of mine in Akron, Ohio. Opened up the very first raw at 53 years old. But $4,000, because at the time that’s all he could put in it. He said, “What do I do with $4,000?”
Well, what he quickly learned was, he could borrow money from someone else. It doesn’t have to from a retirement account, but he can borrow money from a bank, he can borrow money from someone else’s retirement account or from their own… Wherever the money comes from. They lend it to him to purchase property in his Roth IRA. He says, “Well wait a minute, I really don’t need hardly any money in my Roth IRA to grow a Roth IRA. And that’s what we started doing, he’s acquired over 80 properties in about seven years in that Roth IRA.
Here’s the thing and this is the thing you mentioned. When you’re going to borrow money in an IRA there are two things you need to be aware of. First is that you need what is called a non-recourse loan. Non-recourse loan, because there are some rules around it. If you want to get into what that means, Mike, later we can, but for the sake of time I’ll just point it out, that’s what you need, just be aware of that.
The second thing is that the government says, “We’ll allow you to borrow money in your account if you don’t have enough in it. By the way, this is a legal back door to getting more money in your account, past the contribution limits.” So this is why it’s really powerful. But here’s the tradeoff. Whatever profit you generate in that retirement account from the use of that debt, we’re going to charge you something called a UBIT tax Unrelated Business Income Tax.
And so that is taxable. Again, without getting into all the issues on that, you can take deductions and everything else [inaudible 00:20:10] tax. But I just want you to understand those two things because here’s the benefit to the 401(k). You can do that same transaction that you just did in that Roth IRA, but we can do it in a Roth 401(k), you do that transaction Roth 401(k), you eliminate UBIT tax. So the tax goes away when you’re debt financing property inside that retirement account. Again, that’s just another benefit [inaudible 00:20:38].
Mike: Yeah, so let’s get back to this gentleman that you referred to has $4,000. Let’s just use a hypothetical, it was in Roth Solo 401(k), $4,000 in there and he’s able to get non-recourse loan. Let’s just say he wants to rehab a house and resell it. So let’s say he borrowed some amount from a lender that’s willing to do a non-recourse loan, to keep the math simple, let’s just say it’s $60,000 or so. So he borrows 60,000, uses his 4,000, ultimately rehabs it, resells it and let’s just say he makes $20,000 a profit. So that 20,000 would go back into his Roth IRA account? So he started with four levered it up, put 20 back in plus paid himself the four back, and because that’s a Roth self-directed IRA, he’ll never pay taxes on that additional 20,000, even when he withdraws it, when he becomes of age.
Edwin: Okay to clarify…
Mike: I’m sure there’s some technicalities in here.
Edwin: So on the Roth IRA, he would pay tax on some percentage of that profit because some of that 20,000 to use your number, came from the use of debt. Now he can take deductions, because you actually file a return when you trigger UBIT in an account, so you take deductions and everything else. He may or may not pay tax but you’re going to file a return. However, if we did that deal in the Roth 401(k) that whole $20,000 is 100% tax protected. No UBIT tax.
And the second part of your question was, when he turns the magic age of 59 and a half and he takes a distribution, then, yes, that comes out 100% tax free. No income tax, no capital gains tax, no AMT tax, no tax at all.
Mike: Wow. It’s powerful.
Edwin: It’s super powerful. And by the way he does have a Roth Solo(k) today. The reason why we did a Roth IRA was when he opened it, they didn’t have Roth 401(k). The Roth 401(k) was introduced… Those rules were amended back in 2006. And so starting in that year you could actually make Roth contributions. But up until 2006 they only had Roth IRAs. So once they came up with Roth 401(k) we did set up a Roth 401(k). So he’s got multiple accounts that he’s doing this with, but he started with the Roth IRA, that’s where he started at. People don’t have to start there any more. They can start with a Roth 401(k).
Mike: We could probably have like a four part segment on this stuff. But let’s talk for a few more minutes about of Solo 401(k)’s because then I want to get into HSA accounts, Health Savings Accounts. So maybe you could share some of the unknown benefits. I know we talked about a few of them already but about a 401(k), self-directed 401(k) versus what more people know of which is more of, the self directed IRA.
Edwin: Okay, so let me give you a couple additional benefits about 401(k). This is why I get so excited about. You could put more money in it, right? You can make that tax deferred contribution, you can make it a tax-free contribution like a Roth. Income limits don’t apply. So regardless if you make a million dollars this year Mike, you have full permission of the US government to make a million dollars this year and still make that $50 to $60,000 Roth contribution to your Roth 401(k) plan, knowing limits come in to play.
Mike: One question about that, let’s say you have the ability to put, let’s just use 50,000, in to your whatever the limit would be, is that based off of a percentage of your company’s earnings? Do you have to, in order to put 120,000 away, let’s say for a couple, a husband and wife owner of a business, put away 60,000 each $120,000. Does the business have to make more than a 120,000 or has to at least make that amount or some multiple of that? How does that work?
Edwin: Yeah, good question. On the 401(k) there’s two buckets. And the best way to think about this is, well there are two buckets or there can be two buckets. [Inaudible 00:24:46] Roth IRA. I’ll say that there’s two hats also that you can wear. So Mike, you’re an employee of your business, as an employee, you’re eligible to contribute up to 100% of your income, not to exceed… it depends on the year, they’ve been indexing this and it depends on your age. But the range, we’ll just call it 17,500 to $23,000. Okay?
So if you pay yourself 30,000 this year, you can put… actually let’s just say $100,000. We’ll make the math simple, so if you pay yourself 100,000 this year, you could if you’re over 50, put $23,000 in there up to 100% of your earned income. That’s how that first hat works. So that’s your employee hat. I’m going to take off your employee hat and put your employer hat on.
As the employer of your business, you’re going to say, “Man, I did a great job this year, so I’m going to make a full profit sharing contribution or performance contribution.” You can go up to 25% of your compensation. So 25 not to exceed 33,000, I want to say $33,500, this year. Again for current contributions just check with us. So 25% times 100,000 is 25,000, so the 25 plus the 23, right? So 48, is that right? About $48,000? So you’re about $48,000. So there’s a two percentages and there’s two dollar amount. Depends which hat you’re wearing. The employee hat or the employer hat, you can go up to 100% or up to 25%, its tied to your compensation. So that’s the number they’re going to look at.
Mike: Okay, so we’re going talk about some of the benefits of the self-directed 401(k) versus self-directed IRA.
Edwin: Right. So here’s a couple more benefits to that 401K. One benefit is that one of the things that people will say sometimes is, “Well, you know what? I know that there’s rules and regulations and I know that there’s pretty stiff penalties on an IRA, a self-directed IRA, if I make a mistake in that account. One of the things that we’re big on and our company is educating clients so that the set their deals up correctly, and so the rules are things you can learn, and you can invest according to the rules.
It’s not a problem for most people. But it is something that people sometimes get a little concerned about usually because their financial advisor tries to scare you and say, “Don’t take your money out to stock market because you could lose it if you do something wrong in the IRA account.” The penalties on IRA, if you do a prohibited transaction on IRA for example, is that the entire account is subject to that penalty. However, with the 401(k), the penalties are generally limited only to the transaction in itself.
Mike: Oh, wow, that’s great.
Edwin: To completely reduce the risk, particularly if you’re getting started and you’re not familiar with some of the rules and regulations in terms of, if there was a penalty trigger, you’re going to limit what that penalty using a 401(k) plan. That’s another big benefit. Here’s another benefit beyond that, Asset Protection right? We’re all concerned about protecting our hard-earned assets. Qualified plans which is what the Solo(k) or the 401(k) rules fall under, they fall under a little different set of rules than the IRA accounts.
So here’s a really cool thing about it. IRAs offer asset protection, but you have to look on it at a state by state level. Sometimes there’s dollar limits, depends on the state and there’s various factors that are involved. Here’s the great thing about 401(k) and these plans we’re talking about. Those plans are judgment proof in all 50 states, okay? They’re judgment proof in all 50 states. So what does that mean?
If you file a personal bankruptcy, the court will not attach a judgment to those 401(k)assets. If you have a business that goes bankrupt, the court will not attach a judgment to those 401(k)assets. If you’re tried and convicted of a criminal offense, the court can take your life, but they can’t take your 401(k). That doesn’t seem right, but that’s how it works. And so when I say judgment proof when I talk about asset protection, that’s what I mean. So there’re just layers on layers of benefits to the 401(k) that makes it far superior to just a regular IRA, truthfully.
Mike: Sure, sure. So why would anybody do a self directed IRA? What instance would you advise that over a 401(k).
Edwin: Well, there’s a couple of reasons why somebody would choose to do an IRA. Actually let me give you three reasons. One reason is that they may not qualify for the 401(k). So as a general rule you have to have… you can be a sole proprietor, but you have to have a business or the intent to have a business to set up a plan because this 401(k), even though is just for you Mike, or you and your wife. The reality is, it’s sponsored by a company, it’s a company sponsored plan, so you have a company sponsoring it, your company. Again, on a deal breaker, you can set up an LLC, get an [inaudible 00:30:04] and now all of a sudden you have company sponsor it. Not a big deal. Some people, they just don’t have a company.
Second reason why people don’t do it, and this is the biggest reason is because they’re not aware of it. Most people… IRAs are much less sophisticated to manage and operate, [administer], than 401(k) plans. So the reality is, a lot of people don’t offer 401(k)’s because they don’t want mess with it. So many companies don’t offer 401(k)’s, they certainly don’t offer self-directed 401(k)’s and so it’s just not an option that’s available for most people. You have to find a specialty company that provides this.
The third reason why some people elect not to go with a 401(k)is that… and I’m thinking of one well-known competitor, if you look at their self-directed 401(k), the fees start at $2,000 a year. Versus an IRA that might start at $200 a year. A big difference in price.
We believe that this is such a powerful plan, we were very aggressive with the pricing and worked [inaudible 00:31:04] some efficiencies in it. The reality is, at least with us Mike, the fees are very similar to an IRA. The fees aren’t really a reason not to do 401(k) anymore, but those first few reasons do stand out. Somebody has to qualify because you need to have a business or intent to have a business and then they have to be aware there’s an opportunity and find a company that’s wanting to offer them that opportunity.
Mike: Okay, fantastic. Well, let’s switch gears here before we run out of time and talk a little about Health Savings Accounts. I know those are also a powerful vehicle and they’re not… I’ve heard some things recently or over the past year, that really were eye openers to me, as to what you can use those things to pay for which was counter intuitive to what I thought. Maybe you can shed some light on an HSA Health Savings Account and just talk about some misconceptions and how they could be a powerful tool as well.
Edwin: Yeah, so HSA is one of my favorite accounts. It’s one that you won’t hear anyone talk about. The reason why I love it by the way, I use it. So I have one myself, so everything I’m sharing with you, I did it myself. So I use a Roth 401(k), I use HSAs. The reason why I use this is because the HSA is huge, particularly under the new age of the new health care. So cost went up, premiums went up that is, and for most people they seen coverage stay the same or not as good. It’s not a political discussion, it’s just financial here.
So here’s the great thing about it, when you have an HSA, what it takes to qualify for a health savings account is what’s called an HDHP, High Deductible Health Insurance Plan. So the way this concept works is that you have a high deductible on your health insurance plan, and the idea is that you pay first dollar up to your deductible. So it’s like car insurance, you have a deductible on your car insurance, you pay up to the deductible, anything over that the insurance company pays. Same concept with health insurance.
So what happens is, you set up the HDHP, the first thing is, if you’re on standard health insurance right now, this will cut your premiums up to 40 to 50% a month, an actual dollar savings. When I went from standard health insurance to a high deductible health insurance plan, I shaved about $300 a month. What did I do with that $300 a month? I contributed it to my HSA.
Mike: You’re saying you shaved the cost because of the high deductible?
Edwin: Right. When the deductible went up, my premium went down. And so instead of giving the insurance company that $300 a month, I took it and I put it in my health savings accounts. Here’s the cool thing about it. Regardless of what my income level is this year, I get to take a full deduction on every single dollar I deposit in my HSA account. That’s benefit number one.
Benefit number two is that if its self-directed HSA, I can go out and buy as an example, a rental property in that HSA and now all of a sudden, all the money that the tenants paying in rent, comes back to my HSA. Guess how I’m going to pay for my medical expenses and my deductibles this year. Through that rental income coming back into my HSA. So you can invest in anything you want in that HSA, pretty much. Same rules apply as they do the IRA when it comes to investing.
Next benefit is that, when I pay qualified medical expenses, which that’s pretty liberal. But qualified medical expenses paid from an HSA account, the money comes out 100% tax free. The HSA is the only account where the government basically married together the tax benefits of the traditional IRA and the Roth IRA bonded together at the same place.
You get tax deductions on the money going in, you get tax protected growth on all your investments and you get to spend all the money on qualified medical expenses 100% tax free. Huge. By the way, one of the biggest advantages of the agency, different then… a lot of people are familiar with what we call medical savings accounts, or flexible savings account. But what’s the downside of a flexible savings account? Basically the downside is you’ve got to be Nostradamus to figure out how to make that thing work because you have to guess to the penny on the first day of the year, how much money you need in that flexible savings account. Because if you guess too little, you’re using after-tax dollars to pay medical expenses out of pocket expenses. If you guess too much, what happens to the money at the end of the year? It goes away, disappears right? You don’t get it back.
Not true with the health savings account. This is your account, this is your money. If you don’t spend it this year, it rolls over year after year, after year and grows. So this is your money, it doesn’t go away, you can accumulate it over your lifetime. Another just great benefit, Mike, to put in perspective is you don’t have to use money from your HSA to pay out of pocket medical expenses. It’s an option for you, but you don’t have to. Why might you not want to spend the money this year that you contributed to your HSA? Well, because you might want to save an investment, buy a rental property that spins off consistent income every single month to cover all your future medical expenses.
You might want to save for a larger medical things, like orthodontics as an example. So I have four kids, unfortunately for me all of them need braces. My oldest one actually right now is… orthodontists make a lot of money, it costs a lot of money. I can use my HSA account to pay for all that pre-tax, so I can save for that expense in that account.
Mike: And just to clarify, those are at the family level, you can use it to pay for it.
Edwin: Right. So the HSA the way the HSA works is that you set it up and your contribution limits are based on, you have an individual health insurance plan, or do you have a family plan. A family is defined as more than one person and individuals is obviously just you, yourself. And when you use money from the HSA, the HSA money can be used for anybody covered under that plan. So I can use it for myself, my spouse, my four kids, anybody covered under that plan. All those expenses if you pay for that plan.
Mike: So with an HSA, help me understand how you everybody wants to believe that they are bulletproof and they’re never going to get sick and things like that. Of course if you do, you’ll be glad that you socked away a ton of money in here. But how do you not get too much money in there and I guess later in life what are some things you could use that on that aren’t necessarily true medical expenses? Is there a way to basically make sure that doesn’t get trapped in there, I guess?
Edwin: Yeah, I’ll give you couple of answers to that. And first of all it’s a brilliant question.
Mike: I am brilliant Edwin, I am brilliant. No, I’m joking. People I think, automatically assume, I want to get enough in there but not too much because they fear of, nobody wants to believe they’re going to have some major illness or something in their family that’s going to cost hundreds of thousands or millions of dollars. Of course, it could happen and hopefully doesn’t have for anybody that’s listening to any of this. But I’m curious what else you might be able to use these things for or how you prevent that from happening, I guess.
Edwin: Yes, I will give you a couple of examples, but let me say first, I’ve never seen anybody save too much in an HSA. Never happened, not yet, not that I have seen. Second thing I will say is that Ben Bernanke, the world former Fed Reserve Chairman, if we all remember Ben Bernanke, came out with report years ago. And what he was talking about was the health care problem. This is one reason why health care’s been on the minds of government officials for so many years because what Ben Bernanke’s report showed years and years and years ago, was that the largest single expense in a family is health care. Now, I actually think it’s taxes, but apparently they don’t consider that an expense.
Mike: Right, yeah. That’s an investment in your government.
Edwin: That’s just our privilege right? But people don’t think of health care as a large expense. Why? Because most people don’t even know how much they pay for their health insurance because it’s auto-deducted out of their paycheck, if they get a W-2. The company picks up some portion of that. Then you have co-pays, you have deductibles, you have out of pocket expenses on medications, those kinds of things. Nobody takes the time to add all those numbers up. But the reality is, what the federal reserve found out through this research was, is that health care is the single largest component of personal GDP in terms of what the income is and what the expenses are.
Not only that, what they also found was that the average person, once they retire and are on Medicare or Medicaid, so that the average retiree today, this is not future, this is today, needs to have approximately $220,000 for out of pocket medical expenses that they’re expected to spend over their remaining lifetime. How many people do you know who have 220,000 set aside just for medical? Nobody has. That’s why I say, I’ve never seen anyone save too much money. What I would say is, first of all the goal should be they get about $200,000 in that account to cover the out of pocket expenses because most people that I know who are retired have to pick which medications they’re buying every month because they can’t afford all of them.
But here’s the other thing, one of your questions was, what are the other options if you don’t use all of money? Well here’s another really, really huge cool benefit. This is for the FlipNerd audience only.
Mike: All right. Exclusive.
Edwin: Exclusive. Are you familiar with long-term care insurance?
Mike: Yeah, in fact that’s what’s been going on at the back of my mind, so you read my mind.
Edwin: Right. Critically important to have, you don’t want to end up in Medicaid nursing home. Nobody wants to end up there. If you don’t know what one looks like, go visit one and you will never want to end up there. Long term care insurance is very expensive insurance to buy.
However, one of the things that the government put in the rules, is as long as that policy meet certain requirements, which most will, you can actually use those pre-tax dollars, those non tax dollars from the profits and income you generate in that HSA, to pay your long-term care insurance premiums. So you can actually fund long-term care from pre-tax dollars from an HSA. If you factor in the tax benefit alone on that, you’re talking about like taking a 30 to 40% discount on the actual cost of that insurance to you yourself. That’s another benefit of HSA. And so that’s one of the things I would tell people to do. I would focus on having out of pocket expenses covered from that HSA in the future and I would focus on being able to fund a long-term insurance program from your HSA. Those are [inaudible 00:42:30].
Mike: And one of the greatest thing about it too is its at the family level. So if you’re married and it’s not like you have to anticipate which of us is going to be the sickest or need the most care. It’s like, hey, we have kind of a blanket policy over our family. So that’s fantastic. Well, Edwin, we’ve run a little long on time here. I would love the talk some more about this. We may have to have you back again to talk about it. But if folks want to learn more about some of these awesome vehicles and I know that after you use them a little bit they’re not that complicated. But you definitely work with somebody that knows what they’re talking about, knows the rules, knows how to navigate around what the rules are, or in line with the rules are. Where should they go to learn more about this?
Edwin: So the best place to go and learn more is our website, and that’s www.specializedIRAservices, with an S on the end. Specializediraservices.com. And when you go to our website, there’s a lot of great information articles, blogs, those types of things. But one of the things that we offer that’s very valuable to people starting out or even very experienced, is we have a free education and training package that we offer on that site. It comes with a training video, a training manual, as well as a free consultation.
That free consultation truthfully Mike, is the most valuable thing that we offer and the reason why, it’s just everything we’re talking about. There’s no cookie cutter approach to this. Everything is customized. Like we were talking about the difference between a Roth IRA and a Roth Solo(k) or the HSA, which accounts are best for you, how do you use them? What are the rules or rates that apply based on the kinds of deal you’re doing. So that’s where that consultation comes in, so again we offer that free of charge and you just go to our website, you can sign up for that on the website there.
Mike: Okay. Awesome, awesome. Well Edwin, thanks so much for your time today. We’re going to put the link to the website down below here, and appreciate you being with us. It’s very fascinating information and I think most of us in the real estate game are in this to build long-term wealth and security. Sometimes we forget that, we can get caught up in the day to day and doing deals for more of a short-term approach. But ultimately I would argue most of us got in this for the long-term so this is important stuff. Thanks for sharing with us today.
Edwin: Thank you Mike. I appreciate it.
Mike: Yeah, take care and please stay in touch, okay?
Edwin: Yeah, absolutely.
Mike: All right, bye-bye.
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