Problems With and Solutions for Self-Directed IRAs Copyright 2006 Roccy DeFrancesco, JD, CWPP, CAPP The Wealth Preservation Institute 378 River Run Dr. St. Joseph, MI 49085 269-408-1841 www.thewpi.org 1
IRA = Trust 408(a) ''individual retirement account'' means a trust created or organized in the United States for the exclusive benefit of an individual or his beneficiaries, but only if the written governing instrument creating the trust meets the following requirements: 2
Investments Buy Real Estate? Invest in leveraged hedge funds? Invest in private businesses? Purchase Accounts Receivables? Engage in leasing programs? Make Mortgage Loans? Borrow Money? 3
Investments Anything except Life Insurance Contracts Collectibles 4
Prohibited Transactions There are a number of restrictions on the type of transactions in which an IRA can engage with a related party to the IRA. These parties are considered disqualified persons. In a nutshell, a related party is the owner of the IRA, an ancestor, spouse, descendant, spouse of any of the above, and any business entity owned 50% or more by one of the above. Interestingly enough left out of the definition of related party are brothers, sisters, step relations, nieces, and nephews. 5
Prohibited action with a disqualified person (A) sale or exchange, or leasing, of any property between a plan and a disqualified person; (B) lending of money or other extension of credit; (C) furnishing of goods, services, or facilities; (D) transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a plan; (E) act by a disqualified person who is a fiduciary whereby he deals with the income or assets of a plan in his own interests or for his own account; or (F) receipt of any consideration for his own personal account by any disqualified person who is a fiduciary from any party dealing with the plan in connection with a transaction involving the income or assets of the plan. 6
Estate Planning with IRAs and LLCs 7
Can an IRA own an LLC? Sure. So long as the client does not own 50% or more of the business. In what we are discussing today, the IRA will form an LLC from scratch and be the sole owner. There are no issues with this transaction. 8
Concerns What if you leave part or all of the IRA to your kids or grandkids? Will they have unfettered access? Will their spouses? Will they keep the assets in the IRA? Will their spouses? What happens if they distribute the IRA? 9
Examples 1) Client leaves his IRA to his 18 year old daughter, Paris. Paris decides she would rather have a fancy car than money in the bank. 2) Degenerate John, 48, no kids, can t hold a job. Likes to gamble on party poker and always wanted to play in the world series of poker. He decides to go to Vegas with the IRA money and become a poker star. 10
Solution Client, during his life, moves his IRA assets into a Limited Partnership A friend/trusted advisor is the General Partner of the LP If Paris liquidates the IRA, all she gets is LP units 11
LP owned by the IRA IRA Assets The General Partner(s): Provide Investment Experience (Level Head) Follow client s wishes on distributions 12
Questions? 13
Asset Protection and IRAs The Maximizer 14
Concerns The what if concern. What if the market does what it did from 1999-2001? How many of our clients lost 50% of the IRA net worth during that time frame at a time in their lives when they could least afford it. 15
Protection Clients can protect themselves by moving their money from stocks and mutual funds to: CDs Bonds EIAs The problem with CDs and bonds are that the returns will be low. The problem many clients see with EIAs is that the returns while better than fixed investments still have a cap. 16
The Maximizer Would your clients like principally protect 90% of their money while at the same time nearly doubling the returns of the S&P 500 in up years? The answer will be yes. The Maximizer can do this for them. The Maximizer plays to the greed of your clients and to their desire to protect their money from downturns in the stock market. 17
Mutual Funds Provide No Downside Protection Merrill Lynch Mid-Cap Growth Fund <36.6%> Merrill Lynch Premier Growth Fund <52.6%> Merrill Lynch Focused Twenty Fund <70.1%> Merrill Lynch Fundamental Growth Fund <19.4%> Merrill Lynch Global Growth Fund <26.3%> 2001 Results* S&P 500-17.6% *source Morningstar.com 18
Problems with many actively managed mutual funds- No Downside Protection Underperform the Market Very Expensive Right or Wrong Lack of Consistent Results The sad truth of the matter is, that over time the vast majority approximately 80% - of mutual funds underperform the overall stock market. The Motley Fool 19
Actively Managed Mutual Funds Can Be Very Expensive Sales Charges 12b-1 Fees Management Fees Fund Expenses Transaction Costs 20
No Consistent Results the First Become the Worst! This is the consequence of trying to find the hot funds. The S&P 500 index averaged over 12% per year. The average fund annually averaged under 10%, but because of switching to so-called hot funds, the individual fund investor managed an annual return of just 2.7%. DALBAR Associates ( Law of Averages, 2003). 21
Walmart Kmart One of largest companies in the world Consistent earner Pays dividends Just emerging from bankruptcy Big marketing tie to Martha Stewart No anticipated dividends $56.08 Stock Price July 11, 2003* $24.20 $51.76 Stock Price July 11, 2004* $76.80 * Source: Yahoo! Finance 22
Does anyone really know? Does anyone (client or broker) really know which way individual stocks or mutual funds will go (up or down) in any given year? NO. Not if they are honest. Even brokers must admit that they can not guarantee which way things will go. Who can predict the next 9-11 or hurricane or the big earthquake? In our previous slide the broker said to buy Walmart and if we were honest we would all agree that was the proper stock to purchase at the time. 23
Many have switched to an index fund Greater Diversification Reduced or Eliminate Management Fees Match the Market (the client has unlimited Potential for upside growth which they do not Have with the Maximizer.) No Downside Protection 24
Remember the Three Rs?? Reading Writing Arithmetic Less More Quicker Risk Reward Recovery How do clients reach for 15+% rates of return? They MUST assume some kind of financial risk. 25
Use two financial products in combination which produce the following results: Reduce & Control Risk - 0-15% Maximum Loss More Reward - Beat the S&P 500 Every Year* Portfolio Equity Index Annuity Option Strategy * Subject to Maximums 26
Equity Index Annuity Annual Yield Linked to 100% of S&P 500 Index* 100% Principal Guarantee No Management Fee Taxes Deferred Annual Reset Feature *Subject to Cap 27
Equity Index Annuity Annual Reset Feature $115,562 $115,562 $107,500 $107,500 (up 10%) (down 5%) (up 8%) (down 13%) $100,000 Annuity cap = 7.5% 28
Debit Call Spreads You can do the same thing the insurance company does. Some of your Principal Call Options Buy Call Options Sell Call Options The strike prices at which you buy and sell the options will depend on how much you want to risk. 29
Here s an Example- Assume: $100,000 portfolio 10% Risk $100,000 $90,000 $10,000 Equity Index Annuity Call Options Result of Trade: Approximately 80% Participation Rate of Index Approximately 8% Cap Rate (Maximum Return) Buy Call Options 10% Below Current Price Sell Call Options 10% Above Current Price -With the Maximizer, the client can choose to risk any amount on the purchase of call options. Having a said that the typical amount is 5-15% each year. 30
Let s look at a numerical example. Assume: $100,000 portfolio Risk 10% in options Annuity Cap 7.50% Market up 5%- Annuity Grows 5.00% or $4,500 Option Grows 4.00% or 4,000 Total Return 8,500 Percent Return 8.50% Market up 10%- Annuity Grows 7.50% or $6,750 Option Grows 8.0% or 8,000 Total Return 14,750 Percent Return 14.75% 31
Let s look at a numerical example. Assume: $100,000 portfolio Risk 10% in options Annuity Cap 7.50% Market up 20%- Annuity Grows 7.50% or $6,750 Option Grows 8.00% or 8,000 Total Return 14,750 Percent Return 14.75% Market down 5%- Annuity Stays Flat or $ 0 Option Loses 6.0% or -6,000 Total Loss -6,000 Percent Return -6.00% 32
A Few Examples Comparative Returns End of Projected S&P Maximizer Mutual Fund Year Performance Approach Matching Index 1 10.00% 115,200 110,000 2-4.00% 109,440 105,600 3 12.00% 126,075 118,272 4 7.00% 141,078 126,551 These are hypothetical 5 6.50% 156,667 134,777 returns for the S&P 6-18.50% 141,000 109,843 7 8.50% 500 160,740 Index over a 119,180 10 8-22.50% 144,666 year period. 92,364 9 7.50% 163,111 99,292 10 12.00% 187,904 111,207 Avg Return 1.85% Assumes 10% Risk Market Conditions as of 8/1/04 M/F Matches Index After Fees Start with $100,000 33
A Few Examples Comparative Returns End of Projected S&P Maximizer Mutual Fund Year Performance Approach Matching Index 1 10.00% 115,200 110,000 2-4.00% 109,440 105,600 3 12.00% 126,075 118,272 4 7.00% 141,078 126,551 5 6.50% 156,667 134,777 6-18.50% 141,000 109,843 7 8.50% 160,740 119,180 8-22.50% 144,666 92,364 9 7.50% 163,111 99,292 10 12.00% 187,904 111,207 Avg Return 1.85% Assumes 10% Risk Market Conditions as of 8/1/04 M/F Matches Index After Fees Start with $100,000 34
A Few Examples Comparative Returns End of Projected S&P Maximizer Mutual Fund Year Performance Approach Matching Index 1-15.00% 90,000 85,000 2-15.00% Start 81,000 off with three 72,250 3-20.00% very 72,900 bad years 57,800 4 9.00% 83,398 63,002 5 6.50% 92,613 67,097 6-5.00% 87,056 63,742 7 8.50% 99,244 69,160 8-18.00% 89,320 56,712 9 5.00% Market 96,912down 33% 59,547 10 11.00% 111,642 66,097 Avg Return -3.30% Assumes 10% Risk Market Conditions as of 8/1/04 M/F Matches Index After Fees Start with $100,000 35
A Few Examples Comparative Returns End of Projected S&P Maximizer Mutual Fund Year Performance Approach Matching Index 1-15.00% 90,000 85,000 2-15.00% 81,000 72,250 3-20.00% 72,900 57,800 4 9.00% 83,398 63,002 5 6.50% 92,613 67,097 6-5.00% 87,056 63,742 7 8.50% 99,244 69,160 8-18.00% 89,320 56,712 9 5.00% 96,912 59,547 10 11.00% 111,642 66,097 Avg Return -3.30% Assumes 10% Risk Market Conditions as of 8/1/04 M/F Matches Index After Fees Start with $100,000 36
A Few Examples Comparative Returns End of Projected S&P Maximizer Mutual Fund Year Performance Approach Matching Index 1 9.00% 114,400 109,000 2 7.50% 128,986 117,175 3-24.00% 116,087 89,053 4 8.00% 131,875 96,177 5 6.50% Market 146,448 averages 102,429 6 12.00% 168,708 5.4% a year. 114,720 7 8.50% 192,327 124,471 8 6.50% 213,579 132,562 9 9.00% 244,334 144,493 10 11.00% 281,473 160,387 Avg Return 5.40% Assumes 10% Risk Market Conditions as of 8/1/04 M/F Matches Index After Fees Start with $100,000 37
A Few Examples Comparative Returns End of Projected S&P Maximizer Mutual Fund Year Performance Approach Matching Index 1 9.00% 114,400 109,000 2 7.50% 128,986 117,175 3-24.00% 116,087 89,053 4 8.00% 131,875 96,177 5 6.50% 146,448 102,429 6 12.00% 168,708 114,720 7 8.50% 192,327 124,471 8 6.50% 213,579 132,562 9 9.00% 244,334 144,493 10 11.00% 281,473 160,387 Avg Return 5.40% Assumes 10% Risk Market Conditions as of 8/1/04 M/F Matches Index After Fees Start with $100,000 38
A Few Examples Comparative Returns End of Projected S&P Risk Averse Mutual Year Performance Approach Fund 1 20.00% 115,700 120,000 2 20.00% 133,865 144,000 3 20.00% 154,882 172,800 4 20.00% 179,198 207,360 5 20.00% 207,332 248,832 6 20.00% 239,883 298,598 7 20.00% 277,545 358,318 8 20.00% 321,120 429,982 9 20.00% 371,535 515,978 10 20.00% 429,866 619,174 Avg Return 20.00% Assumes 10% Risk Market Conditions as of 8/1/04 M/F Matches Index After Fees Start with $100,000 39
The Crossover Point Where is the crossover point with the Maximizer where the returns in the stock market will out perform the returns of the Maximizer? The answer is slightly higher than 15%. See the following chart which uses a nonreal world return of the same amount ever year (the Maximizer will significantly out perform the blow model if the client has a down year or two starting the ten year window). The following example assumes an initial amount invested of $100,000 (and does not take into account money management fees, capital gains taxes or dividend taxes). End of Year 1 2 3 4 5 6 7 8 9 10 Avg. Return Projected S&P Performance 15.00% 15.00% 15.00% 15.00% 15.00% 15.00% 15.00% 15.00% 15.00% 15.00% 15.00% Total Value 115,200 132,710 152,882 176,121 202,891 233,730 269,257 310,184 357,332 411,647 Mutual Fund Matching Index 115,000 132,250 152,088 174,901 201,136 231,306 266,002 305,902 351,788 404,556 40
How Fast Can You Recover From Down Years? If the market falls Traditional equities must go up RAAM approach the market only need go up* 20% 30% 40% 50% 25% 43% 66% 100% 6.5% 6.5% 6.5% 6.5% Actual Comparison * Assumes 10% risk factor 41
Summary- Reduce and control risk Increase Odds of Achieving Performance Goal Recover more quickly from down years 42
Overview for the Professional Designation: CWPP (Certified Wealth Preservation Planner) The Wealth Preservation Institute 378 River Run Dr. St. Joseph, MI 49085 269-408-1841 www.thewpi.org 43
What do Advisors want? To earn more money? To have more knowledge than other advisors? To provide better advice to clients on multiple topics? To be more credible than other advisors? A team of advisors for support and back office when dealing with advanced planning. The ability to market to CPA, Attorneys and physicians through continuing education credit. Are these of interest to you? If so you are a candidate to become an CAPP or CWPP 44
The WPI and CWPP /CAPP What is the Wealth Preservation Institute (WPI)? The only educational entity in the country devoted to provide education on advanced planning (asset protection, tax and estate planning) The only entity in the country focusing on topics that apply mainly to the high income/net worth client. Certifying entity for the CWPP designation. The CWPP course is a 24 hour certification program which can be taken all online or in person. The Certified Asset Protection Planner designation is for those simply want to deal with AP (18 hours). 45
Are you should learn Asset Protection Why learn asset protection? 99% of your current and future clients are not asset protected. Most clients with wealth, once made aware of this fact, will want help. Once you learn the topic you can help. You are not talking product with a client and therefore will not be seen as pitching product. Of all the topics you would deal with, asset protection is best client gathering tool. 46
Topics What topics are covered in the CWPP course? Asset protection (3 hours) -Domestic -Offshore Deferred Compensation (4 hours) -WealthBuilder Annuity; Traditional NQDC and the Leveraged Bonus Plan -Qualified plans/412(i) plans ( carve-out planning) -ESOPs -IRAs Business Planning (6 hours) -Account Receivables (A/R) Leveraging (done the right way) -VEBAs and 419A(f)(6) Plans -Section 79 Plans -Closely Held Insurance Companies -Corporate Structure 47
Continued Estate Planning (8 hours) -Basic - Advanced -Private Annuities Trusts (capital gains deferral) - Life Insurance -Qualified Pension Insurance Partnership (Mitigating the 75% Tax Trap) -Charitable planning -Long Term Care Insurance Personal Finance (4 hours) -Annuities -Life Settlements -1% CFA Mortgages (Equity Harvesting the right way) -Reverse Mortgages -Private Annuity Trust 48
Marketing The WPI helps is certified advisors market in several very unique ways. 1) The ability to become an instant author through a 340+ page ghost book. The WPI will allow CWPP advisors to give CPE continuing education courses on a local level to CPAs and accountants. Ability to give CME seminars to physicians. 49
Continued The WPI has a number of articles that CWPP advisors can use to place in local medical, accounting, legal and other business journals. The WPI also has dozens of PowerPoint presentations CWPP or CAPP advisors can use to present topics to either client or other advisors. (what a time saver). 50
Marketing continued Ghost Web-Site for those who want a web-site which tells your clients about your special knowledge. www.thewpi.org/template E-newsletters The WPI creates for you to send out to your clients. E-newsletter blasting system so you can drip on your client s with Educational newsletters. This system is setup to track who opens your newsletters and how many times they open them. Can you imagine calling a client and telling them that you noticed they opened the last e-newsletter 5 times and you wondered if you could answer any questions for them. 51
Should you become a CWPP? YES. IF you are looking to learn several new topics which: can help high income/net worth clients; can help position you as the client s trusted advisor and team leader; are very insurance and annuity friendly. If you are looking to become better educated on topics you currently deal with. If you would like keep updated on law changes, new concepts and have access to PowerPoint presentations, articles and the ability to have your own Ghost book and ghost web-site and e-mail 52 blasting system.
How to sign up. If you would like to sign up to become a CWPP and/or CAPP advisor, you can do so by clicking on the appropriate tabs on the left front bottom part of the web-site under Product Categories You can take the course entirely online or in person. You can get started with a $500 deposit which will get you access to over 640 pages of CWPP course material and the tests. 53
Questions Please contact The WPI at 269-408-1841 or e-mail at info@thewpi.org 54