In my adventures in the financial services industry over a twenty five year period, I have had the opportunity to meet and befriend some of the best salesmen in the life insurance industry. These professionals could not only “sell ice to the Eskimos” but come up with variations of the process of reinventing ice. In the course of time, one of my favorite and most respected life insurance colleagues, surfaced a number of planning scenarios involving large traditional and Roth IRAs. His IRA example involved a prospect with $600 million in a traditional IRA. Most of us were astounded by Mitt Romney’s $100 million Roth IRA. How did that happen? As Senator Romney positions himself for another potential run for the White House, the next question is how large is that Roth IRA now? I doubt that he has distributed ten cents from it.
These examples are impressive but the far outlier of the typical Roth IRA. The problem with IRAs for rich taxpayers is that it is hard to get enough money into them from a contribution standpoint along with the requirement of making cash contributions exclusively. For extra measure, the IRS layers on complex prohibited transaction rules and investment restrictions. What is Richie Rich to do?
This article focused on the use of a Malta Pension Plan as a Roth-like account on steroids. The article will focus on the advantages of the Malta Pension Plan over the Roth IRA. Yes, I know the title of the article is vulgar, but if you have gotten this far in the article, and the title did not stop you from reading up to this point, read further. My apologies but keep reading!
The Checkbook Roth IRA
The state of the art in self-directed IRAs is the so-called Checkbook IRA. The Checkbook IRA is a self-directed account that allows the taxpayer to transfer of funds to a passive custodian for a self-directed account. The custodian invests those funds into a new limited liability company (LLC) that is wholly owned by the IRA. The passive IRA custodian allows the taxpayer or a third party to act as manager of the LLC. The taxpayer as the manager of the LLC has the ability to manage and control the Checkbook for the LLC to make non-traditional investments into real estate, precious metals, tax liens and private businesses. All of the income flows through the LLC to the custodial account of the Roth IRA.
The Roth IRA has several key distinctions from the Malta Pension Plan. Unlike the traditional IRA, Roth IRA does not have a maximum age for contributions. The contribution limit in 2019 is $6,000. If the taxpayer is age 50 or older, the limit is $7,000. Contributions are limited to cash contributions. The ability to contribute to the Roth IRA reduces as modified adjusted gross income for joint filers exceeds $193,000. The Roth IRA does not require minimum distributions at age 70 ½.
Qualified tax-free distributions from a Roth IRA receive tax-free treatment. Distributions may be taken tax-free at age 59 1/2 or a distribution taken on account of a disability or death. A special distribution limited to $10,000 is available for a first time home buyer. However, Roth IRAs require a five year waiting period before distributions can be taken.
One of the major limitations of the Roth IRA is the limitations related to unrelated business taxable income (UBTI). UBTI is defined in IRC Sec. 512. as income from a “trade or business” that is regularly carried on by the tax-exempt organization, but which is not substantially related to the exempt organization’s exempt purpose or function. It also applies to pension plans and IRAs. Congress instituted this tax to prevent tax-exempt organizations from having an unfair advantage over taxable organizations.
UBTI is a concern to pension plans and IRAs because it converts income that would otherwise be treated as tax-exempt income into taxable income. UBTI includes income from debt-financed property using loans. It also includes the income from an investment into a private business. The net UBTI income will be taxed as UBTI at the trust tax rate because an IRA is considered a trust for tax purposes and not a corporation.
The top marginal tax bracket for trusts for federal tax purposes is 37 percent which is applicable at $12,750 of trust income. If you aren't already beginning to think twice, add another layer of taxation for state tax purposes. Pretty soon, you can have an unintended result.
When debt is used by an IRA or pension plan, tax is applied to that portion of the gain that is debt-financed. Any property held to produce income is debt-financed property if at any time during the tax year there was acquisition indebtedness outstanding for the property. When any property held for the production of income by an IRA is disposed of at a gain during the tax year, and there was acquisition indebtedness outstanding for that property at any time during the 12-month period before the date of disposition, the property is debt-financed property.
Many taxpayers have significant traditional IRAs due to rollovers from qualified retirement plans in their business. Since 2010, the modified adjusted gross income rules were eliminating allowing taxpayers to convert traditional IRAs into Roth IRAs. The distribution of the traditional IRA would be fully taxable subject to full taxation and the ten percent early withdrawal penalty if applicable for a taxpayer under age 59 ½.
Size Matters! – The Distinctions and Advantages of the Malta Pension Plan
The Plan is a more robust solution that the Roth IRA for high net worth taxpayers for the following reasons:
Unlimited Tax Deferral. Like the Roth IRA, the Malta Pension Plan has no limit on tax deferral. Appreciated assets may be contributed and sold without gain and reinvested on a tax deferred basis.
Unlimited Contributions. Unlike the Roth IRA, the taxpayer is able to make an unlimited contribution to the Malta Pension Plan.
Non-Cash Contributions. Unlike the Roth IRA who is limited to small cash contributions, the taxpayer may make in kind contributions to the Plan through the contribution of the asset or an interest in an entity holding the asset.
No UBTI Tax Treatment. Unlike the Roth IRA, the Malta Pension Plan is no subject to UBTI. The absence of UBTI creates an opportunity for investments in debt-financed real estate and operating businesses.
No Required Minimum Distributions. Like the Roth IRA but unlike a traditional IRA, the Malta Pension Plan is not subject to required minimum distributions at age 70 ½.
Tax-Free Distributions. Like the Roth IRA, the Malta Pension Plan provides substantial tax-free income. Malta law permits distributions to be made from such plans as early as age 50.The rules allow an initial lump sum payment of up to 30% of the value of the member’s pension fund to be made free of taxation. Additional tax-free distributions may be taken at age 54 and every year thereafter up to 50% of the account value. Distributions from a traditional IRA are fully taxable as ordinary income.
The Malta Pension Plan by definition has greater benefits than the Roth IRA does for high net worth taxpayers. The Plan has no contribution limits. The Plan is not limited to cash contributions.
Like the Roth IRA, it is a powerful vehicle designed to provide for substantial tax deferral in a manner similar to the Roth IRA. The Plan has a greater advantage with respect to real estate investment due to the ability to use debt-financing without subjecting the plan to the UBTI rules. The taxpayer may contribute real estate assets with existing debt. The Plan may invest in operating businesses without UBTI.
At distribution a substantial portion of the deferred income may be distributed without taxation in Malta or the United States. Taxpayers looking for a long-term tax deferral without contribution limitations and complicated tax hurdles such as UBTI, should consider the Plan as a planning structure for real estate investments.
Malta is a member of the European Union with significant regulation and compliance requirements and not in the Wild West. Taxpayers can expect we professional administration and operationss while providing significant tax benefits not available in the Roth or traditional IRA. What are waiting for?