Hello MFOers –
I’ve been following the MFO for a little over a year now, and have enjoyed and appreciated the wisdom and advice posted by members.
I’m posting to seek advice on the best course of action for converting a sum of about $50K I have in a past employer’s ESOP. This amount is outside of my main 401K I have with current employer, and my intention is to use it in a more aggressive manner. Below I’ve outlined a couple of scenarios that I’d like to steer this 50K amount into. The main point of the question for each scenario is - what is best account type to convert this to, and what are the potential tax benefits/penalties that I should be aware of.
Scenario 1:
Convert the ESOP to an IRA with brokerage account. This account would be much more active than my current employer 401K account, in that I’d be using up to 50% of the balance toward pure stocks, with the other 50% being spread over cash and mutual funds to steady the tides.
My questions about this scenario are less about the fund/stock selection strategy and more about the best method of moving from the ESOP to a brokerage account where I have more flexibility in fund/stock choices (as an aside, I do have an old 401K with Fidelity kicking around from a past employer, with about 5K which I was thinking may be a candidate to convert to a brokerage account, in conjunction with the 50K from the ESOP). Under this scenario, this account would become my ‘Super’ IRA, into which I would roll small employer 401Ks and 403Bs from past stints of employment.
Scenario 2:
I have been toying with the idea of investing in commercial real estate, using the 50K (reduced after taxes I expect) as a starting point to get a small commercial apartment complex. One of the main ideas here is to generate high cash flow for investing. I’m in the very early stages of researching this, and would probably not pull the trigger for at least another 2 years, realizing that I’ll need to raise more $ to kick off this plan. I would like to have that 50K invested in such a way that it could be made liquid on short notice with minimal tax penalties at the time of withdrawal. I think the ideal would be that I could be growing that 50K in a brokerage account… but am unsure of the implications of converting that 50K to a tax-sheltered IRA set up or a straight-up brokerage account that may be taxable. It may be that I don’t end up following through with the real estate investment idea, so I would like the 50K to be resting in a place where I could take advantage of brokerage services. If it ends up becoming a brokerage account, I don’t foresee becoming an active day-trader, but would be more aligned to the buy and hold strategy of stocks and funds as outlined in Scenario 1, with trimming happening when there are high upsides, etc.
To give you some context for my situation - I am 40 years old, 8 years into owning a home, and have 2 children, ages 8 and 13. Starting in March 2013, I’ll be eligible to move money from the ESOP – not before then. I feel it’s important to move this money as soon as possible as I’m not confident in the company’s outlook, as it is heavily reliant on government agencies purchasing their materials, and the inside rumors are that a lay-off may be immanent in the next year.
Any advice, criticisms, and/or insults will be considered.
Thanks in advance,
~Chris
Comments
If you cost basis is low for your ESOP shares compared to the current price, there might be tax benefits to not rolling it over and taking it out of the tax sheltered account. I don't remember the finer details, but you could pay ordinary income taxes on just the purchase cost of the shares and then long-term cap gains on the balance when you sell. My memory is really hazy here so please do your own research.
For Scenario 2, another option to consider is rolling the ESOP into a self-directed IRA which would allow you to keep the tax deferred status and still invest in commercial real-estate. You wouldn't have to pay taxes now which will help build up your down payment for the property.
But be aware of the time and energy you are going to need to commit in this sort of thing. Even with only four units, it required large amounts of time and energy from all four of us, frequently spending our weekends and evenings doing some very unpleasant chores.
My friend and I were pretty handy with respect to repair work, painting, and general maintenance. But you cannot believe the mess that seemingly normal people will leave behind when they move. And a cleaning deposit doesn't even begin to cover it. Despite a "no pets" restriction, people did in fact manage to keep pets of varying size, shape, and disposition. One otherwise reasonable tenant managed to leave behind large carpets which were totally saturated with cat "stuff". Prying that from the hardwood floors, and then refinishing those floors was a real treat.
You can bank on repainting at the very least,and our experience suggests that you should also be prepared to patch various and sundry holes in sheetrock, which seemingly occur for no apparent reason.
Then there were various financial counseling sessions, explaining that the unexpected departure of a roommate does not constitute a valid reason for missing rent payments. And other counseling sessions with tenants explaining that we really couldn't do much about the baby crying in the apartment below, all the while pretending not to see the "illegal" (but quiet) dog (that none of the other tenants had complained about) hiding in the kitchen.
And all of this was with tenants who had been pretty well screened and came with decent references.
In short, be prepared to spend a significant part of your life picking up after others, and sorting things out between them. Never again. It's like having eight or ten large unruly children. Good luck on that!
@Joe - Thanks for insights into your past experience in the rental real estate biz. The issues you mentioned are ones that give me pause when considering this route, however I'd like to believe that given the right situation, strategy and planning, that some of those issues could be mitigated, or kept to a minimum at least . I think it really boils down to the amount of cashflow that can be generated, versus investment $s and + time/effort involved to see if it's worth it.... as well as the opportunity cost of other investments that may be lost. I'm definitely going to do my due diligence in researching this before jumping in.
One of my other troubles is that I often look at my corporate cubical existence and often fantasize about walking in another set of shoes. Heck, I just replaced the kitchen sink in my house last weekend, and found it quite enjoyable. Build up to a few apartment complexes and maybe I can dump that corporate job route...Although I may be singing another tune when it comes to fixing ten sinks within a few weeks of one another. Anyway, I'll dream on this awhile and see what comes of it.
http://www.buyandhold.com/bh/en/retirement/qa/rollover_ira.html
But the short answer is yes, a rollover IRA is designated for funds that originate from an employer's retirement plan.
The self-directed thing is a type of account that your IRA is held in. Not all brokerages will administer self-directed accounts because it can be tricky to track and manage the assets; there's lots of room to do shady things.
Now, if you later want to implement #2 you will have to withdraw funds from this IRA. This will cause you to pay taxes at that time and since you are younger than 591/2 you will pay penalty as well. This might be the same for your current ESOP too. If you liquidate the ESOP, you will end up with taxes and possibly fines.
BTW, how is your stock selection skills. As a stock investor you said you would be much more active. You will be competing with other traders including institutional accounts, hedge funds, mutual funds etc. You are possibly buying and selling your shares with these guys. They do this for a living. How do you think you will have above average skills?
As for my stock selection skills - I'm not going to claim that I'm an expert by any means. From a formal education standpoint, I've recently received an MBA, and during the process have learned various methods for valuating stocks. That said, I dont feel that day trading is a game worth playing. My approach would be to hone in on sectors that I happen to indepently reasearch for personal interest and may associate with through my work as an SQA Analyst - technology being my main focus. I'd be using a buy-and-hold-long-term approach. Since I haven't used a self directed IRA account nor a brokerage account before, I guess my question really boils down to whether or not all brokerage accounts/self IRA accounts give you access to all stocks listed on the NYSE or NASDAQ, or do some services limit your orders to only certain types of stocks?
'Much more active' in my case means not just doing the auto-scheduled monthly contribution in my employer sponsored 401k, but being able to have more fund choices along with being able to develop some more concentrated holdings in select stocks. This account would definitely rate as being much higher risk than the main 401k I have with my employer.
This link is for Fidelity's brokerage portion which can be set in place when opening an acct.; and with your possible choice of a rollover IRA. This page is a general FAQ, but do review the link at the left page edge for "investment choices", which will note the various choices with the brokerage.
Fidelity brokerage
We have been with Fidelity since the late 70's. The account site is very friendly and provides lots of info; including many investment tools.
Regards,
Catch