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PUTTING YOUR MONEY IN YOUR LIFE

Local investment may sound exotic, but opportunities for putting your savings to work in your community are becoming more common and more lucrative. At this point, most authors of investment books will spin stories that show their financial brilliance. Here’s how I transformed powdered moose antlers into a $100 million health-food empire! Instead, I will tell you an embarrassing story of my own short-sightedness that almost drove me into bankruptcy. If I knew then what I know now, I could have prevented more than a decade of serious financial struggle. My mistake, however, is now your opportunity.

One of my favorite Gary Larson cartoons is of a crisis clinic on fire, floating down a river, about to plunge over a waterfall. That’s what my life was like in 2008. That was the year I had decided to divorce, start paying child support for two young children, move into a new house, and take a new job. Then the financial crisis hit. My new job vanished, and opportunities for consulting work were drying up. Having been married to a talented law professor with an expertise in family law—please don’t laugh—I was struggling to keep up with punishing custody payments and lawyer bills.

The one financial bright spot was that my spouse had accumulated a significant pension, and we agreed, as part of our divorce settlement, that half would be transferred to me. Normally, you cannot touch tax-deferred funds like these until you retire, and if you do, you will be sacked by the Internal Revenue Service (IRS) with a 10 percent penalty. But when a court orders the redistribution of marital assets, you can use them immediately without penalty. Ordinary taxes are taken out of money you withdraw, and then the funds are yours. I decided to use the proceeds to pay off all my debts—credit cards, automobile, various personal loans. I thought it would be smart to begin my new life with a clean financial slate.

About a year later, as I was doing my taxes, I learned something the divorce attorneys never warned me about. The transfer of funds pushed me into a substantially higher income bracket, and the much-dreaded alternative minimum tax kicked in. Suddenly I owed Uncle Sam about $80,000. I paid off some of this debt with credit cards, and the rest went into an IRS payment plan. After paying over 20 percent interest and penalties for several years, my debt situation was far worse than it had been before I divorced!

I have since learned about an option that could have saved me all this grief. A Solo 401k is a retirement savings account designed for self-employed individuals, which is what I was in 2009. I could have transferred my former wife’s pension into that account and given myself a five-year, $50,000 loan to pay off all my debts. There would never have been an awful tax bill from the IRS. In fact, no taxes would have been taken out of the transfer at all, because I would have rolled it over directly into another tax-deferred account. And instead of paying over 20 percent interest to credit card companies for years, I could have paid my Solo 401k back at 5 percent interest over five years, and the literally tens of thousands of dollars of interest I had paid to Visa and Mastercard would have instead gone straight into my retirement account. Rather than being broke with massive debts in front of me, I would have paid everything off in five years and had a healthy nest egg for retirement. Smart local investing in myself would have paid huge dividends.

Okay, I was a fool. But then again, no one in my life—not my lawyers, not financial advisors I consulted, not my many Ivy League–educated friends—knew about the Solo 401k either. Neither did you, I bet. Live and learn. You, however, will never have to repeat this mistake. Because I’m now about to introduce you to the huge, unappreciated potential of DIY Accounts.

Right now, chances are good that your life savings are locked away in Individual Retirement Accounts (IRAs) and their workplace equivalents (401ks or 403bs). The government incentivizes you to maximize your retirement savings in these accounts by deferring taxes until you withdraw the money in retirement. Unfortunately, your investment options in these accounts are almost entirely global corporations. But with the Self-Directed IRA (which anyone can use) or the Solo 401k (which is designed for self-employed people), you can save for your retirement, defer your taxes, and invest locally.

Local investment means putting your money to work in your local businesses, your community, your neighbors, and even yourself. We can quibble about whether your community is your region, your town, or your neighborhood, but for the moment let’s underscore one basic truth: The closer to home you invest, the more benefits you are likely to enjoy and the more informed you will be about the risks.

Let me give you some hypothetical examples of what local investment looks like and how the Self-Directed IRA and Solo 401k can unlock its full potential.

• George is a forty-year-old software engineer who has steadily put away $5,000 per year in his IRA. He has accumulated about $80,000 and manages his investments online through TD Ameritrade. He worries that all his money is supporting Fortune 500 businesses he knows little about, and he now wants to put some of that money into his local food cooperative. The co-op, which has operated for twenty years, is building another store and is prepared to pay members 7 percent per year for loans above $1,000. George decides to set up a Self-Directed IRA through PENSCO Trust, one of several dozen companies that provide this tool, and directs his appointed representative, called his “custodian,” to lend the co-op $10,000. The note from his IRA is payable over five years, and every year the co-op pays $2,495 back into his IRA. The cost of setting this up? About $250 per year.
• Ashley is thirty and has a smaller IRA than George. She has a friend who is launching a nearby clothing business and is crowdfunding on the website Honeycomb Credit for the $250,000 she needs in start-up capital. Ashley also sets up a Self-Directed IRA, rolls over funds from her original IRA, and then directs her custodian to write a $2,000 check to Honeycomb Credit. She now is thrilled that she—along with 550 other people—has loaned her friend’s company the capital it needs to get going.
• Maureen, fifty, is excited about a new museum dedicated to local civil rights activism. Her city has issued municipal bonds to support the museum, but instead of selling the bonds through Wall Street investment banks, it is encouraging residents to buy the bonds directly. According to the mayor, “We are promoting local investment because it’s giving the city a new tool for underwriting municipal projects without raising taxes.” Maureen sets up a Self-Directed IRA, rolls over her savings, and buys $5,000 worth of bonds.
• Ken, thirty-eight and single, has been a self-employed musician. He barely has been making ends meet, but this past year, he recorded a single that’s getting wide play on YouTube and SiriusXM. Six months of wildly successful concerts have netted him $196,000, significantly more than he needs for expenses. He decides to set up a Solo 401k and place his maximum annual contribution, $56,000, into it. Instead of paying roughly $44,000 in taxes on $196,000 worth of income, he pays only $26,000 on $140,000.¹ Since it’s a Solo 401k, he doesn’t need to hire a custodian. Instead, he purchases a license to an agreement from the IRS called a “prototype” from a trust company and uses it to govern a new account he sets up in the name of his Solo 401k at his own bank. At a cost of about $300 per year, he can be his own custodian. A self-proclaimed “solar enthusiast,” he then invests in a half-dozen promising renewable energy projects around his city.
• Robin has worked for the Foreign Service all her life and has steadily built up a million dollars in her Thrift Savings Plan (TSP), the federal government’s equivalent of a 401k. Her investment options, when she was working for the federal government, were mostly global stocks and bonds. When she decides to retire at fifty-six, she sets up her own online knitting business. After she sells her first piece and reports that income on Schedule C of her taxes, she opens up a Solo 401k. She then directs her TSP representative to transfer the million dollars into her Solo account, and she begins to invest in affordable housing projects in her community.
• Robin’s neighbor, Gwen, came over for dinner and shared the awful news that she had breast cancer, had been slammed by huge medical bills, and recently had racked up $25,000 in credit card debt. She was practically in tears, not knowing how she would ever pay it back with annual interest rates over 20 percent. Robin said, “Look, I can help. Right now, I’ve got $25,000 in retirement savings sitting in my bank and earning about 2 percent interest per year. How about I pay off your credit card, and then you pay me back at 5 percent per year over the next five years? You can write me into your life insurance for collateral.” Robin uses her Solo 401k, enters into an agreement with Gwen on behalf of her account, and then cuts her the $25,000 check.

All these examples show how anyone can take money sitting in a tax-deferred account and use DIY Accounts to reinvest it locally. Investing locally, of course, doesn’t mean the investments will pay off as promised. With any investment, whether local or not, the people mentioned here—George, Ashley, Maureen, Ken, and Robin—could lose everything. But local investing gave these people an opportunity to put their money in people, projects, and businesses they really cared about. And it gave them the potential of generating higher returns with lower risks than the typical Wall Street stocks and bonds.