- In 1963, Studebaker – the once-thriving auto manufacturer – produced it’s last car before going out of business
- Before they went out of business, Studebaker was forced by the United Auto Worker’s Union to promise unrealistic pension benefits in lieu of higher pay, which Studebaker couldn’t afford
- When Studebaker went out of business, they raided the corporate pension fund, leaving their former employees without the pensions they’d been promised.
- Studebaker was just one of many companies – nearly all of them highly unionized – that went out of business and raided their corporate pensions in order to pay their debts. But it was Studebaker that got the attention of Congress…
- In 1974, Congress passed a collection of laws called the Employee Retirement Income Security Act (ERISA) which, among other things, created the IRA
- The purpose of the IRA was simple: To empower Americans to save for retirement in a tax-advantaged way without connecting those savings to employers, or to the risk of employer failure
- The law didn’t create “conventional” IRA’s and “self-directed IRA’s“… only the IRA. The distinction between conventional and self-directed is entirely a function of the policies of each individual IRA custodian
Classic American cars… Corrupt Labor Unions… pension raids… and even the implosion of an iconic American company! Get ready to learn why IRA’s were created originally, and how that knowledge can help you avoid the IRA cataclysm known as the prohibited transaction. This is Episode #6 of Self-Directed Investor Talk.
My friends, today you get a history lesson that reads like the script to a great movie. You see, the venerable financial tool known as the IRA – including the self-directed variety – was created to serve a very specific need, in response to a very specific chain of events. Your understanding that chains of events and the motivation it created in Congress can help you to keep your self-directed IRA in the good graces of the IRS, and that’s what we’re going to dive into today.
(Today’s show is Episode #6 – a freshly updated edition of episode #6, no less – and you can find today’s show page… which is rather fascinating and feature-packed, if I do say so myself – at SelfDirected.org/6, SelfDirected.org/6.)
I wonder, my friends, if several decades ago when the very last Studebaker car rolled off of the production line, if everybody working there that day knew that the company that employed them was imploding, and would never recover?
The year was 1963 and Studebaker was at the end of the line for existing as a car company. It’s unfortunate, too… they made cars that had a reputation for excellence, but what they didn’t have was strong, competent leadership… and the failure of Studebaker paved the way for you and me to have Self-Directed IRA’s in the present day.
Here’s what you need to know:
In 1974 a law was passed called the Employee Retirement Income Security Act, or ERISA for short. The package of laws including ERISA that passed in 1974 created, among other things, the venerable tool now known as the IRA.
When Studebaker went out of business, they did something that was increasingly common in those days: They raided their corporate pension to get money to pay their debts.
What that meant was that their tens of thousands of employees who were expecting to receive that money for retirement were left out in the cold.
Now it’s really tempting to me to delve into the details here about what happened with Studebaker, in large part because the story makes it so clear why labor unions in general and the United Auto Workers union in particular are, in my humble but entirely correct opinion, one of the great cancers of American economic history. But I’ll save that awesome story for now, and if you want to hear it, check out the video I’ve posted on today’s show page at SelfDirected.org/6 that tells is quite succinctly.
Now Studebaker wasn’t the first or the last big company to go bankrupt and promptly raid the pensions of their employees. But that was like the straw that broke the camel’s back and forced the hand of Congress to do something about it.
The laws that passed as a result were rather substantial and sweeping, but for our purposes, the biggest result is that a new form of financial account called the “individual retirement account” was created, which provided a way for Americans to save for their retirement in an account that was in no way connected to the fortunes of their employers. If they had an employer that went bankrupt, that employer couldn’t get anywhere near the employee’s IRA. That’s what the “I” stands for… INDIVIDUAL.
Now it’s my humble, but again entirely correct opinion that Congress rarely really understands the motivation or plight of normal American citizens, but they did get at least one thing right with IRA’s: They knew that just an account alone wouldn’t be very enticing for anyone, and what they wanted was for people to save for their own retirements, because even back in 1974, the writing was on the wall for Social Security, and good ole Uncle Sam wanted to do all he could to offload the obligation to actually pay out on that obligation. Thus, there was a great need to make it ATTRACTIVE for Americans to actually put money into their IRA’s.
So what motivation did Congress include? Tax benefits. STRONG tax benefits.
The tradeoff they offered was this: If you put money into your IRA, you can’t touch that money personally in any way until you retire. But between now and then, you get MASSIVE tax benefits… you can deduct money you deposit, and you can roll over profits into additional investments without paying taxes. In fact, you won’t pay taxes at all until retirement.
It was an incredible deal… the tax incentives were very, very strong.
And remember: at the end of the day, Congress’ incentive was to motivate Americans to save and invest for RETIREMENT so that Uncle Sam would have less to pay for Social Security and other benefits in the future when those Americans began retiring. It was not an act of generosity by the government. It was totally self-serving on their part, albeit with benefits for you and me.
And this brings us to the question of prohibited transactions. Remember: Prohibited transactions are those awful things you must NEVER do with your IRA – things like buying from or selling to your IRA, borrowing from your IRA, or even using your IRA to do business with people related to you. We went much deeper into prohibited transactions in a previous episode of this show, and the link for that – including a free ebook download – is available to you on today’s show page at SelfDirected.org/6.
So how does all of this relate to prohibited transactions?
At a core, fundamental level, it’s like this:
The “spirit” of the law where IRA’s are concerned is that you get ASTOUNDING tax benefits… I mean, really great benefits. But the tradeoff is that you must get ZERO benefit from that money until you withdraw it from the IRA during retirement. I mean, ZERO. And to the IRS, if people related to you get some benefit from your IRA, or even if businesses or organizations you own or influence get some benefit from your IRA, then the IRS sees that as an indirect benefit for you, too… and that’s the essence of a prohibited transaction.
Look, we all like to pile onto the IRS, I get it. But here’s the reality: The tax benefits you can get from an IRA can be TREMENDOUS in the here-and-now. For you to try to rig the system so you can use your IRA to benefit yourself or your family BEFORE retirement… well… that’s not in keeping with the spirit of why IRA’s exist, and that IRS really isn’t very flexible when it comes to addressing those violations.
And I hate to say it… but I don’t blame them.
So that’s all I’ve got for you today, my friends. Check out today’s show notes page at SelfDirected.org/6 and you’ll find some great stuff, including links to an article in the Wall Street Journal that gives some more background on the whole Studebaker situation, and a video that I did that expounds on the topic in a more visual way. I think you’ll really like it.
And hey, I’ve got a question for you to ponder: Have you ever stopped to consider whether a transaction you’re contemplating in your IRA is in keeping with the spirit of the law that created the IRA’s originally? Let me know what you think in the discussion area of today’s show page at SelfDirected.org/6.
And my friends… invest wisely today and live well forever!
Links & Resources
- The text of the law known as the Employee Retirement Income Security Act is here
- Wall Street Journal article explaining history of the pension mess, including Studebaker, is here
- Video explaining how Self-Directed IRA’s were created:
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