How to Make the Most of Your Self-Directed IRA
Preparing for retirement is one of the most important things that anyone can do financially in their life. It requires a lot of planning and time to put together an account in just the right way so you can retire and maintain the level of comfort you have become used to during your working life.
What is an IRA?
An IRA (Independent Retirement Account) is a retirement account you set up for yourself that you contribute to every year. It is completely separate from any other types of retirement accounts you might have and is completely controlled by you. This means it is a separate account from any retirement pension or a 401K from you might have from your employer. It can be established through financial institutions such as banks, brokerage, or investment institutions where it will be managed and monitored by an agent who will consult with you yearly about how you want your account to grow. They will also update you if any important things are happening in the financial world that would affect the state of your account.
What are the different types of IRAs?
There are different kinds of retirement accounts that can be opened on your own or as an employee through your employer. Most types of IRAs are opened and managed by a person outside their own work though there are a couple that is opened by the employer themselves.
A traditional IRA is established by the average individual as their own retirement plan. This type of IRA is held by a bank or brokerage that allows for you to have your money invested for you by a representative on the bank or brokerages behalf. Any interest, dividends or other types of monetary gains are not taxed while they are in the account. They will be taxed once you are eligible to withdraw from the account starting when you reach the age of 59 ?.
The Roth IRA is almost the same as a traditional IRA except by how the money is taxed. In the Traditional IRA, the money is taxed as you withdraw it after retirement. In the Roth IRA, the money is taxed as it goes into the account. This means that any money that is contributed is not tax-deductible and is taken only from the income that has been earned and already taxed. Once you start to withdraw the money, it is completely tax-free.
A simple IRA is one in which the employer is the one that provides the account. The money that is put into the account is done with pre-taxed money from your salary. This type of plan is similar to the 401(k), profit-sharing plan and the 403(b) plan. They are also set up by the employer using employer and employee funds that get contributed to the account and an equal rate or one that is 1/3 the amount the employee contributes. In the simple plan, the amount that is allowed to be contributed to it lower than the more traditional employer-employee retirement plans.
The SEP IRA (Simplified Employee Pension IRA) is one designed for the small business owner or the sole business proprietor. It is another IRA that gets sponsored by the employer for their employees. This is perfect for the employer who has few employees or doesnt have any employees. This plan gets all employees the same level of benefit as all the funds will be invested in the same way as other IRAs.
The education IRA is not a real IRA as it is a type of trust that is managed by a bank or financial institution to be used to help pay for higher-education schooling expenses that have been set by the primary account holder. This type of IRA can only accept cash payments and cannot receive more money after the person it is designated for turns 18. It is also restricted from contributions over $500 in one calendar year.
What is a Self-Directed IRA?
A self-directed IRA is one in which you as the investor make all the decisions for how our money is invested. It provides opportunities for the investor to place their money into more pieces of the market. The asset diversification extends beyond the traditional stock market into real estate and private securities. This is all controlled by an account administrator or trustee. These are typically only opened by brokers.
What can I invest in?
This type of account does have an administrator and these administrators let the people wanting to invest in a self-directed IRAs invest in almost anything that can be invested in. The main purpose of the administrator is to help the owner stay within compliance with the IRS tax regulations, but there is little the owner of one of these accounts cannot invest in.
Real Estate: Investing in Real estate is one of the best things about this type of account because of the potential tax benefits in the investment. It can act like a traditional or Roth IRA in how it is set up to handle the taxes. They can be withdrawn once the initial investment is made or only when you start drawing on the funds. Investors in real estate through their IRA still hold the option of buying and selling properties even if they are within the type of portfolio. It just requires the funds entering the account to be rebalanced into other securities.
Businesses: You are allowed to invest into businesses like partnerships and joint ventures through your IRA though this is more difficult. Certain restrictions are placed on the businesses you might want to invest in and you will need to evaluate the potential company and talk with an advisor to find out if you will be exposed to an Unrelated Business Income Taxes (UBIT). This can be applied when you are trading or engaging in business transactions with the company regularly. This can open you up to having to pay this business tax because tax-exempt entities are not allowed to benefit in favor of the tax-pay entities. The benefit of this type of investment is if you are able to sell the investment at a higher rate than which you invested in it though that depends on the companys performance over the years and your own personal choices.
Private lending: investing your money into private lending is done when you purchase a promissory note, secured or unsecured through your IRA. The secured note is less of a risk than the unsecured because it is backed by some type of collateral just in case a default occurs. You can also invest your money into a company through their promissory note. This turns a portion of your IRA into its own mini bank as the note is paid back over installments along with the interest the note is accruing.
Cryptocurrencies: Investing in Cryptocurrencies is completely speculative as this type of investment is not that old and has not had time to mature into a fund that is backed up with the years of investment performance. It is currently a way of investing in a system of digital money that can be exchanged for goods and services. There are different types of currencies that purchase different types of securities and options. They do not all purchase the same types of things or services and what one currency can do another maybe cannot do. They are different in how the money linked together to prove the validity of the funds.
Intellectual property: The rights to intellectual property belong to the company or person who owns them, to buy the rights of the intellectual property requires the purchase of the license or the patent from the company or the person who owns it. This means it is registered and trademarked to the person who holds it until it transfers to you the buyer. This means it is regulated by PFIC and CFC regulations that protect the rights of the holder of the patent. Some of this is taxed and other parts of tax-deferred. It also matters whether or not you are buying the intellectual property from a U.S. Citizen or non-U.S. Citizen on how your taxes will be applied. It also depends on the type of patent it is and where it came from.
Hedge funds: Investing in a hedge fund through a self-directed IRA is reserved for only certain types of people or entities using a self-directed IRA to purchase securities. The hedge fund is structured like a limited partnership with the fees associated with a hedge fund allowing for the management to take 2 percent of the fees and 20 percent of the profits generated by the fund after all parties receive the money they have invested back plus their portion of the accrued interest. Funds cannot be invested into a GP entity and there are restrictions on how and what kind of fund can be used for investment into the fund. The IRS does look closely at how the money is invested and returned to the investor when what is being purchased in a hedge fund. A lot of what they look at is the percentage of ownership the fund gives to the Self-invested IRA owner. If it is less than 50 percent, but you own part of the company out right there may be problems as to how much you are earning as a shareholder, as well as a piece in a self-directed IRA.
Private Equity: Investing in private equity is risky when done through an IRA. It does offer more risk, but there are more rewards if it is done right and if other investments in the portfolio are more conservative. Investing in private equity that has greater liquidity and a larger time frame until retirement can pay off with a larger end return. Having a larger window until retirement offsets some of the weaknesses that come with such a risk and allows for the investor to balance the rest of their account to adjust to a more extended timeline. There are also costs are prohibitive for some investors. It is recommended that the private investor be a qualified purchaser (QP) for the financial institution. This means that they have at least $5 million in assets that can be invested in.
Tax Lien Certificates is a relatively safe investment for a retirement portfolio. When you are buying a tax lien you are buying up the delinquency certificate of a property that has not paid on their taxes. Buying a lien is similar to buying a piece of property except for the person that owns the property has a limited time to pay back the money they owe. By buying their debt you are buying the piece of property should it never be paid on. Investing in tax liens are tax-deferred but your administrator still needs to know about it so that when you do start drawing from the account, the tax will be calculated correctly.
Livestock: You can invest in any type of livestock, but cattle are the most common. Your investment is the price you pay for the purchase of the livestock and your profit from the sale of the livestock which is added to your portfolio. You can invest in two different types of securities when purchasing livestock, livestock weight, and capital gains. Livestock can be sold directly through auctions, to a slaughterhouse or to the average person. The type of animal and the breed of the animal determine the profitability of the purchase and the sale.
What can I not invest in?
A Self-directed IRA account has few restrictions on what can be invested in, but it is very clear on what cannot be invested in.
Life Insurance contracts: This restriction includes whole life, term, and other types of variable policies. The purpose of this type of an account is to be part of a retirement account it is restricted from purchase as a life insurance policy is something purchased a plan in case of your death.
Collectibles: Not allowing for collectibles is to prevent people from trying to avoid taxes by placing them in an IRA and selling them before they can be taxed. This can include figurines, rugs, and certain types of coins.
Certain types of precious metals: This one is designed to prevent most types of coins, gold in particular, from avoiding taxes. There are exceptions to this such as the American eagle coins (proof & non-proof), American Silver Eagle (proof and non-proof), American Gold Buffalo Coins (non-Proof), Australian Gold Philharmonics coins, and the Canadian Maple Leaf Coins. Some coins are allowed as long as they are not collectors items and have a high mineral content.
Because of the nature of this account, most other things that are prohibited constitute investments that could be considered conflicts of interest or unfair gains; an example of this s using funds from your own Self-Directed IRA to buy an entity share that is held by your own father.
If you know someone who has been disqualified and have you try to have transactions with them then you could be disqualified. This can also include suspicious transactions. When you open an account, many organizations will provide you with a list of companies and people you are not allowed to transact business with. Anyone in your family can be considered disqualified if you have been disqualified just to prevent the disqualified funds from being transferred to persons within your family.
Self-Directed IRA vs. Other Retirement Accounts
The structure of this account is very similar to that of a traditional IRA or a Roth IRA. The main difference between them is the range in which the person can invest and where they are able to do the investing. A lot of what they are able t invest in is outside the normal areas of the more normal IRAs. They are also not found at the traditional brokerage. The wide range of investment opportunities places these into the hands of special companies that are willing to manage more complex accounts and investments. There are often constraints placed on this type of account because of the wide diversification of the funds. The way it is taxed for pieces going into or out of the account varies on the type of security the holder of the account wants to invest in.
What are the Rules and Regulations for Self-Directed IRAs?
Many of the rules that are placed on this type of account involve preventing the owner or someone connected to the account from personally benefiting from the account that goes outside tax laws. There are things that can disqualify a person or anyone connected to the account from being able to use the account for its intended purpose of retirement savings. There are lists of actions that are prohibited from occurring on this type of an account that will end your ability to own and control it.
Self-Directed IRA vs. The Stock Market
There are several benefits to investing in a self-directed IRA rather than just the stock market. These benefits are:
1. A self-directed IRA is a more stable investment tool than investing in just the stock market. It allows the investor to put money into securities that are not available for investment through the stock market. It also allows for a very well balanced portfolio that will withstand the ups and downs of the market, the economy, and the general movements of the United States.
2. Another benefit of investing in a self-directed IRA over the stock market has to do with the taxes associated with it. If you are aiming for long term growth than getting an account like a self-directed IRA can help minimize them through its tax-free or tax-deferred options. It means a more complex assignment for anyone handling your accounts and those people that are responsible for handling your portion of the taxes, but its still a stable investment.
3. If you are investing in real estate through buying or selling you are protected from capital tax gains. This makes your investment more tax-free or at least tax reduced.
4. The portfolio you build will be as well balanced as possible so if the stock market goes down, you will have the additional security of your alternative investments. This means you will have financial security for your long term plans because no matter what happens, your portfolio is designed to balance itself.
2019 SDIR Contributions
With the New Year came a new contribution maximum and a deadline. The new contribution amounts are $6,000 for anyone under the age of 50 and $7,000 for anyone over the age of 50. There was also a deadline placed on it for the 2019 contribution year and that coincided with the submission of the U.S. American income tax returns on April 15, 2019. It is relatively easy to contribute if you already have your account set up. Setting it up yourself and working with a company that has the options for distributing your funds as you would like.
All IRAs require a certain distance between yourself and the account while it matures throughout the years. This is the same for the Self-Directed IRA account. There are some differences in the amount of control you are allowed because of the types of investment in the account, but the restrictions on the types and times of access are still there for you and any of your family. This means it is still subject to the restrictions of the regular IRAs which prevent you from accessing any of the funds until you have reached the age of 59 ?.
Opening a self-directed IRA is a good way to invest your money. It is a secure way to balance a retirement portfolio that will be strong no matter what is going on in the world. Your portfolio will grow fast over time and with your account well balance between all your investments. The benefits of this type of an account are many, though if you are disqualified you will end up losing it all with no chance of getting it back.