Top Tax Benefits of a Self-Directed IRA

The IRA is perhaps the most powerful retirement savings vehicle that most of us can count on having available to us each and every year during our working years. (It’s true that 401(k) plans can sometimes offer additional benefits over an IRA, but those plans are often not offered by each and every employer that we’ll work for throughout the course of our careers.) Much of the value of an IRA comes from the various tax benefits that are afforded to the account, whether that IRA is structured as a traditional or Roth IRA, and even if it’s a self-directed IRA (which can be set up as either a traditional or Roth IRA).

Provided that you’re not covered by a retirement plan at work, you’ll be able to deduct the full amount of your annual contributions to your traditional IRA from your taxable income. For 2012, the maximum contribution is $5,000 (or $6,000 if the account holder is age 50 or older). If you are covered by an employer-sponsored retirement plan (such as a 401(k) plan), then you’ll be able to deduce the full amount of your contribution if your modified adjusted gross income is less than $56,000. If your income is between $56,000 and $66,000 then you’ll be subject to a “phase out” and only be able to deduct a lesser amount. Above a modified adjusted gross income of $66,000, contributions to an IRA won’t be deductible.

Note that the income phase out range in the prior paragraph applies to individuals who file single or married filing separately tax returns. If the IRA holder has a different tax filing status such as married filing jointly, married filing jointly (with your spouse being covered by an employee-sponsored retirement plan, but you not being covered), or married filing separately, then the thresholds identified above will be different.

Having your annual contributions reduce your taxable income each year is like getting a significant but immediate return on your money. If you contribute the maximum amount to your IRA each and every year, the tax savings over your lifetime can be significant.

If your IRA is a Roth IRA, then you won’t be able to deduct the amount of the contributions you make into the account. But the earnings you generate in the account (which, assuming you maintain your account for many years, will represent a much greater portion of your account compared to the contributions) can be withdrawn on a completely tax-free basis once you reach retirement age. This is the main advantage that Roth IRAs have over traditional IRAs.

Furthermore, if you open a self-directed IRA with a custodian such as Quest Trust Company, then not only will you be able to take advantage of these tax benefits, but you’ll also be able to invest in far more investment types than you could with an IRA that you open with a more limiting custodian such as your local bank or credit union, or your investment broker. Funds in a self-directed IRA can be used to invest in real estate, private equity, and even certain types of precious metal investments.

A self-directed IRA can therefore give you the highest degree of investment flexibility, while at the same time being able to utilize the maximum tax benefits available.