Income Investing vs. Capital Appreciation Within Your IRA

One technique that some investors use to help identify the best investments for their situation is to identify particular assets as having either an income focus or a capital appreciation focus, and using that determination accordingly. Choosing between these possible investments will require planning and forethought on your part.

For example, within your taxable investment accounts you’re certain to consider large capitalization dividend paying stocks as an “income” investment, and small company speculative stocks that don’t pay a dividend as a “capital appreciation” investment.

So why exactly does this matter for your IRA?

Readily Available Living Expenses. Once you begin using your IRA to fund your retirement living expenses, having investments that generate periodic income can provide you with a greater measure of stability over capital appreciation investments. If your self-directed IRA generates a sufficiently high level of income (as might be the case with certain real estate investments or private company debt), then you may be able to fund your retirement solely with that income stream, and never have to worry about selling the underlying income generating investments.

Required Minimum Distributions. If your self-directed IRA is set up as a traditional IRA, then once you reach age 70½ you’ll need to begin taking required minimum distributions from your account. Depending on the nature of your investments, this could be a significant administrative (and potentially even financial) burden. For example, if your investment portfolio is comprised primarily of capital growth investments, you may have to liquidate some of these investments in order to meet your annual required minimum distribution obligations. On the other hand, if your investments generate a significant amount of periodic income then you may be able to meet all or a significant part of your RMD obligations without having to liquidate any investments. Of course, with a self-directed Roth IRA you would not be subject to the required minimum distribution rules.

Investment Liquidity. As you analyze the income versus capital appreciation aspects of the investments you hold within your self-directed IRA, you might also want to analyze the issue of investment liquidity. For example, while some investors may assume that income generating investments (including bonds and dividend paying stocks) are highly liquid, that’s not always the case. For example, some retirement savers use their self-directed IRAs to hold commercial and multifamily parcels of real estate primarily to generate a high level of current income, rather than any potential long-term capital gains.

By balancing your future liquidity needs along with the desired level of periodic income, you’ll be better able to identify the investments that should have a place in your self-directed IRA.

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Quest Trust Company helps change people’s lives and financial future through self-directed IRA investment education. Quest Trust Company helps people invest in what they know best and build their financial future on their own terms.