IRAs are a powerful way to save for retirement. Self-directed IRAs have even more potential to help individuals save for retirement compared to IRAs with traditional custodians because custodians such as Quest Trust Company allow individuals to invest in a wider range of assets. The basic structure and features of an IRA have caused them to become a popular and widely used investment vehicle.
But why are IRAs such a powerful tool? The most important reason is because they can save you a significant amount of money on your taxes.
Current Year Deductibility
If your self-directed IRA is set up as a traditional IRA, then you may be eligible to deduct your annual contributions. Depending on your modified adjusted gross income (MAGI), the contributions you make to a traditional IRA may be tax deductible.
- Individuals who are not covered by a workplace retirement plan are eligible for full tax deductibility of their contributions, regardless of their MAGI.
- For single individuals who are covered by a plan at work for 2021, IRA contributions are fully deductible for a MAGI of up to $66,000 (with a gradual deductibility phase out between $66,000 and $76,000).
- For married couples filing jointly, where the contributing spouse is covered by a workplace plan, full deductibility is available for a MAGI of $105,000 (with a deductibility phase out between $105,000 and $125,000).
Note that these figures only relate to the deductibility of contributions, not eligibility for contributions. In general, any individual with earned income can contribute to a traditional IRA in an amount not exceeding that earned income. In contrast, being able to make contributions to a Roth IRA (which are not deductible) will depend on your MAGI.
Contributions to a self-directed Roth IRA are never tax deductible
Long Term Tax-Advantaged Growth. The investments held in a self-directed IRA will grow on a tax-deferred basis, regardless of whether the IRA is structured as a Roth IRA or a traditional IRA. This means that all capital gains realized from the sale of any investment property within the account, as well as all income generated by any investments within the account, will not be taxed for as long as those gains and that income remain within the account.
In the case of a traditional IRA, distributions taken after the account owner enters retirement will be taxed at the account owner’s then-applicable tax rate.
If your self-directed IRA is set up as a Roth account, then you will also be able to take all distributions from your account on a tax-free basis during retirement.
The best path forward for each individual, in terms of whether that particular person would save more on taxes from a Roth IRA or a Traditional IRA, will depend on their overall financial situation and circumstances.