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. The deductibility of your contributions to a traditional IRA will depend on whether or not you are covered by a retirement plan at work (such as a 401(k) plan), as well as your level of income.
For the tax year 2014, single taxpayers who aren’t covered by a retirement plan at work can make deductible contributions to a traditional IRA regardless of their modified adjusted gross income (MAGI). Taxpayers who are not covered by a retirement plan whose tax filing status is “married filing jointly” can take a full deduction for their traditional IRA contributions if their MAGI is less than $181,000 (and can take a partial deduction for a MAGI between $181,000 and $191,000).
For single taxpayers who are covered by an employer sponsored retirement plan, full deductibility of contributions to a traditional IRA is available for a MAGI of $60,000 or less (and partial deductibility for a MAGI between $60,000 and $70,000). Taxpayers who are married and file jointly, and who are covered by a retirement plan at work, can take a full deduction if their MAGI is $96,000 or less (and a partial deduction for a MAGI between $96,000 and $116,000).
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.