Most individuals are at least generally aware of the long-term tax savings that can be achieved by having an IRA. Investments in IRAs (including self-directed accounts that are set up with a custodian such as Quest Trust Company) grow on a tax-deferred basis, so that investment interest, dividends and gains that occur within the account are only taxed when they are withdrawn, i.e., when the account holder takes a distribution from their account.
Roth IRAs provide an additional measure of long-term tax savings in that withdrawals are not subject to tax upon distribution to the account holder, provided that the holder has reached full retirement age.
But you can also use your self-directed IRA to save on this year’s taxes as well.
The most direct way of saving taxes this year is to make tax-deductible contributions to a self-directed IRA. Contributions to a Roth IRA are never tax deductible, so you’ll only be able to use this method of saving if you have a traditional self-directed IRA.
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.
A Second Self-Directed IRA
Some retirement savers prefer the Roth self-directed IRA structure over the traditional structure because of the long-term tax savings and estate planning advantages that the Roth account provides, as well as being able to eventually avoid the IRS rules on required minimum distributions.
Still, the immediate benefit of a deductible contribution is quite attractive for current year savings, so some people choose to open a second, traditional self-directed IRA so that they can make deductible contributions in the years that it’s most advantageous to do so.
This second self-directed IRA can be maintained so that it’s available to receive deductible contributions in any future years where that’s advantageous for the taxpayer, or it can eventually be rolled over into the taxpayer’s Roth account.
Permitted Early Withdrawals
Let’s say you’ve incurred a significant medical expense this year, or are now paying for the college expenses of one or more of your children. Many individuals don’t happen to have the cash on hand to pay for these things, so they may choose to sell some of their investments in order to raise the necessary funds. This can trigger a sizable capital gains hit.
The IRS regulations allow penalty-free withdrawals from an IRA if the funds are used for one of several specified purposes. If taken from a Roth self-directed IRA, you won’t face a current tax bill in raising the necessary funds. Contact Quest Trust Company for more information.