How is an IRA Taxed?

No matter what type of IRA you choose, you will eventually pay taxes on it. The question becomes, do you want to pay taxes up front or on the back-end at retirement? If you would rather pay taxes now (for example: you think your tax rate will be lower now than in the future), then a Roth IRA is the way to go. There are income restrictions for qualifying for a Roth, however you can get around this by rolling over funds from a Traditional into a Roth account. If you would rather pay taxes on your distributions upon retirement and enjoy a tax write-off now, then Traditional IRAs are right up your alley. This, of course, is the most simplified explanation. And we all know taxes are a bit more complicated when further investigated.

How Are Roth IRAs Taxed?

With Roth IRAs you don’t get a tax write-off when you make contributions, and you will owe taxes on your contributions based on your income and tax bracket at the time of the contribution. If you qualify for the Saver’s Credit, the amount you owe in taxes may be reduced.

One of the greatest benefits of a Roth IRA is that you do get to pull funds out tax-free under the right conditions. As long as a Roth IRA has been open for 5 years or you are over 59 ½, whichever comes later, you can take distributions on your earnings tax-free. Qualified home purchases and disability requirements also qualify for tax-free status.

If you haven’t had the account for at least 5 years or haven’t reached age 59 ½ yet, you may have to pay a penalty in addition to tax on certain distributions. Distributions on contributions are always penalty free, but not always tax free. Distributions on earnings may be subject to both tax and penalty depending on the circumstances. To learn more about Roth IRA withdrawals, click here.

How Are Traditional IRAs Taxed?

With Traditional IRAs, you can write off your yearly contributions if you meet certain income requirements, but you will owe taxes upon distribution at retirement based on your tax bracket at the time. Traditional IRAs require savers to start taking minimum distributions at age 70 ½ that are based on how much is in the account and your age.

You may also be taxed and fined on Traditional IRA distributions if you withdraw funds before age 59 ½. Just like with Roth IRAs, there are extreme exceptions to this rule. However, one should consider all of the costs, including loss of compounded interest and taxes, before withdrawing early.

To pay taxes required on any qualifying distributions, you will just need to include your contributions and distributions on your yearly tax filing paperwork and use this to figure the amount owed. A tax professional can help you through the process if you are unsure.

One last note on retirement account taxes: You can make a distribution that moves you into a higher tax bracket. If it’s an RMD for a Traditional IRA, you may not have a choice. However, you may want to perform some calculations first to ensure you’re not paying more in taxes than you need to. Always consult your financial advisor before taking any out-of-the-norm distributions.

Tips for Investing Out of State

With an investment like real estate, sometimes it makes more sense to take your money to a different state. Whether the market is slow, stagnant, or just not good in your area, many other places around the country are experiencing amazing growth that’s predicted to last a while. Those who get in on the action now can reap major rewards in just a few short years. Most of us can’t afford two mortgages to make this happen, but we do have available retirement funds at our disposal. Conventional IRAs don’t allow for real estate investments, but Self-Directed IRAs do. Like any investment, real estate investments take education, research, and analysis to increase your chances of coming out ahead. Learn more about how to wisely invest in out-of-state opportunities below.

Learn the Local Laws

Before investing out of state, it’s best to research and understand the local laws pertaining to your investment. If you are planning on investing in a rental property, you may want to check out the tenant-landlord laws in that state. What does the evection process look like and when are tenants liable for damages? Establishing a relationship with a real estate lawyer in that state is also a good idea in the event you need one or have a legal question about your property.

Complete a Market Analysis

Obviously, you will want to investigate the area and understand what the market projections look like in the next five and ten years, or however long you are planning on keeping the investment. Look for previous pricing patterns and learn what new businesses could be driving in jobs for particular areas. What are some of the economic decisions being voted on in the next election and how will they impact your investment? There are dozens of factors at play when it comes to real estate investments, and it’s important to understand most, if not all of them before jumping in. Learn more about Real Estate IRA Rules here.

Narrow Down Your Options

Once you’ve decided on a general area of where to invest, it’s time to choose a specific neighborhood or property. What types of renters does the neighborhood attract? Low income neighborhoods may score you a great deal at first but are more at risk for missed rents or vandalism. Check crime rate statistics and understand how quickly rental properties find qualified tenants in the area. Rural renting can sometimes prove more difficult, which means lost income potential for you.

Analyze Each Property

Just like inspecting your own home before purchasing, you will want to complete a full inspection of your investment as well. Will it need a lot of repairs before any income can be generated from the property? How long will repairs take? Besides initial repairs, it’s also important to be aware of future repairs. How old is the HVAC and water heater? What shape is the roof in and what is the seasonal weather like in the area? Don’t forget to calculate taxes, insurance, and property management costs into the equation as well.

Assemble a Trustworthy Team

Being out of state can be a hinderance when there are emergencies to handle. Having a trustworthy team on the ground can ease your anxieties but will also add to the expense of the investment. Some crucial players you will want to consider for your dream team are real estate attorneys, property managers, contractors, inspectors, insurance providers, and CPAs. Remember, you are essentially hiring them to work for you, so don’t take these decisions lightly. After all, your retirement funds are at stake!

Investing in real estate with a Self-Directed IRA is an exciting adventure no matter where you are. These tips will help you make a smart choice when it comes to choosing the right investment.

What the House Tax Bill Could Mean for Your Savings and Retirement

In late December, the Tax Cuts and Jobs Act spelled big changes for many individuals. Retirees and those close to retirement may be wondering how this will affect the taxation on their funds. The good news is that many limits and regulations involving retirement accounts are staying the same. There are, however, a few changes investors should be aware of in the coming months. Let’s take a look at what’s staying the same and what’s changing starting in the 2018 tax year.

Staying the Same

Before the Act was passed, there were talks about changing pre-taxed contribution limits on 401(k) accounts. In the final draft, limits were left untouched at $18,000 for 2017 and $18,500 for 2018.

The Senate was also looking into restricting the sale of stocks and mutual funds, as right now investors can pick and choose shares to sell if they are selling part of their investment. Many people choose the shares that allow them to pay the least amount in taxes on the gains from the shares. The proposal didn’t make the final draft, and investors still have the liberty to decide which shares to sell.

Changes that Retirees Should be Aware of

The structure of tax brackets is shifting, and it could mean the taxes you pay on Roth IRAs now, or Traditional IRAs upon distribution, will change. If you qualify for a lower tax bracket now, it’s a great time to contribute to a Roth IRA in case congress decides to change the brackets again in the future.

If you’re close to 70 ½, you may want to take another look at the required minimum distributions (RMDs) you’ll have to be taking soon. RMDs are based on a percentage of the total amount of funds you have in your IRA account, so it’s less and less each year. If you have to take a large RMD, it could bump you up to the next tax bracket. You could distribute some funds now to avoid the higher tax bracket, but this only makes sense if the amount you save in taxes outweighs the amount you could have earned on the funds if they were left in your account. Talk with your financial advisor to see if this makes sense for you.

There are a few deductions taxpayers can no longer claim on 2018’s taxes. One is the deduction for fees paid to an investment advisor. Although, this one is set to return in 2025. For those who are used to deducting state and local income and property taxes, you’ll be limited to deducting only a maximum of $10,000 total from now on. If you live in an area with high income and property taxes, you could consider a move at retirement to a location with no income tax to keep from missing out. Keep in mind, moving expenses are no longer deductible as well (except for members of the military).

Investors who have moved funds from a Traditional IRA to a Roth IRA, but took a loss and don’t want to pay taxes on money they don’t have, had the option to recharacterize the Roth back to a Traditional IRA before the end of the year. This is no longer allowed, so investors and retirees need to carefully consider Roth conversions now more than ever. You can wait until close to the end of the year to convert so you’ll know that you have enough to pay the taxes on the Roth funds before transferring.

Deductions for medical expenses are also getting a slight change. Before citizens could deduct whatever expenses exceeded 10% of their AGI, and it’s now been lowered to 7.5% of their AGI. This is helpful for seniors with low income and high or long-term medical expenses. This will be set to return to 10% in 2019.

Charity is another area where retirees may benefit. Up to 60% of AGI may now count toward tax deductions. For retirees who don’t qualify for many deductions, they can take full advantage of this increase by giving directly from their IRAs double the amount they usually give, but only every other year.

Stay Away from These “Self-Dealing” Investments in Your Self-Directed IRA

Self-Dealing” InvestmentsSelf-directed IRAs give you the widest possible range of investment options compared to other tax-advantaged retirement accounts. As compared to an IRA with a traditional custodian, a self-directed IRA with a custodian such as Quest Trust Company allows you to invest in assets such as real estate, private loans, private equity, and precious metals.

As compared to a 401(k), the increased choices you’ll have with a self-directed IRA are even more pronounced. Employer-sponsored 401(k) plans are generally quite limited in terms of investment choice, and you can’t invest in publicly traded stocks or even mutual funds that aren’t offered by the 401(k) plan sponsor.

But this doesn’t mean you have unlimited freedom with investments in your self-directed IRA. For example, you can’t use funds from your account to buy life insurance policies, invest in artwork, or invest in collectible coins. And perhaps more importantly, you can’t use the funds in a self-directed IRA to engage in any transaction that would be considered “self-dealing.”

“Self-dealing” is considered by the IRS to be making any investment that provides a current benefit to the account holder, or engaging in any business or transaction with a “disqualified person” (which include family members such as your parents, grandparents, children, grandchildren or spouse, as well as any corporation, partnership or other legal entity in which the account holder has a controlling interest).

The notion of a current benefit to the account holder is construed broadly. For example, you can purchase real estate with a self-directed IRA, but you can’t engage in any personal use of that property yourself, nor can any disqualified person. This type of use would constitute self-dealing even if you (or the disqualified person) pays fair market value for the rental use of the property.

By the same token, when you make an investment with your self-directed IRA, the asset or investment property you purchase cannot be something that you already own. So if you currently own a piece of real estate as a taxable investment, you can’t sell that property to your self-directed IRA, even if you’re IRA pays fair market value for it. Nor can your account to purchase the property if it’s owned by a disqualified person.

Staying aware of the prohibition on self-dealing with a self-directed IRA is important, because the penalties for noncompliance can be significant. Engaging in such transactions could put the entire set of tax advantages of your account at risk, such that it would no longer be considered a self-directed IRA.

Furthermore, engaging himself dealing could potentially result in the IRS declaring that you have been deemed to take a distribution of the relevant assets from your account. For example, personal use of a vacation home held by your self-directed IRA might lead to that property being forcibly distributed to you individually. If this occurs when you are not yet in retirement, this could trigger a significant current tax liability (depending on the age of your account and whether it is set up as a traditional or Roth account), as well as a 10% early withdrawal penalty on the phone.