Minimize Your 2013 Tax Bill with a Self-Directed IRA

Estimated reading time: 3 minutes

One of the most popular ways for individuals to reduce their personal income tax bill is by making deductible contributions to an Individual Retirement Account.

The contribution limits to IRAs are computed on an annual basis, but once you file your taxes you don’t get to go back and make any additional contributions for years in which you failed to make the maximum. It’s therefore important to get the biggest tax break you can by making the maximum IRA contribution each and every year.

First Consider Deductible IRA Contributions

Most taxpayers will first look to see if they are eligible to make tax deductible contributions to their traditional IRA. If you’re eligible, this is one of the best ways to reduce your 2013 tax bill. This deductibility will only apply to traditional IRAs, and only if you meet certain other requirements. These requirements basically relate to your level of adjusted gross income if you or your spouse is covered by an employer-sponsored retirement plan such as a 401(k). Contributions to Roth IRAs are never deductible.

Drawbacks to Employer-Sponsored 401(k) Plans

Speaking of 401(k)s, you may hear people claim that these plans are far and away the best retirement savings vehicle. After all, the annual contribution limits for 401(k)s are higher than those for IRAs. In truth, however, it’s important to look at all of the retirement savings options you have available, and what combination of them makes the most sense for your financial situation. (For example, even if you have access to a strong 401(k), you can still open a self-directed IRA and save even more for your retirement.)

It’s important to note that one of the traditional strengths of the 401(k) program – employer matching employee contributions – has declined in recent years. Fewer employers are making matching contributions, and many of those are only continuing to do so on a lower percentage basis.

Furthermore, as employees better educate themselves about investment options, many are finding that the investment options available in their employer-sponsored plan are rather limited. Some 401(k) plans only allow employees to choose from a relatively short list of mutual funds. To make matters worse, many of these plans and funds come with high management fees.

Greater Control With a Self-Directed IRA

In contrast to 401(k)s, a self-directed IRA with a custodian such as Quest Trust Company allows a significantly higher degree of control. A full range of investments permitted by the IRS (including real estate, certain precious metals and various types of private investments) are permitted in self-directed IRAs. Savvy retirement savers use this flexibility to hold certain types of tax heavy investments within their self-directed IRAs, while holding more tax preference to investments in their taxable accounts.

Note that this technique for reducing your tax bill will work regardless of whether your self-directed IRA is set up as a Roth account or a traditional account. For more information about how you can put a self-directed IRA to work for you, contact Quest Trust Company today.

Starting Your Own Business? Use Your Self-Directed IRA for Funding

Estimated reading time: 2 minutes

More and more individuals from all walks of life are becoming interested in starting their own businesses. Some of the interest stems from the decrease in the number of good paying “middle management” type jobs from the economy, and some comes from a desire to have more control over one’s career and financial future.

Unfortunately, many businesses require a large amount of funding before they can get off the ground. Most potential small business owners don’t have access to the amount of funds that are required — with one possible exception. Many potential entrepreneurs already have sizable retirement savings accounts.

If you have your IRA funds with a traditional custodian (such as a bank or investment brokerage), then the first step is to open a self-directed IRA. The legal structure of a self-directed IRA and an IRA with a traditional custodian is identical, but the self-directed IRA custodian will permit you to invest in the full range of investment types that are permitted under IRS regulations.

While the self-directed IRA provides you with a much higher degree of flexibility and investment types, including investments in small businesses, there are some very important rules that apply. Basically you can’t be the majority owner or otherwise outright control the small business you are looking to invest in. The IRS wants to make sure your eye are a funds are being “invested,” and not simply used to pay you a salary or otherwise engage in prohibited “self-dealing.”

Furthermore, certain legal structures for a small business will not permit this type of funding, including a general partnership structure. Fortunately, creating a business with a small number of other individuals could in some circumstances qualify you to use your self-directed IRA funds to invest in the business.

Because the rules and regulations governing this type of financing are not always intuitive or clear, it’s important to rely upon a self-directed IRA custodian, such as Quest Trust Company, that has significant experience in helping investors navigate all of the legal requirements.

Finally, you may hear discussion of another technique that small business owners have used to fund their businesses with IRA assets. This technique involves creating a new 401(k) plan for your business, rolling over your IRA assets into the new 401(k), then using the newly deposited 401(k) funds to invest in the company. Unfortunately, the risks and downsides to this technique can sometimes be quite significant. First, if your business has employees, the 401(k) plan would need to make company stock available to them as well. In addition, you wouldn’t be able to make any other investments beyond those that were permitted by the 401(k) custodians (company stock is authorized, but you wouldn’t be able to make nearly as many different types of investments as you could with a Quest Trust Company).