Owning a Checkbook Control IRA

Checkbook IRA is a term that makes reference to IRA accounts that gives holders of a certain account complete control of their investments by using a checking account. To do this, the person in control of the account makes sure things like a trust are created, and these are only able to be managed by the administrator for the account or the holder of the account. Then, a bank account is opened by the IRA, which leads to the owner receiving a checkbook for the account. Investments can now be made by writing a check. So what are the pros and cons of owning a checkbook IRA?

Pros

There are many pros to having a checkbook IRA, but the main benefit to having a checkbook IRA is how much control the owner of the account is given. If there is not a checkbook connected to the account, the holder of the account must regularly stay in contact with the manager of the account so that investments can be made. Checkbook IRAs can also create savings on custodial fees. Usually, a fee will be charged on each investment made using an IRA. Directly making investments allows an owner of an IRA account to avoid large fees that could be charged simply for investing money into their own personal account. Minimal fees may still be charged, but it will be smaller and it will only have to be paid annually.

Cons

Though paying less to make investments does sound really good, there will no longer be a custodian to look over any of your investments before they can be confirmed. Many problems could arise, but the most common problem is that an investment that is not allowed to be used towards IRA funds might be made, which could lead you to getting penalized by the IRA. You also have the option of running into misreports of investments around the time of taxes. Custodians are usually people who get paid for helping you go through with investments and make sure that you are paying your taxes. They are also in charge of your W-4 yearly.  If there are any mistakes with transactions, the custodian is likely to end up misreporting.

When to Use Checkbook IRAs

Though they seem easier to use, checkbook IRAs are not easy for everyone to use. The best people to use these accounts are people who have become very familiarized with how investments work and the processes behind tax accounting. This is a perfect account for someone like a Certified Public Accountant, and since many of them work in private practices, they are not likely to run accounts from an employer. They can still set up accounts for retirement, though. Since they are able to understand investments that are deferred from taxes and understand what can happen with their investments once a transaction goes through, a custodian may not be beneficial to them and further actions with investments. Being unfamiliar with the regulation could be dangerous to your IRA if you are self-directing it.

Why It’s Important To Coordinate Your Taxable Investments With Your Self-Directed IRA Investments

Your self-directed IRA can save you a lot of money in taxes, both in the short term as well as in the long run. If your IRA is set up as a traditional account, then (depending on certain aspects of your financial position) you may be able to take a tax deduction for those contributions. And contributions in traditional IRAs will grow on a tax-deferred basis, while the investment gains within a Roth IRA will never be subject to taxation. Many individuals are well-versed with the various tax implications on this level.

But there’s another perspective from which you may want to consider your self-directed IRA tax analysis, and this is the way that your taxable investment accounts, and investment decisions, can impact your self-directed IRA investments.

Let’s first examine just how valuable your self-directed IRA can be. Consider two hypothetical portfolios of $100,000, one a taxable account and the other a self-directed IRA. Let’s further assume that each portfolio is comprised of stock that pays dividends at a 3% rate annually (with those dividends being reinvested), and that the stock price appreciates 5% annually.

At the end of 25 years, the value of the taxable account would be approximately $525,000, while the self-directed IRA is worth over $630,000. This difference in value is attributable solely to the fact that the owner of the taxable account has to pay taxes on the dividends they receive, even if they choose to reinvest those dividends.

If the self-directed IRA is a traditional account, then you will have to pay taxes on those gains, but they’re likely to be at a lower tax rate (because you’re in retirement and perhaps no longer working full time), and they’ll only be taxed when you take the distribution. If your account is a Roth IRA, then you’ll realize the full value of the investment gains.

So one common tax optimization strategy is for an individual to place income-generating investments that would otherwise incur a tax liability into an IRA in order to avoid that liability.

On the other side of the equation, it’s important to note that there are certain tax advantages that are actually disallowed within an IRA. For example, investment interest (such as borrowing funds to purchase a stock investment, or taking out a mortgage to buy a piece of real estate) can be used to offset gains in a traditional account. But borrowing funds is considered to be outside the scope of permissible activities for self-directed IRAs, and the tax benefit of those expenses will be lost inside the retirement account.

It’s the same situation for investments that have tax advantages built in, such as municipal bonds. Because these investments would already be tax-advantaged outside of an IRA, there’s no reason (and it’s actually a missed financial opportunity) to keep these types of assets inside a retirement account.

Understanding the interplay between your taxable investment accounts and your self-directed IRA will put you in the best position to make the optimal investment decisions.

The Basic Relationship Between Social Security Benefits And Your Self-Directed IRA

Regardless of whether you envision Social Security to be a significant component of your retirement income, or simply a helpful supplement to your self-directed IRA, it’s important to understand how the two are related. The timing and nature of distributions you take from a self-directed IRA can impact the size of your Social Security benefits, as well as the income taxes you may have to pay on those benefits.

First things first. Under current law, your eligibility to receive Social Security retirement benefits, and the amount of those benefits, is a function of your prior work experience and earnings, not how much you have saved. In other words, having a large self-directed IRA or taking significant distributions from your account during retirement won’t make you ineligible for Social Security benefits.

However, those distributions may impact the taxability of the Social Security benefits you receive. Finally, it’s important to keep in mind when you’re planning your retirement income strategy that you control when you begin receiving Social Security retirement benefits (anywhere between age 62 and age 70), and you control when you begin taking distributions from your self-directed IRA – with no limit for Roth account, and required minimum withdrawals from a traditional account kicking in at age 70½.

Early Retirement Scenarios.

Individuals who choose to retire early and begin taking their Social Security retirement benefits before their full retirement age can see those benefits reduced if their earned income exceeds a certain amount. (For 2015, this amount is $15,720.) In short, the Social Security Administration withholds one dollar in benefits for every two dollars and earnings above the this amount, and even more for earnings that are significantly higher. Distributions you take from your self-directed IRA are not considered “earned income,” and therefore do not count against this limitation.

However, when the IRS determines whether your Social Security benefits are subject to income tax, they look to your “combined income,” which will include distributions you take from any IRA that’s set up as a traditional account.

Roth Self-Directed IRA Benefits.

Significantly, distributions from your Roth IRA will not affect your Social Security benefits in any way. Just as is the case with traditional IRAs, they are not considered earned income by the Social Security administration for purposes of calculating your benefits in an early retirement scenario. In addition, they are excluded from the definition of “combined income” when considering the taxability of those Social Security benefits.

Distribution Strategies.

Given that your Social Security benefits will be increased the longer you wait to take them (with the deferred retirement credits increasing up to age 70), some individuals can maximize their total retirement income by waiting as long as possible to take Social Security, and taking distributions from their self-directed IRA in order to fund retirement living expenses. The analysis is highly individualized, and you’ll have even more options to consider if you are married and your spouse is also eligible for Social Security benefits.

But remember that you’ll only put yourself in a stronger financial position by maxing out your self-directed IRA contributions each and every year, and trying to build the largest account possible.

How a Change of Career Can Impact Your Self-Directed IRA

The process of building up a retirement nest egg doesn’t occur in a vacuum. You can come up with a savings plan and investment plan, but if the other financial elements of your life undergo significant changes, you might have to adjust those plans. One thing that can impact your self-directed IRA in several important ways is changing your job or career.

New Income Levels

As you are likely already aware, your ability to contribute to a traditional self-directed IRA or a Roth self-directed will depend on your modified adjusted gross income, as well as whether you’re participating in an employer-sponsored retirement plan such as a 401(k).

For 2014, for example, if you’re a single taxpayer and you’re covered by a retirement plan at work, you can only deduct the full amount of any contributions you make to a traditional self-directed IRA if your modified gross income is $60,000 or less. If you’re not covered by a retirement plan at work then your contributions to a traditional self-directed IRA will be fully deductible regardless of your income. With respect to a Roth self-directed IRA it is irrelevant whether or not you participate in an employer-sponsored retirement plan, but you can only make the maximum contribution to your Roth account if your modified adjusted gross income is less than $181,000.

Clearly there are several moving parts here, but the bottom line is that whenever you switch to a new career or job, the optimal contribution strategy you used in past years may not be the best one in your new position. You may find that you’re much better off making contributions to a traditional account than a Roth account, or vice versa. (And some individuals maintain both Roth and traditional IRAs throughout their saving years for just this reason.)

Ability to Rollover Your 401(k) Account

Whenever you change jobs, you have the ability to roll over your account balance to your new 401(k) account at your new employer (assuming that your new employer offers such a plan). That has certainly been a common approach among many individuals who find themselves moving to a new job or new career.

But that change in job or career gives an opportunity to rollover the balance that’s in your 401(k) account into your self-directed IRA. Not only will this give you the opportunity to reduce your administrative burden by having fewer accounts to manage, but you’ll also have a larger pool of capital that you can use to make some of the less common retirement investments that you can only do with a self-directed IRA.

It’s true that you can generally leave your 401(k) account with your old employer, but if you choose that path you won’t be able to make new contributions to your account, and you’ll be stuck with whatever limited investment options that particular plan happens to offer.

Make sure that you structure this as a direct rollover, not as a distribution and contribution of funds. The negative tax implications of taking a distribution from your 401(k) could be significant.

Common Misconceptions About the Self-Directed IRA

As you research and review your various retirement savings options, you may hear mention of something called a “Self-Directed IRA.” There is a great deal of confusion surrounding this kind of retirement account, so it’s important to clear up some of the most widely held pieces of misinformation in order to understand exactly what a self-directed IRA is.

The IRA specialists at Quest Trust Company want to make sure you have the knowledge you need to make an educated decision about your options. They’ve put together the following list in order to help you know all the facts.

  • It’s Not a Separate Type of IRA. One of the most common points of confusion is that the self-directed IRA has a different legal status from a “traditional” IRA that someone might choose to open with a discount investment broker or local bank. In fact, a self-directed IRA and other IRAs are, legally speaking, the same type of account. The annual contribution limits are the same, the withdrawal rules are the same, and the permitted investment types are the same. The main substantive difference between a self-directed IRA and a traditional or Roth IRA lies with the custodian. Custodians for self-directed IRAs enable account holders to make the investment types that are legally permitted within an IRA, but which other IRA custodians usually do not permit.
  • Not Every Investment Type is Permitted. It’s true that self-directed IRAs allow a greater number of investment choices as compared to what most IRA custodians permit in their accounts. But this doesn’t mean that the self-directed IRA is a “free-for-all” or that an account holder can invest in absolutely anything they want. The IRS rules on prohibited investments still apply, and prevent a self-directed IRA holder from investing in various asset classes, including collectibles or life insurance policies.
  • Self-Dealing Rules Still Apply. The standard rules which prohibit self-dealing within an IRA still apply to self-directed IRAs to the same extent as other IRAs. For example, having a self-directed IRA will certainly make it easier to invest in real estate, but the account holder is not allowed to sell their own property to the account, nor is the account holder (or any prohibited parties directly related to the account holder) allowed to use that real estate for their own personal use.
  • You Can’t Get “Checkbook Control” Over Your IRA. One of the greatest points of confusion surrounding self-directed IRAs is whether you can ever access your account funds and quickly make investments through “checkbook control” over the IRA. The theory is that the account holder sets up a limited liability company, then the IRA purchases all of the LLC interests (while the account holder is still the LLC manager), thereby giving the LLC the power to invest those funds without having to go through the IRA custodian. Unfortunately, this investment technique has never been directly approved by the IRS, and there is a great degree of uncertainty in whether it would withstand a legal challenge.

When you have a clearer understanding of what a self-directed IRA is and is not, you may feel more comfortable with the account, and how it might fit into your overall retirement strategy. To help gain a better understanding, contact Quest Trust Company today at 800-320-5950 for a no-cost, no-obligation appointment. Their specialists can help you interpret your options with a self-directed IRA and put you at ease about your retirement planning decisions.

The Truth About “Checkbook Control” Over a Self-Directed IRA

You’ll hear a lot of things when you start researching the self-directed IRA as a way to save towards your retirement. Some of these things will be true, some will be questionable and others will be flat out wrong.

The basic elements of a self-directed IRA are beyond dispute. A self-directed IRA can be setup either as a traditional IRA or a Roth IRA, and the type you choose will determine your rights and obligations with respect to contribution limits and tax deductibility.

Having a self-directed IRA will enable you to invest in the many asset types that are legally permitted, but which traditional IRA custodians (such as banks, credit unions and investment brokerages) do not allow. Permitted investment types include investments in real estate, making mortgage and other loans to other individuals, buying businesses, purchasing tax liens and making private equity investments.

But one aspect of self-directed IRA is that some custodians handle differently the ability to exercise “checkbook control” over your account (also known as checkbook LLC or checkbook IRAs). According to some IRA custodians, the process for setting up this type of account is as follows: the account holder directs their custodian to use funds from the IRA to purchase all of the units of a new LLC that the account holder creates, the LLC opens a checking account and deposits the funds it received from the investment by the IRA, and the account holder now has the ability to use the LLC’s checking account to make investments. The primary selling point of this structure is that the account holder can make investments quickly, without having to involve the custodian.

Unfortunately, the legal basis for checkbook control IRA isn’t one that’s explicitly set forth in the IRS regulations. Rather, self-directed IRA custodians who offer checkbook control over retirement accounts have to rely on an aggressive (some might say overly aggressive or perhaps even unreasonable) interpretation of a single enforcement case. Because the legal basis for a “checkbook control” IRA is so uncertain, individuals who pursue this type of structure are risking the integrity of the account and even its tax status. If the IRS ever issues a clear but unfavorable pronouncement about these types of IRAs, the account holders could be faced with significant penalties and tax liabilities.

Perhaps more importantly, the supposed need for checkbook control over an IRA account is based on a faulty assumption – that there’s necessarily a need for that type of access to IRA funds in the first place. Most investors take a long term investment outlook with their IRA funds, so the ability to put their account funds to work on a day’s notice is not important. Furthermore, retirements savers can choose a self-directed IRA custodian who responds quickly to their investment directives, and eliminate the need for checkbook control.

Even if you choose to take an aggressive position with your IRA investments, don’t try to push the envelope with respect to your account structure. It is prudent to stay away from self-directed IRAs that promise you checkbook control over your funds.

Quest Trust Company, Inc. is guided by a relentless need to supply the American public with the proper FREE education on what is truly possible with all retirement and qualified plans. We change people’s lives through IRA investment education and free people’s IRAs to invest in what they know best. For a free consultation, visit us at: http://www.questira.com/