Getting Started with a Self-Directed IRA When Your Nest Egg is Small

While you might have been initially drawn to a self-directed IRA because of the investment flexibility that this account type offers when compared to IRAs with traditional custodians (e.g., being able to invest in precious metals, and real estate, and private companies), it’s true in all areas of investing that not every investment option is suitable for every investor.

Precious Metals. One way that this quickly becomes apparent is with respect to investing in precious metals. Investing in bullion or investment grade coins can be a great way to diversify and hedge your other investments, but it’s significantly more expensive than more straightforward investments like publically traded stocks. And some of these expenses are baseline fees to get started, regardless of the size of your investment.

Make the Maximum Contributions Every Year. When your self-directed IRA balance is relatively small, it’s vital that you make the maximum contributions to your account each and every year. If you fail to make the maximum contribution in any given tax year (the contribution limit for the 2015 filing period is $5,500, with an additional $1,000 allowed for taxpayers age 50 and over), you won’t be able to make up for that lost opportunity in later years. Once the chance to make the maximum deposit has passed, it’s gone forever.

Consider Maintaining Two Accounts. It’s a common misconception, but taxpayers are not limited to having a single IRA. In fact, it can be good practice to maintain both a traditional self-directed IRA as well as a Roth self-directed IRA, and then decide where to make your deposits each year based on the tax deduction advantages you might be able to get from contributing to the traditional account. The key is to deposit the maximum each year, regardless of the self-directed IRA you choose. And remember that it’s always possible to convert a traditional self-directed IRA to a Roth account whenever you decide that you only want or need a single account.

Does Small Mean Little Investment Experience? If your nest egg is relatively small because you’re just starting out with your retirement savings and don’t have a lot of investing experience, then don’t feel pressured to start investing in the most complicated and advanced investment types right away. Even though the self-directed IRA structure permits investments in a wide range of investments, you’re still free to choose investments that you have more experience and familiarity with.

Use 401(k) Rollovers. Finally, another way to grow your self-directed IRA is through the use of rollovers. Whenever you leave an employer, you’re permitted to roll over the funds you’ve accumulated in your 401(k) to an IRA. Because many individuals are permitted to contribute to both 401(k)s and IRAs, this can be a great technique for building as large of a nest egg as possible.

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.

Increase Your Private Investment Allocation With Your Self-Directed IRA

Individual retirement accounts are perhaps the single most powerful tool you have in your retirement planning arsenal. You have greater control and flexibility over your retirement funds as compared to an employer-sponsored 401(k), and a Roth IRA can provide significant benefits for tax savings and estate planning purposes.

Self-directed IRAs take things a step further. Having an account with a custodian such as Quest Trust Company will allow you to invest in an even wider range of asset types, including a variety of private investments. Here are some ways to increase your portfolio allocation into these investment types by using a self-directed IRA.

Private Mortgages. Regardless of the state of the economy, people are always going to want (or need) to buy and sell homes. The IRS regulations permit you to use a self-directed IRA in order to issue private mortgages. Provided you understand the process fully, follow all legal requirements and evaluate your risks accordingly, you may find this to be a significant boost to your portfolio.

In fact, when prevailing interest rates increase and it becomes more difficult for the average home buyer to get a loan from a bank, you may have even more opportunities for making private mortgages.

Private Equity. Similarly, a self-directed IRA can be used to make private equity investments as well. Depending on the size of your portfolio and your overall financial situation, this can be a way to gain a completely unique risk/reward exposure that wouldn’t be available in any other investment you could make.

Some private equity investments will require that the investor be a so-called “accredited investor”. This is a legal term defined by the SEC to mean a person who either (1) has a net worth of at least $1,000,000 (not including the value of their primary residence), or (2) has an annual income of at least $200,000 over each of the last two years (or has a joint income of $300,000 in each year with their spouse) and a reasonable expectation to achieve the same income this year.

Note that even if you’re looking to invest with your self-directed IRA and your account meets these standards, you’ll still need to meet those standards individually.

Private Partnership Interests. You can use your self-directed IRA to invest in various types of private partnerships. These may include traditional businesses as well as natural resources development opportunities such as those that can be found in the oil and gas industries.

Remember that when you invest your self-directed IRA in a private partnership, you’re prohibited from benefitting from it individually while the investment is still held within your account. So if the partnership invests in vacation real estate properties, neither you nor your family or any other related parties can stay in the property while you’re still invested.

Regardless of the private investments you’re considering making, be sure to do your research and understand all the risks before you commit your account funds.

Can You Deduct Your Self-Directed IRA Contributions Deductible In 2015?

Being able to deduct your self-directed IRA contributions from your tax return can be a great incentive for you to maximize those contributions each year. But not all IRA contributions are deductible.

Roth vs. Traditional Self-Directed IRA. The first consideration in determining whether you can deduct your 2015 contributions to your self-directed IRA is whether your account is set up as a Roth account or as a traditional account. Contributions to Roth accounts are never deductible, and contributions to traditional IRAs are sometimes deductible. Let’s examine the circumstances under which contributions to your traditional self-directed IRA can be deducted on your 2015 tax return.

You Aren’t Covered By an Employer Sponsored Retirement Plan. If you don’t participate in an employer retirement plan (such as a 401(k) plan, profit-sharing plan, SEP, SIMPLE-IRA or certain defined benefits plans that you participate in), then your contributions to your self-directed IRA will be fully deductible, regardless of your income, if either (a) your tax filing status is single or (b) you file a joint return with your spouse but your spouse is not covered by a retirement plan at their employer.

If you file a joint return but your spouse is covered by a retirement plan at their job, then you’ll be able to deduct the full value of your contribution if your joint income is $183,000 or less. You can take a partial deduction if your joint income is between $183,000 and $193,000, and no deduction is available if your joint income is $193,000 or more. For purposes of these income thresholds, it’s not your gross income, but your Modified Adjusted Gross Income (“MAGI”) that’s relevant.

You Are Covered by an Employer Sponsored Retirement Plan. If you are covered by a retirement plan at work, then your ability to deduct your self-directed IRA contribution will again depend upon your MAGI and your filing status.

If you file a single tax return, then you’ll be eligible for a full deduction if your MAGI in 2015 is$61,000 or less. You can take a partial deduction for an MAGI between $61,000 and $71,000, but no tax deduction for your contributions if your MAGI is $71,000 or greater.

If you’re married and file a joint return, then you can take a full deduction for your contribution if your joint MAGI is $98,000 or less, or a partial deduction if your joint MAGI is between $98,000 and $118,000. Your deduction will not be deductible if your joint MAGI is $118,000 or more.

While being able to get a current year tax deduction for contributions to a traditional self-directed IRA can be valuable, even non-deductible contributions (such as to a Roth self-directed IRA or to a traditional account in years where your MAGI is too high) can be extremely valuable to your retirement future. The ability for your investments to grow in a self-directed IRA for years or decades on a tax-deferred or tax-free basis is something you shouldn’t pass up.


Why You Should Consider Consolidating Multiple Retirement Accounts Into a Single Self-Directed IRA

Over time, many of us accumulate a number of different financial accounts. For example, we might start a new 401(k) or other employer-sponsored retirement plan each time we change jobs. Or we might open a new IRA in order to receive the benefit of a promotional offer that our broker is sponsoring.

Unfortunately there are a number of downsides to maintaining multiple retirement accounts. In most cases, you can benefit from consolidating multiple retirement accounts into a single self-directed IRA.

Investment Options.

Let’s consider two possible scenarios; one in which you have five different IRAs with a $50,000 balance in each, versus a situation where you have a single self-directed IRA with a $250,000 balance. Your nest egg in each of these situations is identical, but your investment options going forward are not.

With the single self-directed IRA, you can make investments of up to $250,000. Given that a self-directed IRA custodian such as Quest Trust Company will not limit your investment choices in the same way that a traditional custodian would, you can use those funds to purchase real estate or to invest in private companies. You can even issue mortgages to real estate buyers or investors.

Those types of investments often require a higher account balance compared to what you would need to purchase stocks or bonds. Simply put, you’ll have more investment choices if you consolidate your multiple retirement accounts into a single self-directed IRA.

Furthermore, if some of your retirement accounts are 401(k)s that you have left at prior employers, rolling these over into your self-directed IRA can open up a new world of investment opportunity. Most employer-sponsored plans are severely limited in terms of available investment options.

Ease of Administration.

Don’t overlook the fact that having to manage multiple IRAs can present you with a significant administrative burden. Even with just four or five separate accounts, you’re going to have to spend a lot of time managing all the paperwork and statements that those various accounts produce. In addition, when it comes time to retire it can be even more of an administrative burden to execute a withdrawal strategy over multiple accounts.

Ease of Contribution Strategies.

If you maintain multiple IRAs, it can be a challenge to decide how to make contributions such that you grow all of your accounts. Remember that the IRS annual contribution limit regarding IRAs is an overall amount, not a per-account maximum. This means that if you’re looking to contribute $5,500 this year, and you have four or five separate IRAs, you need to figure out a plan for how to divide up that contribution amount. In contrast, having a single self-directed IRA simply means that you make the maximum contribution to that one account.

Finally, having a single IRA also makes sense because it allows you a greater level of insight into your investment risk and portfolio makeup. This insight can help you build the largest possible nest egg for your retirement.