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Three Instances Where a Non-Deductible Self-Directed IRA Makes Good Financial Sense

Posted on September 30, 2015December 6, 2018 by Nate Hare

The potential availability of a current year tax deduction for contributions made to a traditional IRA is perhaps its most appealing feature for many taxpayers. After all, getting a tax deduction for your saving activities is like an instant return on investment. For example, if you make a $5,000 contribution that nets you a full $5,000 deduction on your tax return, and your effective tax rate is 25%, then you’re effectively paying just $3,750 for that $5,000 deposit.

But there are situations where that deduction may not be available. In many situations, making a contribution to a non-deductible self-directed IRA will still be in your best long-term financial interests.

When You’re Not Eligible to Make Contributions to a Deductible IRA.

Not everyone is eligible to make a tax-deductible contribution to an IRA. For example, if you’re covered by a retirement plan at work (such as a 401(k)), then you are only eligible to make fully tax deductible contributions if your modified adjusted gross income is $61,000 or less and you file as a single taxpayer. (A partial deduction is available if your income is between $61,000 and $71,000.) Couples who file jointly must have a modified AGI of $90,000 or less (with a partial deduction available for incomes between $90,000 and $118,000).

Despite not being able to get the deduction, the funds you deposit into a self-directed IRA will grow on a tax-advantaged basis. In the case of a Roth self-directed IRA, you’ll never pay taxes on distributions that you take from your account once you reach age 59½.

When The Value of the Contribution Deduction is Low.

Even if you are eligible to make a deductible contribution to a traditional self-directed IRA, it’s important to determine exactly what the value of the deduction will be, and weigh that against the value you could receive in the longer term by making a contribution to a Roth account. For example, taxpayers with relatively low modified AGIs – which may be due to having a large number of other deductions available, and/or a lower income – might not find an IRA deduction to be particularly valuable.

Keep in mind that the IRA contribution deduction is a deduction, not a credit, so the lower your modified AGI, the lower the effective value of that deduction will be. for example, if a $5,000 contribution only yields you a tax bill that’s a few hundred dollars lower, then you should probably consider making that year’s contribution to a Roth self-directed IRA instead in order to receive tax free distributions once you hit retirement.

When You Have Other Sources of Retirement Income.

The rules on required minimum distributions are not given enough attention by many retirement savers. these rules require that, once you reach age 70½, you must begin taking distributions each year from your traditional IRA.this means that not only will your account balance not be able to grow as much, you’ll be hit with a tax bill on those distributions.

In contrast, a Roth self-directed IRA is not subject to those rules. Therefore, if you anticipate having a large nest egg and/or various other sources of income during retirement, your best long-term financial bet may be to prioritize non-deductible contributions to your Roth account rather than trying to make deductible contributions to a traditional account.

The Three Situations Where You Might Consider an Early Withdrawal From Your Self-Directed IRA

Posted on September 28, 2015December 6, 2018 by Nate Hare

It’s important to understand that the default IRS regulations regarding early withdrawals from an IRA. In general, taking a distribution from your account before age 59½ will subject you to a 10% penalty on the amount of the distribution, plus whatever taxes may be due.

In each of the situations below, there are specific requirements that need to be met in order to avoid having to pay the 10% penalty, but in all cases you still may owe taxes on the amount of the distribution. Pay close attention to all the requirements. If you make a mistake in the distribution process it could prove to be quite costly.

To Purchase a First Home. The IRS regulations allow you to take a distribution of up to $10,000 to pay for a down payment on your home if you are a first-time homebuyer (which is defined to mean that you haven’t owned your own home in the past two years). You can also use this penalty free provision to assist a child or grandchild with their down payment, if having access to these additional funds would make the difference between getting a home and not – but it may be worth forgoing future growth of those funds
For Certain Uninsured Medical Expenses. There are actually two situations in which you can use your self-directed IRA in order to pay for some of your medical expenses. The first is in situations where you need to pay for certain unreimbursed medical expenses. The second situation is to pay for medical insurance premiums for you and your family when you are unemployed. one reason taking this type of early withdrawal can be so important is that it eliminates any temptation that might otherwise exist for you to underinsured or yourself or otherwise not seek necessary medical care.
Higher Education Expenses. The third exception we’ll discuss is taking an early withdrawal in order to pay qualified educational expenses. Generally this means paying tuition or room and board for your child, but you can also make such a withdrawal for your own educational expenses, those of your spouse, or those of a grandchild.

There are no limits for how much you can take out of your account early for these purposes. However, given that an early distribution means that you’re losing out on the long-term growth potential of those funds, you may wish to explore other funding options first, including student loans (which in some cases can involve interest and that’s tax-deductible).

In fact, in each of these three situations, it’s always important to consider other alternatives prior to taking an early distribution from your self-directed IRA. Just because you’re authorized to do so doesn’t mean there isn’t a better way.

In addition to losing out on future investment growth, there are other ways in which taking an early distribution can be a bad financial decision. For example if you need to liquidate certain investments early, then the effective loss you experience by taking the early distribution is effectively much greater than the amount of the distribution.

How Much Retirement Income Can You Generate With Real Estate Investments?

Posted on September 15, 2015October 31, 2018 by Nate Hare

Why do you save for retirement? At the most basic level, you probably save so that you’ll be able to pay for your living expenses once you reach your desired retirement age (whatever that age may be). One of the best ways to plan for your retirement finances is to have the goal of putting together a nest egg that generates enough income every year to cover some or all of those living expenses. This will often be preferable to having to liquidate your investments in order to pay your living expenses, and be at risk of depleting your account too quickly, and effectively outliving the usefulness and value of your retirement savings.

Unfortunately, individuals who aren’t familiar with self-directed IRAs, and the additional investment opportunities that those accounts can provide as compared to IRAs with traditional custodians, might take an overly narrow view of the types of investments that can generate meaningful income.

More specifically, many would consider an “income investment” to be something like a municipal bond or U.S. government bond, or a corporate debenture, or perhaps even publicly traded stocks that pay quarterly dividends. While these are certainly income generating investments, they only scratch the surface of what’s available to a retirement saver who has a self-directed IRA.

Private Debt Investments. Self-directed IRAs are authorized to invest in private debt instruments. This can include not only personally guaranteed notes (lending money directly to an individual), but also borrowings from businesses, and even private mortgages. That’s right, with a self-directed IRA you can make loans to people who are looking to buy a home, and use the home as your security for repayment — just like a traditional mortgage lender would do.

These types of investments have the potential to generate a significant income stream, and the more risk you’re willing to take with respect to repayment, the greater that income can be.

Real Estate. Speaking of home buyers, you can use a self-directed IRA to invest in real estate directly, and generate income from renting the properties you buy. In the residential marketplace, stagnant incomes have combined with increasing real estate prices and tighter lending standards to create a huge demand for rentals. In some areas the growth in prevailing rents has actually exceeded the rate of growth for home prices.

And you’re not limited to residential properties when you invest with a self-directed IRA. You can use your account to purchase commercial properties, including office, retail, and industrial properties. These types of investments can provide exposure to a different type of risk if you’re looking to diversify your retirement investment portfolio, but they can still generate a healthy level of periodic income.

Obviously, making these types of investments is a significantly more complicated process than simply buying a corporate bond. When considering these types of investments with your self-directed IRA, be sure to seek out qualified professional assistance to help you as necessary.

Broaden Your Investment Horizon With a Self-Directed IRA

Posted on September 7, 2015October 31, 2018 by Nate Hare

What’s your current level of investment experience? If you’ve done any investing at all, then congratulations! Across the broader U.S. population, things don’t look particularly bright. Over the past few years, various surveys have concluded that approximately one-third of American adults don’t have any savings at all, and nearly half of American adults only have an emergency fund that would cover less than 90 days of their living expenses. The statistics for retirement savings are equally as dismal.

And even among those who have begun saving for retirement, many limit their savings activities to just a few types of assets, the most popular of which include broad market mutual funds and short term U.S. government bonds. And some, concerned with the preservation of capital beyond all other concerns, use their funds to invest in things like bank CDs.

Even amongst those who have actually invested for growth or income, many have limited their activities to mutual funds or whatever other options were available within or promoted by their discount broker or 401(k) plan administrator.

There’s certainly nothing inherently wrong with those types of investments. Mutual funds can make the process easy for individuals who don’t have the time, inclination or confidence to do a lot of research or make more specific investment decisions. But the problem with simply investing in broad market investments like mutual funds is that you’re limiting your long term growth potential, particularly during down market times.

Fortunately, you can use a self-directed IRA to invest in a wide range of assets that can broaden your portfolio so that you can take advantage of various market conditions.

For example, you can use a self-directed IRA to invest in real estate and precious metals, two asset classes that have historically performed well when the stock market has underperformed. You can use your account to invest in a number of different types of real estate, including single-family and multi-family residential properties, commercial properties, farmland, industrial properties, and even undeveloped properties.

In order to gain exposure to precious metals, you can use your self-directed IRA to invest by purchasing metals in their physical form (pure bullion or government issued coins, but not collectible coins), or in precious metals mining and exploration companies. If you choose to invest in physical metals, it’s important to plan for the costs of hiring a professional custodian to hold those metals. If you were to hold that type of precious metals investment yourself, doing so would be considered taking a distribution from your account, which would potentially subject you to an early withdrawal penalty, as well as any taxes that would otherwise be due.

Furthermore, you can use a self-directed IRA to invest in private companies by taking either equity or debt positions. Depending on the nature of the investment, the performance of these types of investments can provide you with the opportunity to improve the return on your portfolio when your other investment types aren’t performing quite as well.

What You Need to Know About Substantially Equal Periodic Payments

Posted on August 31, 2015August 14, 2019 by Nate Hare

You probably know that if you take a distribution from your IRA before you reach age 59½, then in most cases you’ll be subject to a 10% penalty on that amount of the distribution, in addition to any taxes that may be due. (Distributions from a traditional account are generally subject to income tax, while distributions from a Roth account are not.)

You may also know that there are a handful of circumstances in which you can make an early withdrawal from your IRA and avoid the 10% penalty, but not avoid any taxes that are due. These include certain distributions to assist a first-time home buyer in making a down payment, paying for medical expenses, and paying for certain types of higher education expenses.

In certain limited sets of circumstances, these exemptions from the 10% early withdrawal penalty can be useful for certain individuals. But what about IRA owners who find themselves in a extremely serious financial situation that justifies taking money out of their retirement account – is there another option for those individuals?

Fortunately, there’s another option for taking penalty-free distributions that’s far less known. The holder of an IRA can begin taking distributions from their account as part of a series of what is known as “substantially equal periodic payments.”

The “substantially equal periodic payments” exemption allows the account holder to calculate a yearly amount that they can withdraw from their account every year, for at least five years, or until they reach age 59½, whichever is later.

Given the scope of this exemption, it’s essential for an account holder to be completely sure the withdrawal schedule works for them, and that they’ll be able to maintain and build their overall retirement nest egg to adequate levels. Think about this for a moment, a 25 year old who chooses to take a series of substantially equal periodic payments from their account must do so for more than 32 years. Stopping the withdrawals before they reach that point will subject the account holder to significant IRS penalties.

There are three basic methods for calculating the amount of the periodic payments; the “fixed annuitization method” and the “fixed amortization method.” Under a fixed annuitization approach, the account holder uses a life expectancy table and a “reasonable” interest rate (which will be at least as great as 120% of the federal midterm rate). The fixed amortization method uses a simple amortization approach, and generally yields a lower annual payout amount than the fixed annuitization method. The third approach is to use the same method as that for calculating the required minimum distributions that apply to traditional IRAs for account holders age 70½.

The biggest difference between the third method and the first and second methods is that the amount of the annual payment amount can vary greatly from year to year, depending on the investment activities that occur within the account.

The Biggest Secret to Retirement Saving Success With a Self-Directed IRA

Posted on August 20, 2015December 6, 2018 by Nate Hare

There are certainly a lot of different retirement strategies out there. Regardless of your age, income level, or current level of savings, you’re likely to have access to multiple strategies to try to help you reach your goals.

And there’s no shortage of investment advice on what types of investments are best for you. Just pick up a copy of virtually any personal finance magazine and you’ll read about a wide range of options, some of which may even appear to be in direct conflict with one another.

But perhaps the biggest factor that will contribute to you reaching your retirement goals is common across all of these options. And it remains something of a secret even though it’s so easy to do. The secret?

Be consistent with your retirement savings.

By that we mean that if you save as much as you can each year, and you do so year in and year out, then you stand a very good chance of reaching your goals. When you are more consistent with your retirement savings, your choice of investments becomes less important. You won’t have to chase high yielding investments in an effort to boost the value of your nest egg because your account balance will grow over time merely by choosing investments

When you invest consistently, then over long periods of time your investment choices become less of a factor in determining how much you’ll accumulate. This isn’t to say that you should disregard the process of trying to choose your investments wisely, and select assets that meet your risk tolerance and other financial circumstances. Rather, it simply means that your research and analysis of your various investment possibilities shouldn’t overshadow the priority to put money aside in the first place.

In other words, your primary goal should be to contribute the maximum amount to your self-directed IRA every year, and your efforts should be focused on that first and foremost. After you’ve done the work to save as much as the IRS allows, then you can put the time and effort into figuring out how best to put that money to work.

You’ve probably seen the examples before. Looking at several different case studies of hypothetical investors — one who invests each year at the market low, one who invests at the beginning of the year, and one who is unlucky enough to invest at the top of the market — the results are surprising.

Over a period of several decades, the individual who is unfortunate enough to make their investments at the market peak each year has a smaller nest egg than the other two investors, but not by as great of a margin as you might think. And, more importantly, that bad market timer still has accumulated significantly more than an individual who didn’t save as much, or who simply contributed the same amounts to a bank account or other cash equivalent savings vehicle.

Techniques for Making the Maximum Contributions to Your Self-Directed IRA

Posted on August 17, 2015December 3, 2018 by questadmin

Appropriate and suitable investing is certainly one key to accumulating a large enough nest egg by the time you’re ready to retire. But at least as important as your investment approach is you making regular contributions to your account (as in, doing so every single year), and contributing as much as possible (that is, up to the permitted contribution limits for your retirement account).

Giving your account contributions the greatest amount of time to grow is something that you can’t make up in later years. Since your annual contributions to a self-directed IRA are capped, if you miss the opportunity to make a maximum contribution to your account in any given year, you’ll never be able to recapture that opportunity later.

For the 2015 tax year, the maximum annual contribution to a self-directed IRA is $5,500 (or $6,500 if you’re age 50 or over). Here are some techniques for making that maximum contribution to your account this year, as well as in all future years before retirement.

Use Your Tax Refund.

While the most financially prudent situation is to neither owe taxes nor be due a refund at the end of the year (since no refund means that you haven’t given the government an interest free loan of the excessive withholdings that were made from your paychecks), many people still like the “forced saving” element of getting a refund check after they file their returns.

Receiving a refund that may amount to several thousand dollars, or more, these taxpayers now have access to a lump sum of money that they perhaps wouldn’t have been able to accumulate otherwise. While many individual choose to use their refunds as an opportunity to splurge, or treat themselves to something nice, consider this: using your refund check to make some or all of your annual self-directed IRA contribution will free up your budget later and provide you with greater financial flexibility.

In fact, if you file early enough in the year, you may be able to receive back your refund check in plenty of time (that is, before April 15) in order to make some or all of your self-directed IRA contribution for that same tax year.

Incorporate Your Contributions into Your Monthly Budget.

Because the key to success in retirement saving is consistency, you can meet your annual contribution goal by taking steps toward that goal each and every month. Determine how much you need to contribute each month to make the maximum contribution, and work that amount into your budget.

Auto-Debit or Direct Deposit.

Even if you don’t have a formal budget set out for your family, you can still meet your monthly savings target by utilizing tools such as direct deposit (have an appropriate amount taken out of your paycheck each month and deposited directly into your self-directed IRA), or automating monthly transfers from your checking or savings account to your self-directed IRA.

Should You Consider a Non-Deductible Self-Directed IRA?

Posted on August 14, 2015August 14, 2019 by questadmin

For many individuals, their tax planning strategy — to the extent they have one at all — revolves around trying to maximize the deductions they can take each year on their returns. The personal exemption, deductions for dependents, and the home mortgage interest deduction are all extremely popular deductions to personal income.

Many individuals also try to take advantage of the deduction that’s available for contributions to a traditional IRA in certain circumstances. (A similar economic outcome occurs for contributions to a 401(k), because those contributions are generally made with pre-tax earnings via payroll deductions.)

But while the value of a deductible contribution to a self-directed IRA can be significant, it shouldn’t be your only consideration when deciding whether or not to make a contribution to your retirement account, and what type of account to choose to receive those contributions.

Remember that self-directed IRAs come in two basic types. There are traditional self-directed IRAs, to which contributions are sometimes deductible, and Roth self-directed IRAs, to which contributions are never tax deductible.

For example, let’s say that you are covered by a retirement plan at work (such as a 401(k)), and that your modified adjusted gross income exceeds the IRS limits ($71,000 for the 2015 tax year). You’re eligible to contribute to a traditional self-directed IRA, but your contributions won’t be deductible. If your modified adjusted gross income is less than $116,000, then you’ll also be eligible to contribute to a Roth self-directed IRA, but again, your contributions won’t be deductible.

All other factors being equal, your best bet is likely to be making the contributions to a Roth account. The primary advantage that a Roth self-directed IRA has over a traditional self-directed IRA is that all distributions from the account will be tax-free during retirement. This can be a significant source of additional funds for your living expenses during retirement. There are numerous other benefits to a Roth account, including not being subject to the rules on required minimum distributions.

But even making non-deductible contributions to a traditional account can provide you with significant benefits. Investments within a traditional IRA grow on a tax-deferred basis, and no tax will be due until you take a distribution from your account. This means that your non-deductible contributions still have the opportunity to grow for years or even decades without you having to pay tax on the gains or the income from those investments.

Note that it’s not at all uncommon, and entirely permissible under the IRS regulations, to maintain multiple IRAs. If you choose, this means that you can set up a traditional self-directed IRA to which you can make deductible contributions in the years that you’re eligible to do so, and also have a Roth self-directed IRA that you can contribute to when you’re not eligible to make those deductible contributions.

Have You Made a Plan for Taking Distributions From Your Retirement Accounts?

Posted on August 11, 2015October 31, 2018 by questadmin

When most of us think about retirement planning, we tend to focus on the saving and wealth accumulation aspects of the process. That is, we plan how much we think we need to have accumulated by the time we reach our desired retirement age, in order to be able to lead the retirement lifestyle we want.

But a truly effective retirement plan also gives a significant amount of attention to what happens after you’ve built your nest egg and reached your target retirement age. You also need to plan how you’re going to take distributions from your retirement accounts during retirement.

Why Having a Plan is Important.

In short, having a plan for withdrawing money from your retirement accounts is important because you don’t want to outlive your retirement savings. Since it’s impossible for anyone to know when they’re going to pass, it’s important to have a plan, and to build some cushion into the timing of how long you’re going to need to fund your retirement.

Furthermore, this cushion can be vitally important if some of the assumptions you’re making now about your retirement don’t hold true. For example, you might not be able to work as long as you think. Or you might not have accumulated as much as you would have liked, either due to sub-maximal contributions or poor investment returns.

In any case, you’re not likely to be able to reach your retirement goals without giving careful consideration to all the factors relating to that retirement, and coming up with a plan for how and when you intend to take money out of your account.

Are You Subject to the Rules on Required Minimum Distributions?

If your self-directed IRA is set up as a traditional account, then you’ll be subject to the IRS rules on required minimum distributions. These rules state that once you reach age 70½, you must begin taking minimum distributions for your account every year for the rest of your life.

Having to make withdrawals from your account every year can require some degree of advance planning, particularly if you’ve used your account to invest in assets such as real estate or private equity, as these assets often require a significant lead time to be able to liquidate.

Roth self-directed IRAs are not subject to the rules on required minimum distributions.

Don’t Forget About Social Security.

Even if you haven’t been relying on your Social Security benefits when doing your retirement planning, there are still ways that the government retirement benefits program can impact your decision making. For example, you may choose to delay taking your Social Security benefits until you’re past your full retirement age, in order to increase the monthly check you receive from the government. Doing so may require you to withdraw a greater amount from your self-directed IRA until you start receiving benefits, but the long-term payout could make for a more comfortable retirement.

Why Family Changes Can Affect Your Self-Directed IRA Investment Planning And Strategy

Posted on April 20, 2015December 6, 2018 by questadmin

It should be apparent that any significant change to your financial situation – such as getting a new job with a significantly higher salary, getting hit with significant long-term expenses, or receiving a large inheritance – can impact your retirement investment planning and strategy.

But changes to your personal life, particularly your family status and composition, can have a significant impact on your self-directed IRA investment planning as well. Let’s take a look at a few of the most common situations.

Marriage. Getting married can change virtually every aspect of your life, and your retirement strategy is no exception. Doing your long-term retirement planning as a couple, you may decide upon a vastly different investment strategy than you had when you were single. For example, if your income is significantly higher than that of your spouse, or can make larger contributions to your self-directed IRA and other retirement accounts, then you’ll need to come up with an appropriate joint investing strategy to maximize your collective nest egg.

Divorce. On the other side of the coin, a divorce can also be a personal change that requires you to re-evaluate your retirement planning.Not only will a divorce likely cause you to name new beneficiaries for your account, depending on the nature of your divorce, you may need to go through the process of dividing up the assets within your account, and doing so in the most tax-advantaged manner.

A court-approved divorce settlement can divide one spouse’s IRA between the two individuals, but the tax consequences can be significant, depending on how the division is made.Under federal law, this type of transfer can be performed on a tax-free basis provided that (1) the division is formally included in the property settlement agreement or divorce decree, and (2) the funds are transferred directly from one spouse’s IRA directly to the other spouse’s account. Not meeting these two requirements could subject the original account holder to an immediate year tax liability.

Having Children. The birth of your first child is certain to be one of the most memorable days of your life. Among everything else that will change, you’ll need to plan for their financial security, and this might impact your investment allocation within your self-directed IRA, and you may even wish to name your children as beneficiaries of your account.

And when your children grow up and move away from home, either to go to college or to enter the workforce, you may be able to use your self-directed IRA to provide them with an extra measure of support. You can make penalty-free withdrawals from your account before reaching retirement age if you’re paying their qualified educational expenses, or contributing up to $10,000 to help them buy their first home.

As your family grows and changes over time, you’ll put yourself in the best position to reach your retirement goals if you understand how family changes can impact your investment and planning strategy.

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