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Why the Self-Directed IRA is the Best Long-Term Savings Vehicle

Posted on December 1, 2015April 13, 2021 by Ingrid Chavez

Estimated reading time: 2 minutes

Being able to save for a financial goal is one of the most valuable skills a person can ever develop. You’ll likely set a variety of savings goals throughout your life, including short-term, medium-term and long-term goals. The ultimate long-term savings goal is saving for your retirement. And the ultimate savings vehicle for retirement is the self-directed IRA.

Let’s look at a few of the reasons why.

Tax-Deferred Growth.

Like other traditional IRAs, the biggest strength of a traditional self-directed IRA is that it provides the opportunity for your investments to grow on a tax-deferred basis. This means that any income you receive from the investments within your account will not be subject to tax for as long as those funds remain in the account. Similarly, any gains from the sale of investments within your account will be free from taxation, provided that those funds (and any investments you make with those funds) remain within your account.

Additional Investment Options.

A self-directed IRA with a custodian such as Quest Trust Company affords the account holder with investment options that traditional IRA custodian will not permit. For example, you can use a self-directed IRA to invest in assets such as private equity and real estate, and to make loans to businesses or even for real estate mortgages. Many of these asset types have long investment timeframes, which allows you make investment choices to precisely match your retirement goals.

The breadth of investment choices you’ll have with a self-directed IRA is even more apparent when you compare them with any 401(k) plan options that you may have through your employer.

Administrative Advantages.

Speaking of 401(k) plans, you’re likely to accumulate multiple 401(k) accounts over the course of your career. Many plan administrators limit your ability to make new investments once you leave the employer, and having to keep track of multiple accounts can reduce your ability to execute on your retirement plan. Having a self-directed IRA as your sole or primary retirement account can lessen your administrative burden.

Additional Roth Self-Directed IRA Advantages.

If the features we’ve discussed above aren’t enough, then consider the additional benefits you receive by structuring your self-directed IRA as a Roth account.

In addition to having your investments grow on a tax-deferred basis as is the case with a traditional IRA, distributions can also be taken from a Roth IRA on a tax-free basis. Furthermore, Roth IRAs are not subject to the rules on required minimum distribution requirements in the same way that traditional IRAs are. These rules require you to take minimum distributions from a traditional IRA once you reach age 72.

Finally, eligibility to contribute to a Roth IRA does not end at age 72 as it does with a traditional IRA. This means that if you have other sources of income during retirement you can continue leveraging the various contributions.

What You Need to Know About Substantially Equal Periodic Payments

Posted on August 31, 2015April 13, 2021 by Ingrid Chavez

Estimated reading time: 3 minutes

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 72.

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.

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

Posted on August 11, 2015April 13, 2021 by questadmin

Estimated reading time: 3 minutes

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 72, 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.

Three Key Diversification Principles For Self-Directed IRAs

Posted on April 10, 2015August 12, 2019 by questadmin

Estimated reading time: 3 minutes

Most investors are at least somewhat familiar with the concept of diversification, even if they don’t give it much thought or put the notion into practice within their own accounts. And while some investment commentators might occasionally proclaim that the idea of diversification is outdated, most experts recognize its importance even today.

The basic theory of investment portfolio diversification holds that by investing in more than just a single asset, the investor can reduce their risk of losing a significant portion of their portfolio if that one asset were to decline in value. Diversification is one reason that mutual funds and exchange traded funds are a more popular choice than individual stocks for many investors.

Diversification can become particularly important with an account such as a self-directed IRA, because there are so many more investment choices available to self-directed IRA account holders and those who have their retirement funds with a traditional custodian. Here are three key diversification principles to keep in mind.

Diversify Not Just For Your Age, But For Your Investing Profile. Discussions of diversification often start with your age. The argument is something along the lines of taking a more aggressive diversification stance younger in life so that you have the best opportunity to maximize your nest egg, while keeping in mind that you’ll have more time before retirement to recoup any losses that may result from such a stance.

But you also need to take into account your individual investing personality. How risk averse are you, generally speaking? Does the prospect of losing money, even if it comes with the opportunity to gain more, keep you up at night? These types of questions should give you some idea of your starting approach for retirement account diversification.

Don’t Over-Diversify. By this we simply mean that while diversification should be an important principle to incorporate into your retirement investment decisions, it shouldn’t be the sole driver of your actions.

For example, if you have a large investment in your self-directed IRA that has performed very well and now represents a significant part of your portfolio, your diversification principles may suggest that you sell the investment in order to maintain a “proper” investment mix. However, if you still have significant confidence in that investment, you may not wish to get rid of that quite yet.

Furthermore, if you’re faced with significant transaction costs in connection with trying to meet some diversification goal (such as selling real estate holdings or private investments), then this may impact your decision.

Different Considerations During Retirement. How will you be using your self-directed IRA during retirement? Will it be your principal source of retirement income, or do you have other adequate sources of income (such as employer-sponsored 401(k) plans, employer pensions, and Social Security) and want to use your self-directed IRA as more of an investment and/or estate planning tool?

In addition, if you plan to use your self-directed IRA to make pre-retirement withdrawals in order to help your children or grandchildren with educational expenses, medical expenses or even down payment assistance for their first homes, then you’ll want to be sure that you have appropriate liquid assets available in order to withdraw on the appropriate schedule.

Should You Set Up A Separate Self-Directed IRA For Your Real Estate Investments?

Posted on April 4, 2015December 6, 2018 by questadmin

Estimated reading time: 3 minutes

Real estate is a popular investment choice for people who have a self-directed IRA, but it’s a much different asset class than investments like stocks or bonds. Real estate requires a much greater level of planning and monitoring throughout the holding period of the investment, and for this reason some individuals choose to create separate self-directed IRAs for each of their real estate investments. Here are some factors to take into account when you’re faced with that decision.

Carrying Costs. As you consider whether to set up a separate self-directed IRA for a particular piece of real estate, you will need to plan for how you’re going to cover the maintenance and upkeep of that piece of real estate. These expenses and fees will include annual property taxes, physical upkeep and repairs of the property, insurance premiums, plus any other expenses that you’ve agreed to bear on behalf of your tenant.

You can cover these costs with whatever income the property itself generates, or with your permitted annual contributions to an account, or some combination of both. But you are not allowed to use any outside or personal funds to pay any expenses or fees related to your real estate investment.

Distribution Matters. It’s also worth considering that, depending on whether your self-directed IRA is set up as a traditional account or not, you may be responsible for a significant tax liability upon taking a distribution of the property in retirement. If your self-directed IRA is set up as a traditional account, you’ll have to pay taxes on the full amount of the distribution – i.e., fair market value of the property. If your account is set up as a Roth self-directed IRA, then you’ll have no tax liability upon distribution once you reach retirement age.

Furthermore, a traditional IRA will be subject to the IRS rules on required minimum distributions, and this can be particularly difficult to comply with if the only asset in the account is a single piece of real estate.

Prohibitions on Self-Dealing. But even if you set up a separate self-directed IRA to hold a piece of real estate, you still need to be aware of and have respect for the IRS prohibitions on self-dealing. This means you cannot engage in any personal use of your investment property while it’s still in your account, nor can any of your family members or other related parties make use of the property. You can only use the property after you take a distribution of it from your account.

There is no minimum threshold for this rule, and even a single day of personal use can open you up to a risk that the IRS would consider you to have taken an early distribution of property.

Think about the entire time-frame of your real estate investment, from acquisition to holding, to eventual disposition. You don’t necessarily need to have a detailed or inflexible plan for this type of investment, but it’s important to consider the issues that you’re likely to face along the way.

Deciding When It’s Time To Seek Outside Help With Your Self-Directed IRA

Posted on March 7, 2015October 31, 2018 by questadmin

Estimated reading time: 3 minutes

When considered broadly, perhaps the most powerful aspect of a self-directed IRA is that you have the greatest degree of control over your financial future. Unlike traditional employer pension plans (which give you no opportunity to invest wisely and maximize your retirement nest egg based on your individual choices) or 401(k)s (which generally limit your investment options to a very small number of choices), a self-directed IRA puts you in complete control.

But sometimes handling all this control can be a heavy burden. You may be comfortable using your self-directed IRA to invest in assets that you’ve had prior experience with, but what if you’re looking to invest in something new? That’s the time when you may have to decide to seek professional assistance with your self-directed IRA investments.

When You’re Spending Too Much Time on Your Portfolio. It’s obviously important to spend time doing the financial planning for retirement, including making investment choices, deciding on a withdrawal schedule, and even planning your annual contributions. But if you find yourself spending too much time administering your account, whether it’s because your account has grown too large or contains too many different assets, or because your portfolio includes assets with which you have little experience, then hiring an outside expert may be a good use of your funds.

When You Aren’t Confident in Your Investment Choices. If you find it difficult to commit to making particular investments with your account, or aren’t confident in the investments you’ve already made, then seeking outside help can help you get over the “analysis paralysis”.

When Your Investments Require Management Expertise. As you are likely already aware, different types of assets require different levels of involvement. Consider, for example, how much involvement and management you need to exert over investment in a stock market index fund as compared to a single-family home. If you don’t have the experience to confidently manage a particular asset in your account, get help.

When You’re Spending Too Much Money. Different asset classes may also require different levels of maintenance fees and expenses in order to maintain. Again, consider a piece of residential real estate versus a stock market index fund. You’ll spend nothing maintaining your index fund position (the management fees are automatically paid by the fund), while you’ll be responsible for upkeep of the real estate. If you’re doing this all yourself, you may not be able to accomplish it in the most cost-effective manner. If you find yourself spending too much money trying to accomplish these management tasks, then consider bringing in help. Believe it or not, sometimes bringing in outside expert assistance will end up saving you money, even though you’ll be paying additional fees for their assistance.

Because your goal with your self-directed IRA should be to maximize your account value, don’t let ego or pride get in the way of maximizing your nest egg. Sometimes bringing in outside help is the best way to meet your long-term retirement goals.

Calculating A Fair Market Value Of Your Illiquid Self-Directed IRA Investments – And Why It Matters

Posted on February 19, 2015April 13, 2021 by questadmin

Estimated reading time: 2 minutes

When you want to know the true, fair market value of your checking account, savings account, or bank CDs, you simply check your balance. It’s the same case with your publically traded stock investments; you simply log into your account while the market is open and you’ll get an instant and accurate valuation.

But what’s the fair market value of your home or your car? You might have a general idea of the proper value, but it can be challenging to come up with an accurate assessment. You may also find it a bit challenging to come up with a fair market value for illiquid investments you hold inside your self-directed IRA.

Let’s examine some of the most common illiquid investments in self-directed IRAs, how you can calculate a fair market value, and why this can be so important.

Real Estate. Real estate investments are generally considered to be illiquid, even if the property is located in a “hot” market where the number of buyers greatly exceeds the number of sellers. That’s because the sales transaction itself generally takes some time, so even if you have strong buyer interest in a property you’re trying to sell,it can take several weeks or more before you actually liquidate and receive your check.

Because a property is only worth what someone is willing to pay for it, you can calculate a fair market value for investment by looking at recent comparable sales in your area, or enlist the help of a local estate expert and draw upon their experience.

Private Equity and Debt Instruments. You’ll probably need to rely more on expert assistance when you need to find the fair market value of any private equity or private debt investments you hold within your self-directed IRA. This is due in large part to the fact that the data regarding prior transactions won’t likely be available – such transactions are not a matter of public record in the same manner as are real estate transactions.

Why Does it Matter? Knowing the fair market value of illiquid investments within your self-directed IRA is important for several different reasons. First, the more accurate the valuation information you have about the investments in your self-directed IRA (and the other investments you have), the better you’ll be able to plan, assess the risks, and diversify your overall investment portfolio.

In addition, if your self-directed IRA is set up as a traditional account, you’ll become subject to the rules on required minimum distributions once you reach age 72. This isn’t particularly problematic from an administrative perspective if all of your investments are liquid, like stocks. You always know what your account is worth, and therefore you can easily calculate your RMD obligations. You can also quickly sell whatever investments you need to in order to meet those obligations.

Is Your Nest Egg Large Enough for a Self-Directed IRA?

Posted on October 6, 2014December 9, 2019 by questadmin

Estimated reading time: 2 minutes

Self-directed IRAs are great foundation for your long term retirement planning. But because self-directed IRAs are not offered by more familiar discount brokerage custodians, some potential account holders may be intimidated at the prospect of paying for services on a different fee structure. This is true regardless of the fact that those fees are reasonable for the services that the individual receives when they invest in more complicated assets such as real estate and private equity.

Furthermore, some individuals may assume that their account balances simply aren’t large enough to effectively invest in a self-directed IRA. This simply isn’t the case. Regardless of the size of your nest egg, you can benefit from having a self-directed IRA.

You Probably Have More Options Than You Think

First of all, let’s be clear that you probably don’t need as large of an account balance as you might think in order to leverage the power of a self-directed IRA. While it’s true that having a modest account might preclude you from purchasing large real estate investments such as multi-family units or apartment buildings (or at least doing so without having to borrow with your account and incur unrelated business taxable income), you’re certainly not frozen out of real estate investments as a whole.

Smaller self-directed IRAs can be used to purchase more speculative real estate investments, including undeveloped land, as well as properties that may be located in areas that have fallen out of favor with homeowners and investors (but which you believe will make a comeback).

Your Account Will Grow Over Time

By making the maximum contributions to your self-directed IRA each year, and investing sensibly, you can expect that your account balance will grow over time. Once you have a self-directed IRA established you can make contributions to that account each year, as well as rollover any other IRAs or 401(k) accounts that you have.

Are You Interested in Traditional Investment Classes?

Another factor that sometimes leads retirement savers to stay away from self-directed IRAs is that they mistakenly assume that such an account can only be used to invest in things such as real estate, precious metals, and private equity. It’s true that those investment classes are possible with a self-directed IRA, but that account can just as easily be used to invest in publically traded stocks and mutual funds.

When it comes to having a relatively small nest egg, the only real limitations on a self-directed IRA are the time and level effort you’re willing to invest. A self-directed IRA can benefit retirement savers at every stage of life, individuals with a relatively small stake, and anyone who wants to maximize their retirement investment options.

Best Practices for Maximizing Your Tax Benefits With a Self-Directed IRA

Posted on August 28, 2014 by questadmin

Estimated reading time: 3 minutes

Self-directed IRAs are a powerful tool to help individuals build the largest possible retirement nest eggs. Obviously there is great value to being able to choose from the widest possible range of investment options. But the greatest upside of having a self-directed IRA and making regular contributions to it is the fact that it provides you with long term tax-deferred (or, in the case of a Roth IRA, tax-free) growth.

Here are some of the best practices for maximizing all the available tax benefits you have with a self-directed IRA.

Current Year Tax Deductions for Contributions

If your self-directed IRA is structured as a traditional account, then you may be able to take a current year tax deduction for the value of your annual contributions, depending on your income and whether you are covered by a retirement plan at work. While you’ll be subject to taxation on withdrawals from your traditional self-directed IRA once you reach retirement (which wouldn’t be the case for withdrawals from a Roth account), you may decide that the current year tax advantage is worth it to you.

Hold Tax-Advantaged Investments in Your Taxable Accounts

Because all investment income and capital growth that happens within a self-directed IRA is tax-advantaged, holding investments that have built in tax-advantages is redundant and wasteful in terms of tax benefits. Therefore, if you invest in tax-free government bonds then those assets would be better held in a taxable account, and not your self-directed IRA.

Avoid UBTI

Also in the same category of avoiding mistakes is making sure used to your clear of unrelated business taxable income (UBTI). In the context of self-directed IRAs, UBTI most often becomes an issue when an account holder borrows money to make an investment – commonly by taking out a mortgage in order to buy real estate. Borrowing money to invest is outside of the statutory authorizations of any IRA, so it’s important to avoid any transactions that would lessen the tax benefits of your account.

Maximize Tax Free Growth

In order to maximize the benefits of tax-deferred or tax-free growth within your self-directed IRA, it’s important to let your account grow for as long as possible. One implication is that you should try to avoid taking any early withdrawals from your account. Even if you fall within one of the penalty-free exemptions for doing so, by reducing the amount you have invested you reduce the amount of tax benefit you’ll achieve in the years leading up to retirement.

Consider a Conversion to a Self-Directed Roth IRA

Finally, if you truly want to maximize your tax benefits, consider converting a traditional self-directed IRA into a self-directed Roth account. You’ll need to pay taxes on the conversion amount, but if you can afford that current year tax hit, and you have a number of years before retirement, it may be the best long-term decision.

Of course, tax laws evolve and change over time, so it’s also very important that you stay up-to-date on all the rules and regulations regarding self-directed IRAs.

Tips for Using Your Self-Directed IRA to Invest Internationally

Posted on July 31, 2014 by questadmin

Estimated reading time: 3 minutes

Seasoned investors often look to make investments wherever they feel gives them the best opportunity for the highest return. In some cases this may lead them to invest outside of the U.S. And individuals who have a self-directed IRA may also be interested in using that account to make international investments.

Identifying International Investments.

Your first line of research should be to investigate relatively straightforward investments such as stocks, mutual funds and exchange-traded funds to see if you can find investments that have appropriate international exposure.

Keep in mind that not everyone who is interested in international exposure will want to embrace that exposure to the exclusion of other markets. For example, did you know that a significant portion of the revenues from one of the most iconic American brands – McDonald’s – comes from their international territories? You may be able to find a number of different options with your research that can provide you with the level international exposure you are looking for.

Have a Trusted Advisor.

If you are interested in other types of international investments, including those that are “on the ground” outside of the U.S., then make sure that you always have expert assistance and advice to help you understand all of the parameters of any potential investment.

For example, it’s not uncommon for areas outside of the U.S. to have restrictions or limitations on who can own real estate. In some instances noncitizens are prohibited from owning property outright. If you want to pursue that type of investment, then you need to structure some type of non-majority ownership interest along with a local investor in order to close the deal. Getting expert assistance on these types of arrangements is essential.

Understand Your Taxes.

Recall that while self-directed IRAs provide you with the maximum degree of investment flexibility as compared to other retirement savings vehicles, certain aspects of your investing may have negative implications. For example, borrowing money inside an IRA in order to purchase real estate or make other investments will generally trigger UBTI (unrelated business taxable income) implications. Certain international investments may trigger similar concerns.

By the same token, you’ll need to understand whether making an investment internationally will subject you to any legal requirements or obligations as a result, including any foreign tax liabilities. Many countries have tax treaties with the United States in order to prevent undue taxation of investments, but it’s important that you research and understand all the implications of a potential investment.

Have an Exit Strategy.

If you do choose to invest in assets that are physically located outside the US, be sure to have given some thought to your long-term investment strategy, including when and under what conditions you will want to exit your position or liquidate your investment. If this process is more time-consuming than you are used to for a corresponding U.S.-based investment, for example, then you’ll need to plan accordingly.

As with any investment, the most important aspects to investing internationally, particularly if you are using your self-directed IRA, is to have a plan and do your homework.