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

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 70½.

Finally, eligibility to contribute to a Roth IRA does not end at age 70½ 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

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 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.

3 Reasons Why Self-Directed IRAs are Worth the Time and Energy

You’ve likely found that setting up a new IRA is usually a quick and easy process. After all, many traditional IRA custodians use online forms and (in the case of a bank or brokerage that’s acting as custodian) these custodians generally allow you to instantly transfer money to fund your new IRA from other accounts you may have at the same institution.

But setting up a self-directed IRA isn’t that much more time consuming than an IRA with a more traditional custodian. It’s true that it might take a little extra time to fill out an extra form or two, or to fund your account. But what’s more important is that the benefits of having a self-directed IRA instead of a traditional account far outweigh the small amount of extra time and energy you’ll have to expend.

1.         The Opportunity for Greater Gains. If you have an IRA with a bank or brokerage as the custodian, then you’re going to be significantly limited in the types of investments you can choose for your account. Traditional IRA custodians generally limit investments to stocks, bonds, mutual funds and bank CDs. While there’s nothing inherently wrong with this selection of investments, many individuals would like to be able to invest at least a portion of their retirement funds and investment classes that have an opportunity for higher rates of return.

With a self-directed IRA with a custodian such as Quest Trust Company, you’ll also be able to invest in precious metals, real estate, private equity, mortgages and other negotiable interests, and even privately held companies.

2.         Great Opportunities for Real Estate Investing. As noted above, a self-directed IRA with a custodian like Quest Trust Company gives you the opportunity to invest in real estate. For many individuals, their largest single investment asset (apart from their primary residence) is their IRA. This means that the IRA balance you’ve accumulated over the years can be put to use investing in the wide variety of opportunities in the real estate market.

For example, it’s possible to use a self-directed IRA to invest specifically in the property or piece of real estate that you intend to live in during retirement. Some self-directed IRA account holders have used their accounts to purchase a future retirement property, rent that property out to third parties (thus generating additional income to their account), then simply take a distribution of the entire property from the account once they retire. This can provide great peace of mind for individuals who may be worried about their living expenses and situation once they enter retirement.

3.         Pinpoint Targeting of Your Investing. Let’s say you’ve researched a particular market or industry or type of product and want to invest in it. With a traditional IRA, unless you’re able to identify a publically traded company with exposure to that market (assuming such a public company exists), you’re frozen out of that investment option. With a self-directed IRA you can invest in private companies in that market, make loans to those companies, and various other types of related transactions.

In short, the self-directed IRA will give you investing opportunities that simply don’t exist elsewhere.