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Three Key Investments You Can Make in Your Self-Directed IRA, But Not in Your 401(k)

Posted on December 14, 2015April 13, 2021 by Ingrid Chavez

Estimated reading time: 2 minutes

Despite the larger annual contribution limits that are available to participants of a 401(k) plan, there’s one essential aspect in which 401(k) plans fail to measure up to self-directed IRAs, and that’s in the area of investment options. Even if you consider participating in your employer’s plan in order to receive matching contributions from them, you’re likely to find yourself faced with a handful of investment options, likely in the form of mutual funds that come with above-market fees.

But even if you have the best 401(k) plan on the market, and have a wide range of options to choose from, you still aren’t likely to be able to invest in publicly traded stocks. Furthermore, there are going to be three key investment classes that certainly won’t be available in your employer’s plan.

Real Estate.

Real estate investments are one of the most popular types of investments for self-directed IRAs. These types of assets allow investors to purchase virtually any type of investment property, including single family homes, condominiums, multi-family units, commercial properties, farm land, industrial property, and even undeveloped properties.

With a self-directed IRA you have freedom in your investment goals and approach with real estate as well. You can rent the property in order to generate an income stream, invest for capital gains, invest for speculative purposes, or some combination of these considerations. Note that you cannot use any of these properties yourself, nor can any members of your family use the properties. Doing so could subject you to financial penalties and taxes.

There are additional financial burdens if you seek to borrow money with your self-directed IRA in order to purchase the property, so many investors choose to limit themselves to properties or property interests for which they can pay cash from their account.

Private Loans.

Finally, you can use your self-directed IRA to make private loans to third parties. These loans can take the form of mortgages to prospective homebuyers, or to businesses looking to expand their operations. The basic concept of making private loans is easy to grasp, but preparing the necessary documentation and making sure the transaction is properly structured is essential.

While you may only choose to devote a part of your overall retirement nest egg to these retirement classes, it can be a great advantage to have access through them through a self-directed IRA.

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

Posted on September 28, 2015December 6, 2018 by Ingrid Chavez

Estimated reading time: 3 minutes

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.

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.

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

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

Estimated reading time: 3 minutes

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.

Using Your Self-Directed IRA To Invest Outside the U.S.

Posted on April 17, 2015August 12, 2019 by questadmin

Estimated reading time: 3 minutes

Even though self-directed IRAs held with a custodian such as Quest Trust Company are generally recognized as the most flexible retirement savings option, most investors choose to limit themselves to assets or companies located within the United States. In fact, many countries have well-developed investment markets, so looking outside the U.S. may be just the key to helping you find the perfect investment for your needs. If you choose to consider investing abroad, here are some of the biggest issues to keep in mind.

Foreign Taxation Issues.

You should not assume that everything you know about U.S. tax law when it comes to property held within an individual retirement account holds true abroad. It may be possible that certain types of investing activities, even if they happen within a self-directed IRA, will subject you to a foreign tax liability.

Real Estate Considerations.

Let’s take a closer look at one of the more popular foreign investment types; real estate. The first thing to remember is that all of the IRS rules prohibiting self-dealing continue to apply even for real estate outside the U.S. That means if you’re investing your account in a vacation property abroad, you and your family (and other related parties) are prohibited from using it – even for a single day – when it is still held within your account.

Foreign Ownership Restrictions.

It’s not uncommon for foreign countries, or regional or local government bodies, to impose restrictions or limitations on foreign ownership of real property. In some cases a foreigner is prohibited from owning property outright, which means that your investment options would be limited to some type of minority stake. This may or may not help you achieve your investing goals, depending on precisely why you’re investing.

In some countries, similar restrictions may also apply to owning manufacturing facilities or other types of business as well.

The Investment Process.

If this will be your first time investing abroad, you’ll also need to familiarize yourself with whatever the local investing process may be. Continuing with our real estate example, you’ll need to know and understand which local agencies need to be involved in the process, what types of taxes, fees or assessments need to be paid as part of the transaction, and how the documentation for the transfer of ownership needs to be recorded or otherwise formalized. The best approach will almost certainly be to do your homework before you spend a lot of time looking for investment opportunities.

Consider a Partnership.

In many instances, the best way to address many of these issues is to partner with a local investor and approach the investment opportunity jointly. Again, you will have to do your homework in identifying potential partners that suit your needs, but in some cases choosing not to undertake the investment by yourself can make the process much easier.

Regardless of the investment opportunities you’re considering pursuing abroad, it becomes essential that you understand all the limitations, restrictions and risks that may be unique to the investment you are considering.

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.

Now Is The Time To Investigate Oil And Gas Investments With Your Self-Directed IRA

Posted on April 1, 2015December 5, 2018 by questadmin

Estimated reading time: 2 minutes

From a consumer perspective, one of the biggest stories from the latter parts of 2014 and early parts of 2015 is the drop in gasoline prices. While this seems to suggest that making investments now in the oil or natural gas industries would be poorly timed, in fact the current state of the market might actually indicate that this is precisely the time to start investigating further.

Low Prices for Some Assets. The sharp decline in oil and gas prices has resulted in what may be a good buying opportunity for related investments. You may wish to consider not only stock in publicly traded oil and gas exploration companies, but also private investments as well.

Having a self-directed IRA with a company such as Quest Trust Company gives you the opportunity to use your retirement funds to make these types of investments. Because the laws relating to the exploration and development of natural resources are sometimes arcane and complicated, these investments can take many different forms – forms that may not be familiar to even relatively experienced investors.

Seek Professional Assistance. If you don’t have familiarity investing in oil and gas companies, particularly private investments, you may wish to seek professional assistance before committing any funds from your self-directed IRA. Certain types of investments in the industry may carry additional tax benefits – benefits that would be lost or redundant if done within a retirement account. You may wish to leave these investments to your taxable accounts, and use your self-directed IRA for those oil and gas investments that would otherwise generate a significant tax bill (and which you’d therefore avoid by having the investment in a tax-advantaged account).

Local Legislation and Politics. One way to come up with new investment opportunities in the oil and gas industry is to pay attention to your local legislative and political scene. Hydraulic fracturing (or “fracking”) has become a hot button issue in many jurisdictions, for example, so the direction that your city, county, or state takes with respect to allowing fracking – and under what circumstances or regulatory restrictions – could significantly change the investing landscape.

Volatile Markets Create Opportunities. The recent price volatility for oil and gasoline has demonstrated that even as consumer demand remains relatively steady, the underlying commodity markets themselves often move in unexpected and sometimes hard to explain ways. However, generally speaking, volatile markets create more investment opportunities. Remember that for practically every bullish investment opportunity there is someone on the other side of the coin willing to take a bearish position.

Your self-directed IRA can be a great opportunity for you to invest in assets and investment types that you’d never be able to make with your 401(k) at work or a traditional IRA. Now just might be a great time to take a closer look at oil and gas investments.

How To Save On Investment And Management Expenses Next Year With Your Self-Directed IRA

Posted on March 16, 2015April 21, 2021 by questadmin

Estimated reading time: 2 minutes

There’s no such thing as a free lunch, or so goes the saying. Even in the context of saving money for retirement, you’re going to have to pay for the various services provided by your account custodian. Even if you have a “free” account at a discount brokerage, you’ll still pay transaction based fees for buying and selling investments.

All other things being equal, the more you spend on fees, the smaller your retirement nest egg will be. With that in mind, here are some suggestions for saving on investment and management expenses next year in your self-directed IRA.

Understand Your Baseline. The first step to reducing the fees you pay is to understand what you are paying now. Take a look at your prior account statements and identify all the fees and expenses you paid. It may be helpful to separate them out by investment type, so that you can compare appropriate categories going forward.

It’s important to acknowledge and understand that when it comes to fees and expenses, you’ll need to pay more in order to get a higher level of involvement and service. The fees and commissions applicable to buying a few hundred shares of a publicly traded stock are always going to be significantly less than those for purchasing a piece of real estate or for other custodial services..

Leverage Your Own Investment Experience. The next step is to examine those areas in which you have substantive investing experience, and consider cutting back on the professional management. For example, if you’ve accumulated years of experience investing in real estate with your taxable accounts, then you may be able to use that knowledge and expertise to make real estate investments with your self-directed IRA.

Professional Management. On the other side of the equation (and this might seem a bit counterintuitive), bringing in outside help in the form of professional active management might end up being a positive for your account. A professional may be able to identify areas in which your investment is underperforming and thereby increase your overall net return even once their fees are taken into account.

Evaluate Your Options. You may have more options available to you when it comes to structuring the fees you pay than you realize. For example, some custodians let you choose how your annual account maintenance fee is structured, whether that’s based on a percentage of your total account value, an asset by asset calculation, or even a flat fee that covers your account as well as the accounts of your immediate family members. You may be able to save a significant amount of money next year simply by going back to your custodian’s fee schedule and taking another look.

Getting A Head Start On Your Annual Self-Directed IRA Contributions

Posted on March 12, 2015April 13, 2021 by questadmin

Estimated reading time: 2 minutes

How much do you plan to contribute to your self-directed IRA this year? The annual limit for IRA contributions for 2021 remains unchanged at $6,000, with an additional $1,000 contribution permissible for taxpayers aged 50 and older. Hopefully you plan to contribute the maximum allowable amount, and you’ve been making such maximum contributions every year for quite a while.

Now the trickier question; when do you plan to make those contributions? If you’re like most IRA account holders, you’ll wait until the end of the year to make your contributions. But when you think about it, there’s no reason to automatically consider your IRA contributions to be an end of the year financial matter.

By getting a head start on your annual contribution, and making the contribution to your account earlier in the year, you’ll give your money the most time and greatest opportunity to grow. Here are some tips for getting that jump on your future.

Use Your Tax Refund. If you’ve already planned for how you’re going to spend your next tax return, then you might want take another look at your plan. This might seem like a tough adjustment the first year you make the change, but if you can create a new habit for yourself it can really pay off for you in the long run.

Anticipate Future Deductibility and Make a Contribution Now. If you have a good idea of how much you’ll pay in taxes this year, and how much of a refund you expect to receive, then you may be able to find a way to bridge the gap until you receive the refund and make your deposit immediately. Again, given the significant value that can accrue from having money in your account longer, being able to shift each annual contribution up slightly earlier, even if it’s just a matter of an extra month or two each year can really boost the value of your nest egg by the time you reach retirement.

Maximize Your Prior Year Contributions First. Remember that you have until you file your prior year’s taxes. Still, if you haven’t been able to maximize your prior year’s contributions yet, you should first make those prior year contributions. Your annual contribution amounts are a “use it or lose it” proposition, so making sure not to lose any opportunity to make a contribution should be your primary consideration.

The specific methods you use to make your annual self-directed IRA contributions as early as possible each year will vary, depending on your other financial circumstances. But given how important this can be for your financial health during retirement, it’s worth your time and effort to do so.

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.