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How To Invest With A Self-Directed IRA

01 Sep
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How To Invest With A Self-Directed IRA

8 Things You Should Know About Self-Directed IRAs

If you’ re looking to diversify your portfolio to include real estate overseas—as you should be—you may be hoping to fund that investment strategy with the help of your IRA or 401(k).

Buying property with a self-directed IRA allows you to generate income and capital gains free from U.S. income taxes (until you finally withdraw funds from the account).

But, while the self-directed IRA can produce a windfall of investment capital, it comes with a few strings attached. IRAs require a special setup, advance planning, and are bound by a handful of restrictions.

The term “self-” is sometimes used to describe IRAs with companies like Schwab and Fidelity because you can pick your own investments. But these are not truly “self-directed,” as you can only pick from the options they give you. Believe me, a condo in Belize or a few physical gold bars won’ t be among your choices at Fidelity.

A truly self-directed IRA allows you to invest in anything the law allows, from condos or bullion to currencies and beyond.

Here are eight things to understand to help you take maximum advantage of this investment option:

All IRAs require a custodian, by law

The IRA custodian is usually a bank or trust company. The custodian’ s job is to make sure the IRA—whether self-directed or not—is compliant with the law, and that all investments are permitted by IRS regulations. The custodian reviews and approves all investments made by your IRA. Custodians charge fees for their services. The fee structure varies from one custodian to another.

Facilitators and financial advisors are not custodians

In the world of self-directed IRAs, there are a bevy of financial service companies and financial advisors who bring “account setup and administration services” to the table and provide an interface between you and the custodian. Often these financial service companies claim to be custodians, but most are not. Their fees will be on top of any fees charged by the custodian.

There is a US$7,000 annual contribution limit (for 2022) for any IRA for those 50 or over… US$6,000 if you' re under 50

Whatever you contribute to the IRA is deducted from your taxable earned income. Note: If you have significant self-employment income and would like to tax-defer more than US$7,000 per year, a 401(k) might be a better option than an IRA. We’ ll cover self-directed 401(k)s next month.

You can fund your self-directed IRA with a "rollover" from either another IRA or a 401(k)

A “rollover” means that the funds went directly from the old IRA to the new self-directed IRA, without passing through a non-IRA account. These “direct rollovers” are not taxable.

You can create a self-directed Roth IRA, rather than a traditional IRA

With a Roth IRA, you fund it with after-tax dollars… so there’ s no current-year tax deduction. But thereafter, all earnings and profits from the IRA grow tax-free. Whether a Roth is better for you depends on your age and your personal financial situation.

IRAs cannot be jointly held with a spouse (or anyone else)

A 401(k) will permit a joint account, and we’ ll cover that next month.

You can pair your self-directed IRA with an LLC

In order to circumvent the custodian’ s review, you can form a limited liability company (LLC) and then invest your IRA funds in the LLC, with custodian approval. Thereafter, as manager of the LLC, you can have the LLC make the actual investments without custodian approval. This gives you what the industry calls “checkbook control” of your retirement funds. The LLC, of course, brings an added layer of expense, complexity, and reporting requirements. More on this process in a minute…

Required Minimum Distributions (RMDs) are mandatory withdrawals from IRAs, which you must begin taking at age 72

It’ s the government’ s way of making sure you start paying tax on these tax-deferred savings. Be sure there’ s enough cash available, between all your IRAs, to take that withdrawal. RMDs do not apply to Roth IRAs, since their balance is not taxable.

Lief Simon