Self-directed IRAs have been around a long time, and their increasing popularity has grown over time, especially with those who like a lot more control in their financial future. A self-directed IRA provides diversification of assets for everyone from the average Joe to investors looking to expand beyond stocks, bonds and treasuries.
A self-directed IRA involves a custodian holding your money in the account and makes investments in things like real estate, private placements, and metals for you based on your directive. Self-directed accounts put more responsibility on you, meaning you have to understand all the rules governing any particular investment and the tax implications. Not to mention you’ll have to do your own due diligence when choosing investments.
For complex investment opportunities, particularly those which involve the opening or creation of a new account outside a traditional financial institution or well-recognized broker, investors should consider getting a second opinion from a licensed unbiased investment professional or an attorney.
Traditional Self-Directed IRAs
Contributions: Each year you can contribute $6,000 annually to your IRA, plus an additional $1,000 for catch-up contribution if you have reached age 50 or older.
Taxes: You are potentially eligible to deduct Traditional IRA contributions and in turn get a tax break for the year you make the contribution. In order to receive that tax break though you must meet certain requirements.
Age limits: You can only contribute to your Traditional IRA until you reach the age 70.5.
Income limits: There are no limits to contributions based on your income.
RMDs: Traditional IRAs are subject to required minimum distributions (RMDs). You must begin to take RMDs by April 1 of the year following the year you reach age 70.5. Regardless if you need the funds you must start taking this distribution.
Penalties: Traditional IRA contributions are generally treated as ordinary income and subject to income taxes. If you withdraw from your IRA before 59.5 you may be subject to early-distribution penalties that can be up to 10% penalty tax.
Self-Directed IRA Investments are not Guaranteed
Like any and every investment, there’s no such thing as a “sure thing”. While that’s unfortunate that there’s no guarantee, that doesn’t mean that investments should be avoided, it just means that you, as the investor, should just tread lightly.
Consulting with a seasoned and qualified provider, doing due diligence and research into an investment beforehand, and keeping a pulse on technology, like apps, startups, and gadgets are your best bets for secure investments.
Borrowing and Lending Money
Borrowing and lending in a self-directed IRA gives the owner the ability to loan their IRA money to non-disqualified persons. How it works is that if pre-agreed to, an IRA can receive a certain amount of principal and interest, just like a bank would. What’s appealing is that the IRA holder chooses who to lend to, the interest rate, the principal amount, length of the loan, payment amount, and frequency, and whether the loan is secured by collateral or not.
Play by the Rules
Every IRA has a list of persons and entities that are considered disqualified to that IRA. IRS rules prohibit the IRA from dealing with these people and entities. Any transactions that do take place between an IRA and Disqualified Persons result in what’s called a Prohibited Transaction.
One of the easier ways someone can violate self-directed IRA rules is by not understanding who exactly is a disqualified person. According to the IRS, these people include the IRA owner’s parents, spouse, children, and grandchildren. These people are excluded from benefitting from the IRA owner’s investments, for example, if the IRA owner’s adult child needs a home to rent, and the IRA owner has property in their IRA, their child cannot stay in that investment property.
Those disqualified persons to an IRA cannot buy or sell any asset from the plan. Nor can they make personal use of an asset. Disqualified persons cannot live in or rent IRA-owned real estate, nor can they provide “sweat equity” to that property.
Your IRA cannot acquire life insurance or collectibles as assets. Some examples include:
- Any work of art
- Rugs or antiques
- Stamps or collectibles
- Any alcoholic beverages
- Life insurance
Investing in your retirement doesn’t have to be complicated or unnerving, it can be easily navigated and even fun at times, so long as you have the right people working with you and for you, and always have your best interests at heart.