Diversity is key to both managing investment risk and growing your investments. Yet with most tax-qualified retirement savings vehicles, your investment options are limited to mutual funds, bonds, and ETFs. While you can diversify within the sub-classes of these types of investments, they’re all still tied to the stock market. A self-directed IRA, however, provides more choice and more opportunity. By opening a self-directed IRA, you open the door to a wide array of investment alternatives, and you don’t need to be a millionaire to have one. Here are the top 10 things you should know about self-directed IRAs.
With a self-directed IRA, a world of potential investments is available to you. For example, you could invest in a limited liability company (LLC), real estate, gold or private equities. Financial professionals can help you evaluate investment opportunities, risks, and costs, but there are few actual restrictions on your options. You decide when and how much to contribute. Each year you have the option to contribute up to the annual limit ($6,500 for 2020) or to contribute nothing for that year. And you can take your investment or your money out whenever you want (10% early distribution tax applies to taxable distributions before age 59½ if you don’t meet an exception).
Depending on the types of alternative investments you select, you may achieve multiple investment objectives within your self-directed IRA. For example, some investors seek to invest in an asset that not only grows in value over time, but also produces rental or business income each year. A self-directed IRA can also be used to maintain some liquidity with cash assets or publicly traded investments, as well as alternative investments that fit more long-term objectives.
Annual contributions to your self-directed traditional IRA are tax-deductible following the same rules that apply to traditional IRAs, and investment growth within the IRA is tax-deferred. This means you generally will not have to pay tax on investment earnings until you take the asset or the funds out of the self-directed IRA. (An exception applies to earnings from investments deemed to generate Unrelated Business Taxable Income, which are taxable).
Although no deduction is allowed for contributions to a Roth IRA, the tax benefit can be significant when you decide to withdraw from the Roth IRA. If you take a qualified distribution, all investment gains are tax-free. This can be significant if your investments increase significantly in value or you want access to tax-free income in retirement. Distributions are never required while you’re alive, which allows you to continue growing your savings. And you can contribute at any age as long as your income is within certain limits.
Many investors are now choosing investments based on their social or environmental impact in addition to potential investment returns. You could invest solely in green companies, or in ventures focused on combatting global warming. You could use your investments to support women-owned businesses or to boost capital for businesses in your hometown. If you have professional expertise or a special interest in an area such as real estate or precious metals, a self-directed IRA allows you to capitalize on that knowledge.
Self-directed IRAs may be funded through transfers and rollovers from other IRAs and rollovers from employer-sponsored retirement plans. You can liquidate your investments first or you may be able to move the investment or physical asset “in-kind” (i.e., without being liquidated). If an investment is moved in-kind from another IRA, the transfer or rollover into the IRA must be the same property that was distributed from the other IRA. There is no dollar limit on transfers and rollovers, and they do not count toward your annual contribution limit each year.
You can save in a self-directed IRA even if you contribute to an employer-sponsored retirement plan. The only requirements for contributing to a self-directed traditional IRA are having earned income and being younger than age 70½. If you participate in an employer plan, then your eligibility to deduct annual self-directed IRA contributions may be affected depending on your level of income (just as it would with a regular IRA).
Self-directed IRA assets are protected from creditors in a bankruptcy proceeding up to approximately $1.3 million (subject to increases every three years). In addition to this exemption, individuals may exempt an unlimited amount of self-directed SEP and SIMPLE IRA assets and an unlimited amount of assets that have been rolled over into a self-directed IRA from a qualified retirement plan. (The protections for IRA assets from creditors outside of bankruptcy proceedings is subject to state law.
You may have heard that self-directed IRAs are risky because of the potential for a “prohibited transaction” with alternative investments. But it’s not the investments that are prohibited (only life insurance and collectibles are expressly prohibited). The tax code limits the interactions you and others can have with the investments in your IRA. In general, make certain that neither you nor your family members are buying, selling, borrowing or benefitting from your IRA investment. For example, you cannot use the real estate owned by your IRA as your vacation home
Certain IRA custodians specialize in providing custodial services for alternative IRA assets that you may want to hold in your self-directed IRA, as well as the more traditional publicly traded assets. You have the freedom to select an IRA custodian that provides the services and support you need to manage your self-directed IRA and investments.
Visit Mainstar Trust to find out more about self-directed IRAs. To open a self-directed IRA with Mainstar Trust, you can access the account opening instructions here. If you have any questions, please contact our team at 1-800-521-9897 or email@example.com.