Table of Content
- What is a Self-Directed IRA?
- Traditional vs. Roth Self Directed IRA
- Benefits of Self-Directed IRA
- How does a Self-Directed IRA work?
- Setting up a Self-Directed IRA
- Checkbook Control
- Self-Directed IRA (SDIRA) Investment Options
- Self-Directed IRA (SDIRA) Rules
Last updated on July 28th, 2021
Written by: Rick Pendykoski
What is a Self-Directed IRA?
A Self-Directed Individual Retirement Account (SDIRA) is an individual retirement account (IRA) that gives you more control over your retirement savings. Although SDIRA is administered by a trustee or a custodian, it is directly managed by the account holder, hence the name “self-directed.” Self-directed IRA’s allow you to make a variety of investments that are usually not available from regular IRAs.
Self-Directed IRAs can be either Traditional or Roth. A traditional IRA contribution is before tax meaning the contribution amount is tax deductible. A Roth contribution on the other hand is after tax – meaning you do not get a tax deduction. Later in life when it comes time to take a distribution from the IRA, the Traditional distribution will be taxed but the Roth distribution will be tax free! If you are a savvy investor looking to diversify in a tax-advantaged account, Self-Directed IRAs are well suited to your investment needs.
IRAs established and administered by brokerage firms, banks, and other institutions, tend to limit you to bonds, mutual funds, or stocks. Self-Directed IRA allows you to invest in alternative assets, such as LLCs, gold, limited partnerships, real estate, and more.
By law, every IRA has to have a custodian; so, the choice of custodians is critical. Some custodians have investment products they force you to invest in. Some have asset and/or transaction fees. Self-Directed Retirement LLC uses passive custodians. We also take the self-directed IRA to a new level. Custodians generally do not allow for or have checkbook capabilities. We always create an underlying LLC for our IRA clients. This LLC is “owned” by the IRA. Our clients, then open an LLC checking account at a financial institution of their choice So, at the end of the process, our clients are managers and check signers of the LLC and have true autonomy for investment selections. Of course, we help them through the whole process.
Traditional vs. Roth Self-Directed IRA
Although Self-Directed IRAs can be set up as traditional IRAs or as Roths, they have different eligibility requirements, tax treatments, contribution guidelines, and distribution rules.
As a reminder, a key difference between a traditional and Roth IRA is the tax treatment to each of these accounts. With a traditional IRA, you are not taxed on your contributions, but taxes are applicable when you withdraw your contributions during retirement. On the other hand, with a Roth IRA, you pay taxes when you make your contributions, your contributions and earnings grow tax-free, and your withdrawals/distributions during retirement are also tax-free.
Here’s a quick rundown of other differences
|Traditional IRA||Roth IRA|
|Income limits||There are no income limits||There are income limits that needs to be met according to the IRS rules|
|Required minimum distributions (RMDs)||Must start taking RMDs at age 72||No RMDs during your lifetime|
|Early withdrawals||You can withdraw penalty-free starting at age 59½. All withdrawals are taxable.||Withdrawals are tax and penalty-free after age 59½ if you have had the account for a minimum of five years.|
Benefits of Self-Directed IRA
- The Flexibility to Truly Diversify / Diversified portfolio for potential growth A Self-Directed IRA brings you the freedom to diversify your financial portfolio into lucrative assets like property, mortgage notes, foreign currency, annuities, raw land, limited liability companies, and many other investments. If you have the required knowledge and expertise to succeed with a particular investment type, you can leverage the asset to help secure your financial future.
- Build Wealth for Future Generations
A new law came into effect January 1st called “Secure”. It basically is a tax grab by the IRS to the tune of $15 Billion!. One of the main features of the law is the elimination of STRETCH IRA’s. Before this law an IRA beneficiary could pay RMD’s over their lifetime, not the deceased. Now IRA beneficiaries have to distribute the entire IRA over ten years. This has huge tax disadvantages if you don’t know how to use existing rules. At Self Directed Retirement Plans LLC, we know how to maintain the STRETCH provisions. We cannot stress how important this is for generational planning!
- Excellent Tax Advantages
Being a tax-advantaged account, a Traditional Self-Directed IRA brings you the benefit of significant tax deductions, which help you create lasting wealth. With a Roth IRA you can combine tax-free profits with investing diversity for long term financial freedom.
- Complete Control
You have full control over your retirement funds as long as you are making investments that meet the requirements of your retirement plan.
How does a Self-Directed IRA work?
- Open a Self-Directed IRA Account
You’ll need to appoint a qualified IRA custodian that specializes in such types of accounts.
- Fund the Account
Transfers and new contributions are the main funding vehicles for self-directed IRAs. Transfers can come from the following: Any qualified retirement account can be rolled over or transferred to a Traditional IRA. Only Roth funds can rollover to a Roth IRA. For example, IRA’s, SEP’s, KEOGHS, MONEY PURCHASE PLANS, 401(k) s, 401 a’s etc can be rolled over.
- Identify Where to Invest
You can invest in stocks, mutual funds, and CDs, or expand your investment portfolio by investing in precious metals, real estate, etc. After you have decided on where to invest, you will simply write a check from the LLC and “that’s it”.
- Request Funds to Purchase IRA Investment
There are two main ways to employ a Self-Directed IRA. For people who don’t know about using an underlying LLC they send instructions to the custodian to send a check or wire and purchase the investments in the name of the IRA. This is what custodians prefer because it allows them to charge for activity fees, etc. continuously. The second and most preferred way is to use an underlying LLC. At Self Directed Retirement Plans LLC, we establish state-approved LLCs for each client. The LLCs are “owned” by the Self-Directed IRA and become the investment arm for the IRA. Our clients open a checking account for the LLC at a bank of their choice. We assist them in transferring the funds from the IRA (custodian) to the new self-directed IRA LLC checking account. Now they have a truly Self-Directed IRA with checkbook control. When an investment opportunity arises, they simply write a check and immediately take advantage. There isn’t any waiting for permission etc.
Setting up a Self-Directed IRA
At Self Directed Retirement Plans LLC, we assist and guide the client through every phase of establishing a true self-directed IRA. Educating the client is a large part of our service. In many cases, this is a new and sometimes scary world the client is entering and we do our best to inform the client and make them comfortable with their decision.
Below is a brief description of the steps we take to establish a self-directed IRA.
- Establish the new self directed IRA account.
- Assist the client to transfer their funds.
- Create a new state LLC that becomes the investment arm for the SD IRA.
- Using a SS4 IRS form, we obtain a new EIN for the LLC.
- We create a proprietary operating agreement for the LLC.
- We co-ordinate with the custodian all the required documents, such as transfer requests, Direction of Investment Letters (used to fund the LLC), LLC operating agreement, banking instructions etc.
One of the most important things we do is make ourselves available to answer all the client’s questions along the way and especially down the road. Nothing beats years and years of experience.
The Checkbook control allows the IRA holder to make investment decisions, write a check, and take charge. Checkbook control eliminates the need for a Third Party Administrator or TPA. Most custodians adhere to the TPA model because it is very profitable. Imagine having to “ask” the custodian’s permission to invest your own money. Not only is it expensive, but very time-consuming. Compare that with the ability to immediately make a decision, write a check, and add assets to the self-directed IRA!
Self-Directed IRA (SDIRA) Investment Options
The investment options with a self-directed IRA are virtually limitless, provided that the guidelines laid down by the IRS are followed. Some of the permissible alternative investments are but not limited to:
- Real Estate – residential and commercial
- Raw Land
- Precious Metals
- Trust Deeds/Mortgage and Mortgage Pools
- Private Notes and Loans – e.g., Loans to a non-disqualified person for a car, etc.
- Private Stock Offerings – also referred to as PPMs
- Limited Liability Companies – LLCs
- Limited Partnerships – LPs
- Tax Certificates – Tax Liens
- Commercial Paper
- And MANY other investments
Self-Directed IRA (SDIRA) Rules
Although the guidelines for self-directed IRAs are almost similar to other retirement accounts, it’s important to get familiarized with Self-Directed IRA rules and regulations. These include prohibited transactions, distribution rules, IRA contribution limits, and more.
- IRA Contribution Limits
Each type of IRA has a maximum dollar amount that can be contributed each year. The IRA contribution limits are provided and enforced by the IRS. Check the IRA contribution limits here.
- Disqualified persons
- The IRA holder and his or her spouse, ancestors, lineal descendants, and their spouses.
- Investment advisors and managers.
- Any corporation, partnership, trust or estate in which the IRA holder has a 50% or greater interest.
- Anyone providing services to the IRA, such as a trustee or custodian.
- Prohibited Transactions
- Collectibles – artwork, rugs, antiques, metals, gems, stamps, collectible coins
- Stock in an S-Corporation
- IRA Distribution Rules
IRA distributions, or the withdrawal of an asset or cash, can be made at any time. However, certain criteria will determine whether there are penalties and taxes associated with any distribution.