Help Understanding Self-Directed IRAs
Should I be using a self-directed IRA (SDIRA)? What should I be considering? Should I keep it in the 401k? Should I roll it over? Do I have a self-directed IRA and just not know about it? I am so confused, what should I do?!?
Does this sound like you when you hear “self-directed IRA?”
Don’t worry, you’re not alone with these questions. So many of my clients have come to me inquiring about how to best utilize their IRA or old 401k.
Before we jump into how to use a self-directed IRA or if you should even have one, let’s get some background on it.
What is a Self-Directed IRA?
Understand, I am not a licensed securities broker and I’m not giving investment advice. But I do have a lot of experience with SDIRAs. I was a financial advisor for four years and in that time, I never really understood how a self-directed IRA worked. It wasn’t until I was a stock coach that I was told you can trade stocks inside of your SDIRA instead of buying common mutual funds. You can trade stocks with these, but you have to be careful because the IRS won’t let you do certain types of strategies, like many stock options strategies, collectibles, etc. You get to invest your own money as long as the government approves of your strategy.
Another great benefit is you can invest in strategies that can yield a higher return than common mutual funds where you may be paying expensive 401k administration fees, while earning mediocre returns.
The most important part of SDIRA you have to remember is, it is self-directed, meaning you are in control of the alternative investments you want to put into it. Your SDIRA custodian doesn’t give you financial advice. You need to be well researched and plan out your strategy before you invest.
Will Self-Directed IRAs Work for Retirement?
So if you have the goal to retire before your 60’s, this may not be the vehicle to get you there. The rules are the same with a self-directed IRA, as it is with any qualified plans like 401ks… you need to wait until you’re 59.5 before you can access this money without the 10% early withdrawal penalty. On the other hand, if you are willing to wait until your 60’s, this strategy can work really well.
Certain Investments Work Better With Self-Directed IRAs
If you want to put your real estate properties in SDIRAs, I would suggest caution. First, you lose the tax benefits. Second, you could be taxed TWICE on your cash. And, just like other IRAs, if you withdraw before you’re 59.5, you get a 10% penalty for early withdrawal. Your money could be taxed while it is sitting there (UBIT), and taxed again when it comes out (ordinary income tax). That defeats one of the purposes of owning an investment property where, through depreciation write-offs, you could reduce the taxes on your passive income.
A “Backdoor” Roth IRA can be a useful strategy here. You can convert your self-directed IRA to a self-directed Roth IRA, and after 5 years, and turning 59.5 years old, you can pull out that money tax-free! You will be required to pay income taxes on the money you roll over into a Roth, however. But after that, it grows tax-deferred and comes out tax-free.
The general rule of thumb – look to invest in assets where there are few or no tax advantages in the first place, such as certain types of funds, lending, syndications, and so forth.
Here is a list of investment strategies that work well with self-directed IRAs:
- Stock Trading
- Real Estate Syndications
- Life Settlements
- Active Real Estate Investing, like notes, liens, and land transactions
Interested in learning more about Self-Directed IRAs?
Hopefully, this article has given you a bit of direction on how SDIRAs differ from traditional IRAs. SDIRA can be a helpful tool when diversifying your investments. If you are well-educated on your investments and understand what type of investments work in your self-directed IRA strategy, they can be a great tool.
Do you still have questions about how to use a SDIRA? You can ask me anything, just fill out the contact us form right here on the website.