There’s no way around it: Taxes are a drag on retirement savings efforts. Any taxes you pay represent money that you can’t use for your own support during your retirement years. Self-Directed IRA owners, like anyone else, should be vigilant about paying needless taxes and penalties. However, they should not go so far as to let the tax ramifications of an investment decision drive the whole train. “Don’t let the tax tail wag the investment dog,” the saying goes.
So Self-Directed IRA owners should certainly look to hold the investments, or combination of investments that generates the highest risk-adjusted expected returns possible, while hedging against unknowns. But there are still ways to trim the tax bill on the margins.
- Choose a low-tax jurisdiction. Of course, ‘low tax’ depends on your portfolio and your behavior as a consumer, as well. Do you expect to have a very high income in retirement? That’s not a terrible problem to have. But it does mean that you may want to domicile in states that don’t have a state income tax on IRA income, such as Texas and Florida. If you want to live in a state with high income tax, then lean towards the Roth IRA, Roth 401(k), permanent life insurance and other tax-free investment or savings vehicles.
If your income is lower, though, and you expect you will have to spend most of your available income, then sales tax may be the bigger threat. States with no sales tax at the state level include Delaware, Montana, Oregon and New Hampshire. High sales tax states include Tennessee, Arkansas, Alabama, Louisiana and Washington, according to information from The Tax Foundation.
- Take your required minimum distributions. Yes, you will have to pay income taxes on RMDs you take from tax deferred retirement vehicles like self-directed traditional IRAs, traditional IRAs, SEPs, 401(k)s, 403(b)s and annuities. But the consequences for not taking the RMDs are even worse: 50 percent of the amount you were supposed to take out but didn’t. That’s much higher than any tax bracket even the wealthiest retirees need worry about.
- Begin taking withdrawals before you have to. Yes, this may be counterintuitive. But if you begin taking withdrawals when you retire at age 62, and squirrel them away in tax-efficient non-retirement accounts, you may be able to rescue some retirement money from higher marginal tax brackets in later years. Meanwhile, you can use real estate, index mutual funds, low-turn-over mutual funds, and growth stocks to continue deferring the vast majority of these assets from income tax and capital gains tax liability until such time as you choose.
- Convert to a Roth. This may work for anyone expecting to retire in a higher tax bracket or who believes their income in future years will be higher than it is now. By converting a part of your Self-Directed IRA or traditional IRA to a Roth account, you can pay today’s tax rate on the money rather than tomorrow’s. This technique works best done relatively early in retirement or when earnings from work and other sources is unusually low and expected to be greater in the future. It also works best if you can pay the income taxes from funds outside your retirement accounts.
- Concentrate income-heavy investments, or assets with most of their returns in the form of income, rather than capital appreciation or qualified dividends, in retirement accounts. Non-dividend-paying securities may do just fine in taxable accounts, where you would pay lower long-term taxes on capital gains and qualified dividends. If you expect lots of capital appreciation, though, try to find room in your Roth IRA or self-directed Roth IRA or Roth Solo 401(k) for this particular investment.
American IRA, LLC, based in Charlotte and Asheville, North Carolina, is among America’s leading experts in IRA administration, with a particular focus on Self-Directed IRAs. For a free, no-obligation consultation and complementary review, or for more information, call us today at 866-7500-IRA(472)
We look forward to working with you.