What is a Self-Directed IRA?
The Self-Directed IRA was also authorized by Congress in 1974. A Self-Directed IRA is the same as a Traditional IRA. It is just set up to hold some non-traditional asset, like real estate, farms and ranches, closely-held businesses including partnerships and LLCs, cryptocurrencies and tokens, venture capital investments, hedge funds, private placements, private lending, equipment leasing, and a wide variety of other assets. These nontraditional types of investments are called alternative asset classes.
What You Need to Know
Early Withdrawal Penalties
Congress imposed a 10 percent excise tax on amounts withdrawn prior to age 59½, to encourage Americans to use the IRA to fund a more secure retirement.
Congress also foresaw that if they made it too difficult for contributors to withdraw their funds in an emergency, it would discourage contributions. So Congress made exceptions to the 10 percent early withdrawal penalty. The exceptions are for several hardship conditions, such as the death or total disability of the taxpayer, to forestall eviction or foreclosure, or to pay for medical bills.
Congress also allows taxpayers to take early distributions from Self-Directed IRAs to fund education expenses, a down payment on a home for the account owner or a family member, or as part of a series of substantially equal periodic withdrawals for early retirees, under Section 72(t) of the Internal Revenue Code.
Required Minimum Distributions (RMDs)
Congress did not want to grant wealthier Americans a way to defer taxes on Self-Directed IRA contributions and growth forever. That would constitute a significant tax subsidy to the rich at the expense of the rest of the tax base. So, in addition to the income limits and thresholds, Congress also requires Self-Directed IRA owners to begin taking distributions – and paying income taxes on these distributions – by April 1st of the year after the year the IRA account owner turns age 70½. These distributions, called “required minimum distributions,” or RMDs, are mandated by law.
Wealth Protection Benefits
In addition to the tax deferral benefits (and the benefit of tax-free growth for Self-Directed Roth IRAs), assets in Self-Directed IRAs enjoy substantial protection from creditors under federal law and in all 50 states. This means if you are sued, personally, or declare bankruptcy, your creditors generally cannot seize IRA assets that you rely on for your retirement.
Inherited Self-Directed IRAs do not receive the same level of protection as Self-Directed IRAs that you fund yourself.
What Investments Can I Own Within a Self-Directed IRA?
You can invest your Self-Directed IRA money in almost anything you like. Most people are accustomed to thinking of Self-Directed IRAs as principally a vehicle for mutual funds, stocks, bonds, cash and annuities. These are the assets that Wall Street companies market to us every day. But the Self-Directed IRA is a much more flexible investment vehicle than most people realize.
With Self-Directed IRAs, you are not limited to the menu of stocks, funds and bonds that your broker or financial advisor has in his or her inventory. You have a whole universe of investment options, and you can think beyond paper securities and hold all kinds of assets. Congress only set a few limits on what can be held in a Self-Directed IRA account. So, you can invest in almost anything, with just a few limited exceptions.
Here are the types of assets you cannot own within a Self-Directed IRA:
- Life insurance
- Jewelry and gems
- Alcoholic beverages (i.e., wine collections)
- Gold coins and bullion of inconsistent or insufficient purity
- Shares of S corporations
That is it.
The Self-Directed IRA structure allows you to hold any other investment asset you can imagine, other than these few exceptions. Which means it is possible to fully diversify your retirement assets across a much broader spectrum of the economy than most people think possible.
In some cases, you may need to pay attention to how to title the asset. For example, if your Self-Directed IRA purchases a rental real estate property, you will need to ensure the property is titled in your Self-Directed IRA’s name, not your own personal name.
The freedom the law allows when it comes to Self-Directed IRA investments means that you do not need to rely on your broker or financial advisor to invest. You can choose to ‘self-direct your IRA.’
This means breaking free of your financial advisor, mutual fund manager, broker or other Wall Street employee or salesperson, and taking a more direct managerial role in your own retirement investing.
You are still using the same underlying Self-Directed IRA structure. But by bypassing Wall Street, you can expand your ability to diversify into a nearly infinite array of alternative asset classes and investments.
The result: Greater potential diversity, and greater potential risk-adjusted returns.
What is a Self-Directed IRA?
An ordinary non-Roth Self-Directed IRA is the same as a Traditional IRA. It is just set up to hold some non-traditional assets, like real estate, farms and ranches, closely-held businesses including partnerships and LLCs, cryptocurrencies and tokens, venture capital investments, hedge funds, private placements, private lending, equipment leasing, and a wide variety of other assets. These nontraditional types of investments are called alternative asset classes.
Why use alternative asset classes?
The chief benefit of using Self-Directed IRAs to invest in alternative asset classes is diversification. Many conventional assets are closely correlated with the performance of the U.S. stock or bond markets. So, one significant correction in stocks could take a lot of other assets down with it. Therefore, it can be dangerous to keep your entire investment portfolio invested in the conventional asset classes sold by most investment companies: Stocks, bonds, cash and cash equivalents (money markets and CDs).
Maintaining exposure to alternative asset classes can help you cancel out stock market, bond market or interest-rate risk, while keeping you invested in an asset you believe will still generate profits over the long run.
Common alternative asset classes that you can own within a Self-Directed IRA include:
- Privately-traded REITs
- Precious metals (coins and bullion), provided you do not take direct possession
- Hedge funds
- Venture capital
- Oil, gas and pipeline interests
- Mining and timber ventures
- Private lending portfolios
- Foreign real estate
- Asset-backed securities
- Tax liens and certificates
- Long-short funds
- Cryptocurrencies and crypto tokens
In fact, professionally managed pension funds and insurance company portfolio managers controlling billions of dollars commonly use many of these alternative asset classes to help keep their portfolios diversified and maximize risk-adjusted return.
Alternative assets tend not to have a high correlation with the U.S. stock market. So even when there is a stock market correction or even a full bear market, alternative asset classes may be holding their own or even prospering. Hence much of the risk of investing in stocks is canceled out.
Meanwhile, in some cases, the alternative assets themselves can make outstanding long-term investments.
Why is my financial advisor not talking to me about this?
Most Wall Street financial advisors get paid to bring investments into the company. If they are commissioned, they can only get compensated for selling the investment products that their company sells and is equipped to handle.
So even if your retirement portfolio is woefully underweighted in, say, real estate, your financial advisor typically has no interest in convincing you to purchase real estate. In fact, if they do, their parent company could fire them for “selling away.” That is, selling assets outside of their company.
In many cases, financial advisors and brokers are not even aware of the advantages of Self-Directed IRA investing, and they know little or nothing of how it works.
Who should consider a Self-Directed IRA?
Self-Directed IRA investing may be an excellent idea if some or all the following conditions apply to you:
- You want to diversify against stock market risk.
- You want to diversify against bond market and interest rate risk.
- You want to hedge against the possibility of significant economic dislocation.
- You have a tradeable competitive advantage in a specific field and you want to leverage your Self-Directed IRA assets in this field.
- You do not want to pay an outsized percentage of your assets in expense ratios or assets under management fees.
- You enjoy real estate investing, or other common types of Self-Directed IRA investing.
- You are willing to do your own due diligence.
- You are willing to take more direct responsibility for your investments.
Common Types of Alternative Assets Held in Self-Directed IRAs
Here is a brief list of the types of alternative assets most commonly held within Self-Directed IRAs. Keep in mind there are thousands more.
- Rental real estate
- Multi-family real estate
- Fix-and-flip real estate opportunities
- Gold and precious metals (coins and bullion of established purity)
- Cryptocurrencies and tokens
- Private lending
- Tax liens and certificates
- Oil & gas investments
- Limited Liability Companies (LLCs)
- Joint ventures
- Hedge funds
- Venture capital
- Private placements
- Farms and ranches
- Equipment leasing
- Sports teams
Again, your only limitations are the prohibitions against life insurance, collectibles, jewelry and gemstones, alcoholic beverages, and S-corporations.
Gold and Silver Self-Directed IRAs
Precious metals such as gold, silver, platinum and palladium are proven long-term hedges against economic decline and uncertainty. They deserve a place in any long-term investment portfolio, and they often do best when paper assets such as stocks and bonds are falling. Congress approved gold and other precious metals as an investment for Self-Directed IRAs in 1997. Self-Directed Precious Metal IRAs are commonly referred to as Gold IRAs or Silver IRAs.
Self-Directed IRAs cannot own jewelry or gemstones directly as an IRA investment. But you can own a wide variety of types of coins or bullion.
Your holdings must adhere to strict rules regarding purity of precious metals. All coins and bullion must meet the following purity thresholds:
- Gold: 0.995%
- Silver: 0.999%
- Platinum: 0.9995%
- Palladium: 0.9995%
Exception: Gold American Eagles are authorized for Self-Directed IRAs, even though they do not consistently meet the purity criteria.
IRS Rules allow you to purchase the following coins:
- American Eagle (bullion and proof coins, non-graded)
- American Buffalo (non-proof, non-circulated only)
- Australian Philharmonics
- Australian Kangaroos
- Canadian Maple Leaf’s
- Australian Platinum Koalas
- Isle of Man Nobles
And many others.
However, some coins are forbidden. The well-known South African Krugerrand coin, for example, while popular with collectors, is not authorized to hold in Self-Directed IRAs. Mexican 50 pesos coins and old American gold coins are also not authorized for Self-Directed IRAs due to purity rules, along with many other coins from around the world.
You cannot take direct possession of Precious Metal IRA assets. You cannot store them in a safe in your home, for example, or in a safe deposit box that you control. Your Self-Directed IRA account precious metal asset may not be held by you but must be held by a qualified depository. As a third-party IRA administrator, American IRA has relationships with qualified depositories around the county that provide this service to your Self-Directed IRA account.
Depositories vary, but you can choose them based on cost, security measures, insurance and bonding, and customer service considerations.
Tax Lien Investing in Your Self-Directed IRA
When a property owner becomes delinquent on his or her taxes, local governments still have a need for cash. When that happens, rather than foreclose on the property, a local government may offer members of the public a chance to pay property taxes on that property owner’s behalf. If you pay the taxes for the owner, you can then take out a first-position tax lien on the property.
Before the property can be sold, the owner must satisfy the tax lien. That means you must be paid back, with a very attractive rate of interest – frequently between 12 percent and 50 percent, depending on the laws in your local jurisdiction.
It is very easy to set up a Self-Directed IRA to make tax lien investments. They are very illiquid – you never know when the owner is going to pay you back – but your interest is secured by the property itself. Because the tax lien is a first-position lien, you will be first in line for repayment once a property is sold or foreclosed – even ahead of the original mortgage holder, if there is a mortgage on the property.
Again, specifics vary by jurisdiction. But generally, the property owner has a limited amount of time to pay off the tax lien or lien certificate – all the while interest accrues. After a certain amount of time elapses, commonly three years, however, government officials simply award the property outright to the lienholder.
Tax lien investments can be very beneficial for the Self-Directed IRA investor, not just because they are very safe returns with superior interest earnings compared to other types of debt instruments, but because these investments have little or no correlation with stocks. If your equity portfolio takes a nose dive, your tax lien or certificate will continue to perform.
For more information on tax liens and certificate investing in a Self-Directed IRA, download our free guide to tax lien investing by clicking the blue button at the top of this page, or click here.
Self-Directed IRA Lending
Self-Directed IRA lending is a very popular option among investors. You can lend cash in your Self-Directed IRA on any asset to any borrower, other than those borrowers specifically designated as prohibited or disqualified parties by law. In most cases, you can offer any terms, or any interest rate the market will bear, in most cases. Generally Self-Directed IRA lenders can command a significantly higher interest rate than they can get buying publicly-traded bonds, preferred stock, annuities or other more liquid forms of debt.
Your Self-Directed IRA can lend in any industry or field in which you believe you have a real market advantage and in which you can find willing borrowers. Examples include:
- Private placements
- Accounts Receivable
- Hard money lending
- Bridge loans
- Small-business loans
- Discounted notes
- Auto loans
- Equipment leasing
- Factoring accounts receivable
- Micro-lending and community lending
- Unsecured loans
- Asset-based lending
- Commercial lending
- Private education loans
- Student debt refinancing
And much more.
Note: American IRA, LLC does not handle collections. If you have a delinquent borrower or tenant, you and your attorney must handle collection actions, including legal actions, foreclosures, garnishments and evictions. We will, however, gladly provide you with any documentary evidence we have on file that you need to support your case.
For more information on how to use your Self-Directed IRA to engage in private lending, download our free guide. r call us today at 866-7500-IRA (472).
Owning a Business Within Your Self-Directed IRA
If you are willing to give up current income from your Self-Directed IRA closely-held business until you reach retirement age, you may consider owning your business within your Self-Directed IRA. The advantage: All income and capital gains tax from your business is deferred. Except for unrelated business income tax referred to as UBIT, you need pay no tax until you take distributions from your Self-Directed IRA.
Unrelated Business Income Tax (UBIT) comes from activity engaged in by a tax-exempt entity such as a Self-Directed IRA account that is not related to the tax-exempt purpose of that organization.
They are subject to a 21 percent rate.
If you hold it in a Self-Directed Roth IRA for at least five years and you are at least 59½ , you can get the benefit of all that growth tax-free!
A Self-Directed IRA is a great way to get tax-advantaged growth from your own LLC, partnership or C corporation.
Note: You cannot use your Self-Directed IRA to own an S corporation.
Holding a small business entirely within a retirement account works best for entrepreneurially-minded investors who have a solid understanding of the businesses they own, who have substantial liquidity within the Self-Directed IRA and who will not need to make large, unexpected cash infusions into these businesses.
You must pay any business expenses from funds within the Self-Directed IRA. You may not intervene with your own funds beyond the allowable contribution each year ( ), plus any allowable rollovers from other accounts.
Furthermore, Self-Directed IRA owners should not make payments to their closely-held business directly. Any moneys coming from outside the Self-Directed IRA should be directed to the third-party administrator, along with a deposit coupon, prior to the funds being deposited into your Self-Directed IRA’s cash account.
Interest in cryptocurrencies, crypto tokens and initial coin offerings (ICOs) has exploded in recent years. While crypto assets are as yet an unproven asset class, they certainly provide some diversification benefit when combined with stocks, bonds and other traditional asset classes. They are extremely volatile, but the potential exists for tremendous returns – as well as significant losses.
It is legal to own crypto assets within a Self-Directed IRA or other self-directed retirement account. Outside a Self-Directed IRA, cryptocurrencies get treated like commodities for tax purposes. But inside a Self-Directed IRA, your gains and any income generated by your crypto investments are treated like any other asset.
Holding the crypto assets is an issue, and one that is still largely undefined by the IRS. Self-Directed IRA holders must keep their assets carefully segregated from their Self-Directed IRA assets – so holding your crypto assets in a digital wallet in your desk may run afoul of IRS rules. For this reason, we recommend exercising extreme caution in holding cryptocurrencies and other crypto assets in a Self-Directed IRA unless you never touch the digital wallet.
Furthermore, hacking and theft have been significant issues on some cryptocurrency exchanges. Security, and the ability of any exchanges or counterparties you use to make good on any breaches, should be a foremost consideration.
For example, you could use your American IRA, LLC Self-Directed IRA to own shares in a fund that specializes in holding crypto assets, as you would with any mutual or hedge fund.
Checkbook IRAs are an increasingly popular type of Self-Directed IRA investment. It refers to the practice of holding a Single-Member LLC within your Self-Directed IRA. The Operating Agreement preparer must be an attorney or a facilitator company whose standard documents have been reviewed by legal counsel. Operating Agreements prepared by the Self-Directed IRA Participant, an accountant, or websites such as LegalZoom.com or BizFilings.com are not acceptable
This type of structure gives you the maximum level of control over your Self-Directed IRA assets. It also allows you to make decisions and commit funds very quickly. However, with this technique you are not running your transactions through an intermediary or administrator that can do a compliance review before you commit funds. For this reason, the checkbook control IRA is an advanced option that investors should employ with caution. The risk of accidentally running afoul of Self-Directed IRA prohibited transaction rules, or intermingling personal and IRA assets, is relatively high. One mistake could cost thousands in taxes, legal fees and penalties and even get your entire IRA disallowed.
We strongly recommend that investors use this option only in conjunction with the advice of experienced professionals with specific experience in Self-Directed IRA investing.
Prohibited or Disqualified Persons
When they drafted the rules governing Self-Directed IRA investments, Congress imposed strict rules designed to prevent self-dealing. Their intent was to prevent wealthier taxpayers from abusing the tax subsidies of Self-Directed IRAs to enrich family members, make straw purchases or use the assets for purposes other than retirement security.
For these reasons, your Self-Directed IRA cannot transact directly with any of the following persons:
- Your spouse
- Your lineal descendants or those of your spouse
- Your lineal ascendants or those of your spouse
- Any financial or legal professional advising you on your Self-Directed IRA in a fiduciary capacity
- Any business entity any of these individuals own or control
Your Self-Directed IRA cannot buy from or sell to any of these individuals or entities. Nor can your Self-Directed IRA borrow from or lend money to anyone on this list.
This prohibition extends beyond buying, selling, lending and borrowing. For example, you cannot hold real estate in a Self-Directed IRA and rent it to your son, nor can you hire your spouse and pay her a salary to manage the property.
In fact, you cannot even remain overnight in your Self-Directed IRA rental property, even if you pay your IRA a fair market rental rate. Nor can you allow your parents or grandparents to stay overnight. However, you may be able to rent the place to your cousins, uncles, aunts, brothers and sisters. These individuals are not listed as prohibited counterparties.
If you do allow your Self-Directed IRA to transact directly with a prohibited counterparty, and the IRS finds out, they could disallow your entire IRA, and force you to take an immediate distribution. This could cost thousands in immediate income tax liability and penalties.
Prohibited Transactions Section 4975
(a) Initial taxes on disqualified person
There is hereby imposed a tax on each prohibited transaction. The rate of tax shall be equal to 15 percent of the amount involved with respect to the prohibited transaction for each year (or part thereof) in the taxable period. The tax imposed by this subsection shall be paid by any disqualified person who participates in the prohibited transaction (other than a fiduciary acting only as such).
(b) Additional taxes on disqualified person
In any case in which an initial tax is imposed by subsection (a) on a prohibited transaction and the transaction is not corrected within the taxable period, there is hereby imposed a tax equal to 100 percent of the amount involved. The tax imposed by this subsection shall be paid by any disqualified person who participated in the prohibited transaction (other than a fiduciary acting only as such).
(c) Prohibited transaction
(1) General rule For purposes of this section, the term “prohibited transaction” means any direct or indirect—
(A) sale or exchange, or leasing, of any property between a plan and a disqualified person;
(B) lending of money or other extension of credit between a plan and a disqualified person;
(C) furnishing of goods, services, or facilities between a plan and a disqualified person;
(D) transfer to, or use by or for the benefit of, a disqualified personof the income or assets of a plan;
(E) act by a disqualified person who is a fiduciary whereby he deals with the income or assets of a plan in his own interest or for his own account; or
(F) receipt of any consideration for his own personal account by any disqualified person who is a fiduciary from any party dealing with the plan in connection with a transaction involving the income or assets of the plan.
(2) Special exemption
The Secretary shall establish an exemption procedure for purposes of this subsection. Pursuant to such procedure, he may grant a conditional or unconditional exemption of any disqualified person or transaction, orders of disqualified persons or transactions, from all or part of the restrictions imposed by paragraph (1) of this subsection. Action under this subparagraph may be taken only after consultation and coordination with the Secretary of Labor. The Secretary may not grant an exemption under this paragraph unless he finds that such exemption is—
(A) administratively feasible,
(B) in the interests of the plan and of its participants and beneficiaries, and
(C) protective of the rights of participants and beneficiaries of the plan.
Before granting an exemption under this paragraph, the Secretary shall require adequate notice to be given to interested persons and shall publish notice in the Federal Register of the pendency of such exemption and shall afford interested persons an opportunity to present views. No exemption may be granted under this paragraph with respect to a transaction described in subparagraph (E) or (F) of paragraph (1) unless the Secretary affords an opportunity for a hearing and makes a determination on the record with respect to the findings required under subparagraphs (A), (B), and (C) of this paragraph, except that in lieu of such hearing the Secretary may accept any record made by the Secretary of Labor with respect to an application for exemption under section 408(a) of title I of the Employee Retirement Income Security Act of 1974.
(3) Special rule for individual retirement accounts
An individual for whose benefit an individual retirement account is established and his beneficiaries shall be exempt from the tax imposed by this section with respect to any transaction concerning such account (which would otherwise be taxable under this section) if, with respect to such transaction, the account ceases to be an individual retirement account by reason of the application of section 408(e)(2)(A) or if section 408(e)(4) applies to such account.
(5) Special rule for Coverdell education savings accounts
An individual for whose benefit a Coverdell education savings account is established and any contributor to such account shall be exempt from the tax imposed by this section with respect to any transactionconcerning such account (which would otherwise be taxable under this section) if section 530(d) applies with respect to such transaction.
(6) Special rule for health savings accounts
An individual for whose benefit a health savings account (within the meaning of section 223(d)) is established shall be exempt from the taximposed by this section with respect to any transaction concerning such account (which would otherwise be taxable under this section) if, with respect to such transaction, the account ceases to be a health savings account by reason of the application of section 223(e)(2) to such account
Self-Directed Solo 401(K)
Self-Directed Solo 401(K)s are special defined contribution pension plans that are specifically designed to appeal to small businesses including sole proprietors, LLCs, s-corps, c-corps, limited partnerships, operated by an owner-employee, a married couple, or business partners which generally have no other full-time employees.
You may also see these plans referred to as “Self-Directed Solo-K” “one participant 401(K)s” or “Uni-K” plans.
These plans have all the same tax benefits and contribution limits as standard 401(K)s that are frequently operated by very large businesses, though some of the administrative requirements are streamlined.
To understand these plans, business owners should think of themselves as both the business owner and the employee.
Self-Directed Solo 401(K) Pre-tax and Roth Elective Deferrals.
As employees, they can each contribute elective deferrals up to $19,000 (as of 2019). Plan participants over age 50 can contribute an additional $6,000 per year in “catch-up” contributions, for a total potential contribution via elective salary deferral up to $25,000
These are usually pre-tax contributions, made via salary deferral, though some plan sponsors elect to have these contributions made to a special Roth sub-account, which are taxed similarly to Self-Directed Roth IRAs.
Self-Directed Solo 401(K)s fully support establishing a Roth option, should you prefer. Just ask your plan administrator to set up a Roth account within the Self-Directed Solo 401(K)
Self-Directed Solo 401(K) Employer Contributions
As the business owner, you can also make contributions to the plan for yourself, an employee spouse, or a business partner. If you are the owner/employee of your own corporation, can contribute up to 25 percent of the total compensation as defined by the plan for yourself and your spouse. However, if you are self-employed, then you must perform a special calculation to determine your plan contribution limit for the year.
However, the total combined contribution limit for both the employer and beneficiary is capped at $56,000 for the years if under the age of 50 or $62,000 if over the age of 50 with catch-up contributions of $6,000, as of 2019.
Example: Allen, age 51, earned $50,000 in wages via the S Corporation he owns and works for in 2019. He defers the maximum allowable amount, $19,000 in regular elective deferrals. In addition, since he is over age 50, he can and does contribute an additional $6,000 in “catch-up contributions to the Self-Directed 401(K) plan.
In addition, as the owner of the business, he elected to have the business contributed 25 percent of his compensation to the plan, which comes to $12,500. Total contributions to the plan for 2018 were $37,500 or 74% of compensation. This is the maximum that can be contributed to the plan for Allen for 2019.
Special provision for self-employed individuals
Because of the effects of self-employment tax on eligible income, those who are self-employed must make a special computation to figure the maximum amount of elective deferrals and non-elective contributions you can make on your own behalf, or on your employee/partner/spouse.
When this is the case, your eligible compensation is your earned income, which is defined as net earnings from self-employment after deducting both:
- one-half of your self-employment tax, and
- contributions for yourself
For help with performing these calculations, consult your tax advisor, or use the worksheets in Chapter 5 of IRS Publication 560 – Retirement Plans for Small Business.
Note: If the Self-Directed Solo 401(K) plan has $250,000 in assets in it or more at the end of the year, you must file a Form 5500-SF with the Internal Revenue Service.
These Self-Directed Solo 401(K) plans are popular because of their substantial protection from creditors, as well as their high potential contribution limits. Furthermore, contribution to these plans does not reduce the amount you can contribute to a Self-Directed IRA. You can participate in a Self-Directed Solo 401(K) and still contribute the full $6,000 if under the age of 50 and $7,000 if over the age of 50 annual limit to a Traditional IRA or Self-Directed Roth IRA out of your own personal income. Plus, your non-working spouse can still contribute to a Spousal Self-Directed IRA or Spousal Roth IRA.
401(k)s Exempt From Unrelated Debt-Financed Income Tax
Another benefit of the Self-Directed Solo 401(K) over other forms of retirement accounts is in
For example, if 50 percent of the money in a Self-Directed Real Estate IRA is borrowed, and 50 percent is your IRA’s own equity in an investment, then 50 percent of the income and gains for the year, less applicable deductions such as depreciation and interest will be subject to the unrelated debt-financed income tax.
However, 401(k) plans are not subject to this tax. IRC Section 514 exempts them from the tax on income and gains attributed to leverage that normally apply to IRAs, because Congress wanted to encourage pension fund managers and other trustees of employer-sponsored retirement plans to diversify into other asset classes in which leverage was routine – including real estate.
Solo 401(k)s fall under this category, and are therefore often better options for those interested in pursuing investment strategies involving leverage and non-recourse borrowing.
401(k) Plan Loans
Additionally, Self-Directed Solo 401(K) plans can be designed to allow $50,000 as maximum or 50% of the account value whichever is less. It must be paid back within five years with minimum equal quarterly payments for plan loans to participants – a powerful potential benefit.
This makes the Self-Directed Solo 401(K) a popular feature among small business owners who want to own real estate within their 401(K)s.
Self-Directed Solo 401(K)s and Non-Discrimination Rules
Note: While the standard 401(K) plan has testing requirements that prohibit employers from discriminating in favor of management and highly-compensated individuals when administering the plan, these rules do not apply to Self-Directed Solo 401(K) plans.
The plan and benefits have to be offered to all qualified employees, whether they are rank-and-file employees, managers or owners. This is because under the Self-Directed Solo 401(K) concept, there are no rank-and-file employees that you could discriminate against. Everyone in a Self-Directed Solo 401(K) plan is either one of the owners or married to the owner.
However, if you do take on employees, your Self-Directed Solo 401(K) plan ceases to become a Solo 401(K) plan, and you will need to address the non-discrimination rules that apply to 401(K)s.
For more information, call American IRA today at 866-7500-IRA (472).
Self-Directed SEP IRA (Simplified Employee Pension Plan)
The other popular small business retirement plan is known as the Self-Directed SEP IRA (Simplified Employee Pension Plan.)
A Self-Directed SEP IRA is a special type of defined contribution pension plan that allows employers to contribute to Traditional IRAs (SEP-IRAs) on behalf of their employees. Employees cannot contribute directly to a Self-Directed SEP IRA. All contributions must come from the company, not the employee.
Self-Directed SEP IRAs offer many of the advantages of the Self-Directed Solo 401(K) to small businesses with just one employee, or which are entirely operated by a married couple.
Self-Directed SEP IRAs can be established by businesses of any size, and there is generally no annual filing requirement by the company. You can set up a Self-Directed SEP IRA for a year as late as the due date (including extensions) of your business income tax return for the year you want to establish the plan
These plans are popular among small business owners because of the following advantages:
- Ease of execution
- Low administrative costs
- Flexible benefit commitment
The catch: You must contribute on an equal basis for all employees. You cannot carve out management or owners for a better Self-Directed SEP IRA benefit compared to rank-and-file employees. Moreover, you cannot set up a Self-Directed SEP IRA plan to allow for plan loans. If the ability to borrow from your retirement plan is important to you, you should lean towards the Self-Directed Solo 401(K) rather than the Self-Directed SEP IRA.
Self-Directed SEP IRA Contribution Limits
Again, all contributions to Self-Directed SEP IRA accounts must come from the employer. Employees cannot contribute to a SEP IRA plan.
The maximum total annual Self-Directed SEP IRA contribution as of 2018 is the lesser of:
- 25 percent of the employee’s compensation for the year.
Unlike Self-Directed Solo 401(K) plans, Self-Directed SEP IRAs do not have catch-up provisions for those over age 50.
Self-Directed SEP IRA Set-up
Setting up a Self-Directed SEP IRA plan is very easy. American IRA has helped many businesses set up Self-Directed SEP IRA plans. Just
To learn more about self-directed small business retirement plans, call us today at 866-7500-IRA (472).
Self-Directed HSA (Health Savings Account)
Self-Directed HSAs are designed to help certain taxpayers accumulate pre-tax money to cover deductibles on certain health insurance policies, called high deductible health plans, or HDHPs. These policies have minimum annual deductibles of $1,350 for individual beneficiaries, and $2,700 for family plans.
You can only contribute to a Self-Directed HSA if you are covered under one of these policies, and you are not eligible for other coverage.
Money contributed to one of these accounts is before-tax. That is, it is not counted as income when you file your income tax return.
For 2019, you can contribute up to $3,500 for -only HDHP plan and up to $7,000 for family HDHP coverage. Self-Directed HSA funds roll over year to year if you do not spend them. Meanwhile money in the Self-Directed HSA accumulates tax free as long as the assets remain in the account. Distributions to pay qualified medical expenses are tax-free. These qualified expenses include deductibles, prescription drugs, dental and vision care, long-term care coverage and Medicare Part B premiums.
Distributions for other purposes are taxed as income, and a penalty of 20 percent may apply if you are under Age 65.
Some taxpayers are funding Self-Directed HSAs not just to help pay for medical expenses, but also to accumulate money that can be used to help supplement their retirement incomes: Once you turn 65, the penalty no longer applies, and the money is treated like a Self-Directed Solo 401(K) or Self-Directed IRA balance: You can withdraw money for any reason. Some people are even funding their Self-Directed HSAs before Self-Directed IRAs.
Self-Directed HSAs are not subject to required minimum distributions like most other kinds of retirement accounts.
Time horizons with Self-Directed HSAs can be very long, and more and more investors are taking advantage of the substantial tax benefits of Self-Directed HSAs to accumulate money for retirement in addition to funding Self-Directed IRAs. And, of course, as with other kinds of retirement accounts, you do not have to limit yourself to the investments your wirehouse broker or insurance agent wants you to know about. With American IRA as your third-party administrator, you can invest your HSA balance in real estate, gold or precious metals, private lending, land, and any other asset class you can invest in within a Self-Directed IRA.
This ability may help you achieve greater long-term returns over time, or reduce your exposure to stock market risk, or both.
Self-Directed Coverdell Education Savings Account (ESA)
Self-Directed CESAs are specialized accounts that allow taxpayers to save money to cover educational expenses for children, grandchildren, or other minor family members on a tax-advantaged basis. Taxation on these accounts is similar to the Self-Directed Roth IRA concept: Contributions of up to $2,000 per child per year as of 2018 are made with after-tax dollars. That is, there is no first-year deduction available for Self-Directed CESA contributions. But once the assets are in the account, they grow tax-deferred, and withdrawals are tax-free as long as you use them to pay for qualified education expenses.
The definition of qualified education expenses is relatively broad and can include expenses for elementary and secondary school students as well as for college students. You can also use Self-Directed CESA funds to pay for services for students with special needs, as well as equipment such as computers and other necessary school supplies.
A portion of distributions in excess of qualified educational expenses in a given year are taxed as ordinary income.
There are some other rules that apply:
- The beneficiary must be under 18 when the account is established.
- You must designate the account as a Self-Directed CESA at the time it is established.
- The documents establishing the account must meet certain technical requirements.
- Contributions must be made in cash – you cannot make in-kind contributions of securities or property.
- Contributions can be made by individuals, corporations or trusts.
- Assets within the accounts must be completely distributed by the time the beneficiary reaches age 30, unless the beneficiary has special needs.
- Any individual, including the beneficiary, can establish and contribute to a Self-Directed CESA, as long as his or her modified adjusted gross income is $100,000 or less. That limit doubles to $220,000 for married couples.
- Contributions must be made while the beneficiary is younger than age 18.
- Contributions for a given year must be made by the tax return deadline for that year, excluding extensions.
- You can set up Self-Directed CESAs for multiple children. However, total contributions to Self-Directed CESAs cannot exceed $2,000 for any given beneficiaryin a given year.
Self-directing investments in a Coverdell Education Savings Account (ESA) may help increase potential returns, reduce overall portfolio risk due to stock market volatility, or both. Meanwhile, they are an underutilized way to accumulate money for a child’s education expenses while receiving important tax advantages. The Self-Directed Coverdell Education Savings Account (ESA) can also be used in conjunction with the 529 plan offered by many states.
Contact us for more information on each of these types of self-directed retirement accounts.
How to Get Started
Getting started in Self-Directed IRA investing is very easy: Call American IRA, LLC at 866-7500-IRA, or click here to download the forms directly and we will make the process as smooth as possible for you.
Here are the basic steps:
- Open an account with American IRA, LLC.
- Fund your new self-directed account. You have four options:
- Contribution – Each retirement plan allows you to contribute personal funds throughout the year. The amount you are permitted to contribute each year varies depending on your age, income and retirement plan type.
- Conversion – You can withdraw all or part of your assets in a Traditional IRA and reinvest them in a Self-Directed Roth IRA. The assets must be contributed to the Self-Directed Roth IRA within 60 days of the distribution from the Traditional IRA. It is important that you understand the taxable consequences of this conversion before you accept the distribution from your Traditional IRA.
- Rollover – A tax-free distribution of cash and/or assets from a retirement account given to you directly to contribute to another retirement account. One rollover is permitted per 12 months and there is no taxable consequence if the cash and/or assets are rolled into the new retirement accounts within 60 days of the distribution.
- Transfer – A direct transfer of cash and/or assets from one Self-Directed IRA retirement account to a similar account. Since this is a trustee-to-trustee transfer and the investor does not directly take possession of the cash and/or assets, there is no tax on this transfer and there is no limit to the amount of transfers within a year.
- Identify your investment.
- Send us a Buy Direction Letter. This is just a document that tells us what you want to buy, from whom, and for how much. We will ensure the transaction goes as smoothly as possible. Make sure you title everything in your accounts’ name and not your own personal name.
- Provide payment authorization. This is a basic document that authorizes us to pay the basic expenses incidental to your Self-Directed IRA investment. For example, if you own residential rental property within the Self-Directed IRA, you may want to authorize us to make a monthly payment to your property manager, or to insurance companies or for your ongoing property taxes, to keep your investment functioning.
We take safety and security of your funds seriously. To that end, American IRA has implemented policies and protocols to protect against unauthorized or fraudulent transactions.
- Funds never move out of your account without a signed Buy Direction Letter from you.
- Wire and ACH instructions are not implemented until you have signed them ‘read and approved.’
- Our closing coordinator reviews all funding requests and verifies that you have signed in the appropriate places.
- The American IRA Compliance Officer receives the reviewed paperwork and verifies that funding documents are correct before wire transfers ACHs or checks are issued from your account.
- A member of senior management then compares the funding paperwork to the wires, ACHs, and/or checks written and gives their final approval for the funds to be moved. Only senior management has the authority to give final approval.
- Confirmation call to release funds.
- Encrypted Emails.
- Your custodian is the New Vision Trust Company, a South Dakota Chartered Trust Company.
Furthermore, you are working with American IRA an IRA administrative services vendor that is bonded and carries errors & omissions insurance to protect you.
For more information, or to open an account immediately so you can get started as an investor, call us today at 866-7500-IRA (472). Or write us at [email protected].
Investment Research Institute – The Role of IRAs in US Households’ Saving for Retirement, 2017
IRS Publication 590A – Contributions to Individual Retirement Arrangements
IRS Publication 590B – Distributions from Individual Retirement Arrangements
IRS Publication 560 – Retirement Plans for Small Businesses
IRS Publication 969 – Health Savings Accounts and other Tax-Favored Health Plans
IRS Publication 970 – Tax Benefits for Education
26 U.S. Code § 4975 – Tax on prohibited transactions
26 U.S. Code § 408 – Individual retirement accounts