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Lead by Example
With 401Ks, traditional Individual Retirement Accounts (IRAs) and Roth IRAs, retirement account options are plentiful. However, one type of IRA could be of particular interest to business people who have accumulated a lifetime of experience and knowledge in a particular industry: self-directed IRAs.
The self-directed IRA offers an almost infinite set of investment options, and as the owner, you determine where and how your money is invested. The self-directed IRA also brings tax advantages that will help you meet your retirement goals.
Traditional IRAs and Roth IRAs limit investments to stocks, bonds and mutual funds, but self-directed IRAs are different. If you have been building knowledge of a particular industry—be it biotech, construction or hospitality—a self-directed IRA is a flexible tool that allows you to use your expertise to choose wealth-building investments.
For example, many investors enjoy the self-directed IRA’s potential to include real estate. Using a self-directed IRA to hold real estate assets has advantages such as tax-deferred or tax-free profits, compound interest, asset protection and estate planning.
Additional investment options include limited liability corporations (LLCs), partnerships, private equity and real estate, including land, land trusts, single-family homes and apartment buildings. While the options are broad, a strict set of IRS guidelines apply to self-directed IRAs.
Exploring Your Options
If you think a self-directed IRA might be a good option for you, first consult with your CPA and then seek the advice of a financial institution that has trust powers to hold self-directed IRAs. As the fund custodian, your banker will manage your IRA assets under your direction by filing all needed tax reports in compliance with regulations, issuing bank statements of net gains and losses, recording all transactions, performing administrative duties and paying related expenses, such as property taxes, utility bills and maintenance expenses.
In my career as a trust officer for Bank of Utah, I have helped many individuals with their self-directed IRAs, and they have found positive results. Paul shares his story:
“As I thought about the requirements of retirement, I wanted to have the option of directing money from my IRA into real estate investments where I thought there was an opportunity. I was familiar with IRA regulations and knew about self-directed accounts. Self-directed IRAs are not complicated and the bank is always quick to answer questions and provide direction. A self-directed IRA account is not for everyone, but if you are seeking different investment options, they may be your answer.”
To set up a self-directed IRA, you begin by transferring funds from an existing retirement account. Self-directed IRAs cannot be funded with personal money. Qualified annual contributions include traditional IRAs, Roth IRAs, SEP IRAs, 401(k)s, 403(b)s, qualified annuities and profit-sharing plans.
Another client, Jamie, applied a self-directed account to a Roth IRA he opened while finishing college. He says, “It was easy to see how using a Roth IRA would be a beneficial financial investment tool. I liked the idea that I could make contributions into a Roth IRA while I’m young and my tax bracket is low, and know that as my Roth IRA grows, the earnings will be tax free even as my net worth and income level increases. A self-directed Roth IRA allowed me to make decisions and choose my own investments. I typically use my self-directed Roth IRA to purchase real estate notes; the Bank of Utah trust department manages the IRA, and I have Escrow Specialists Inc. bill, collect and track the balances, so it requires very little work by me.”
Navigating the Rules
Jamie was smart to invest at an early age and use experts to help him navigate the rules and restrictions imposed by the IRS on self-directed IRAs. This is very important because violation of the rules can put the tax-deferred status of your account at risk, as well as lead to the disqualification of the IRA and tax consequences.
For example, you cannot engage in transactions with “disqualified persons” related to your self-directed IRA, including you (the IRA owner), your family members or your service providers such as the IRA custodian, CPA or financial planner.
In addition, your IRA may not buy from or sell an investment to a disqualified person. And, since the IRA is intended for retirement, you may not engage in a transaction that benefits you immediately. Some assets are excluded from a self-directed IRA: collectables like art, antiques, cars, wine, stamps and coins; capital stock in an “S” corporation; and life insurance contracts.
Self-directed IRAs grow tax deferred. This means that you do not pay taxes on your holdings until you reach the age of retirement. For most, the tax rate is lower at this time because their retirement income is less. Distributions from your IRA can start at age 59-and-a-half, but are required to start at age 70-and-a-half.
IRAs are not guaranteed, and a self-directed IRA is best suited to someone who wants to use their expertise to grow wealth for retirement. Your banker cannot offer investment advice, but their partnership is essential in helping you follow regulations.
Jodie LeBlanc is a trust officer at Bank of Utah