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Learn more | Benefits of the Self-Directed IRA

Benefits of the Self-Directed IRA Structure

Self-Directed IRA Structure

A Self-Directed IRA (SDIRA) is a type of individual retirement account. It allows retirement investors to use his or her IRA funds to make alternative asset investments. Also known as non-traditional investments, alternative assets include real estate, precious metals, tax liens, cryptocurrencies and more. A Self-Directed IRA is like a traditional IRA but gives IRA holders more investment options.

With a Self-Directed IRA, you're no longer confided to investments in stocks, bonds, mutual funds, and other traditional assets. Of course, you can still make traditional asset investments, but if you’re more comfortable investing in assets like real estate and precious metals, the Self-Directed IRA structure allows you to do so. This diversifies the assets inside of your retirement account, so your investments don’t flow in the same direction. This is just one benefit of the Self-Directed IRA structure.

More Control

With the Self-Directed IRA, you gain more control over your retirement funds. Not all Self-Directed IRAs are the same, and the level of control you receive is dependent upon where you establish your structure. Because not all Self-Directed IRAs are the same, this is not a term you will find in the Internal Revenue Code (IRC).

Prohibited Investments

There are certain investments you cannot make with your Self-Directed IRA. You cannot invest in life insurance or collectibles. You also cannot make any transaction under IRC Section 4975(c), which includes prohibited transactions broken down into two groups. Other than these prohibited investments/transactions, you can make almost any type of investment with your Self-Directed IRA.

You can self-direct all types of retirement accounts:

  • Traditional (pre-tax) IRA
  • Roth IRA
  • SEP IRA
  • Simple IRA

Let’s see more benefits of the Self-Directed IRA structure.

Diversify Your Retirement Portfolio

Most Americans have an enormous amount of financial exposure to the financial markets. Whether it is through retirement investments, such as IRAs or 401(k) plans, or personal savings, several Americans have a majority of their savings connected to the stock market.

Over 90% of retirement assets are invested in the financial markets. Therefore, if you invest in alternative assets, such as real estate, it provides investment diversification from the equity markets. As a result, your assets are less likely to move in the same direction. However, diversification does not assure profit or protect against loss.

Nevertheless, the use of alternative asset classes can help protect your retirement funds when the market is down and prevent you from losing more than the market.

Make Investments You Know and Understand

After the 2008 financial crisis, many Americans became frustrated with the equity markets. Since 2008, the financial markets have rebounded, but many Americans feel less confident in Wall Street due to the market swings. Some skepticism derives from the fact that some investors aren't completely clear what occurs in Wall Street, or how it works.

Many middle and lower class investors feel more confident in assets like real estate, because they were more likely exposed to real estate growing up than stocks or bonds. On the other hand, the upper class are more familiar with Wall Street and other securities. The Self-Directed IRA structure enables investors who are wary about Wall Street to invest outside of Wall Street.

It is very important to own a home, and the real estate industry can be lucrative. From Donald Trump to reality TV, real estate is fast becoming mainstream and a trusted asset class for Americans.

Of course, it’s not without risk, but many investors feel more comfortable buying and selling real estate than they do stocks. This applies to making other alternative asset investments.

Protect IRA Assets Against Inflation

Rising food and energy prices, along with high federal debt levels and low interest rates have recently fueled new inflationary fears. As a result, some investors may look for ways to protect their portfolios from the ravages of inflation.

It is a matter of guesswork to estimate whether these inflation risks are real. For some retirement investors, protecting retirement assets from inflation is a big concern. Inflation can have a nasty impact on a retirement portfolio because it means a dollar today may not be worth a dollar tomorrow.

Inflation also increases the cost of things that are necessary for individuals to live and enjoy life. Some examples are gas, shelter, clothing and medical services. It decreases the value of money so that goods and services cost more.

Hard Asset

Another significant benefit of Self-Directing is the ability to make more hard asset investments. Countless alternative assets, such as gold, real estate and precious metal are hard assets that investors can see and touch. Real estate is a great example, because it acts as a hedge against inflation. For many people, hard tangible assets provide security during times of financial instability, because it offers psychological security.

Tax Deferral

Among the most well known benefits of the Self-Directed IRA structure, and other qualified retirement accounts, is the concept of tax deferral. Also known as "compounding", tax deferral means that you put off paying taxes. The most common types of tax-deferred investments include those in IRAs or Qualified Retirement Plans. Tax-deferral means that all income, gains, and earnings will accumulate tax-free until the investor or IRA owner withdraws the funds and takes possession of them.

If the funds remain in the retirement account, the funds will grow tax-free. This allows your retirement funds to grow at a faster pace than if the funds were held personally. As a result, you can build for your retirement faster.

When you take a distribution after you retire, you will likely be in a lower tax bracket and be able to keep more of what you accumulate.

With a traditional IRA retirement savings vehicle, you don’t pay taxes on the money you invested, and you may pay taxes at a lower rate when you finally do “take home” your money.

Pay Taxes Later

The concept of tax-deferral stems from the notion that all income and gains the pre-tax retirement account generates will flow back into the account tax-free.

For example, if an IRA holder establishes a Self-Directed IRA LLC and invests $100,000 in 2019 and the account earns $10,000 in 2019, the IRA holder won’t owe tax on that $10,000 then, but when he or she withdraws the money from the IRA. This may be many years later. Assuming the IRA investor is in a 33% federal income tax bracket, he or she will have to pay $3,333 in federal income taxes on the $10,000 earned on the IRA in 2019. That leaves $6,667 in the account. At an 8% annual return, those earnings go on to produce $533.36 in 2019.

However, because IRAs are tax-deferred, the Self-Directed IRA investor can earn a return on the full $10,000 rather than the $533.36 he or she must pay in taxes that year. At an 8% annual return, the investor would earn $800 in 2019. The deferral compounds each year.

Example:

Joe is 40 years old and makes a $5,000 contribution to an IRA. Joe is in a 30% federal income tax bracket. Joe invests his IRA funds and receives a 6% average annual return. When Joe retires at 70, his $5,000 contribution will be worth $21,609.71. If Joe invested the $5,000 personally, the account would only be worth $14,033.97.

We wrote the book on Self-Directed IRAs

The second installment in a four-part series, The Checkbook IRA: Why You Want it, Why You Need it, explores important topics regarding the self-directed IRA and why it has become the leading retirement structure to purchase real estate using IRA funds.

Following the success of Adam Bergman’s previous self-directed IRA book comes Self-Directed IRA in a Nutshell, a straightforward explanation on what IRA investors need to know about self-directed IRA retirement structure.

Learn more about the books →

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