The Biggest Secret to Retirement Saving Success With a Self-Directed IRA

There are certainly a lot of different retirement strategies out there. Regardless of your age, income level, or current level of savings, you’re likely to have access to multiple strategies to try to help you reach your goals.

And there’s no shortage of investment advice on what types of investments are best for you. Just pick up a copy of virtually any personal finance magazine and you’ll read about a wide range of options, some of which may even appear to be in direct conflict with one another.

But perhaps the biggest factor that will contribute to you reaching your retirement goals is common across all of these options. And it remains something of a secret even though it’s so easy to do. The secret?

Be consistent with your retirement savings.

By that we mean that if you save as much as you can each year, and you do so year in and year out, then you stand a very good chance of reaching your goals. When you are more consistent with your retirement savings, your choice of investments becomes less important. You won’t have to chase high yielding investments in an effort to boost the value of your nest egg because your account balance will grow over time merely by choosing investments

When you invest consistently, then over long periods of time your investment choices become less of a factor in determining how much you’ll accumulate. This isn’t to say that you should disregard the process of trying to choose your investments wisely, and select assets that meet your risk tolerance and other financial circumstances. Rather, it simply means that your research and analysis of your various investment possibilities shouldn’t overshadow the priority to put money aside in the first place.

In other words, your primary goal should be to contribute the maximum amount to your self-directed IRA every year, and your efforts should be focused on that first and foremost. After you’ve done the work to save as much as the IRS allows, then you can put the time and effort into figuring out how best to put that money to work.

You’ve probably seen the examples before. Looking at several different case studies of hypothetical investors — one who invests each year at the market low, one who invests at the beginning of the year, and one who is unlucky enough to invest at the top of the market — the results are surprising.

Over a period of several decades, the individual who is unfortunate enough to make their investments at the market peak each year has a smaller nest egg than the other two investors, but not by as great of a margin as you might think. And, more importantly, that bad market timer still has accumulated significantly more than an individual who didn’t save as much, or who simply contributed the same amounts to a bank account or other cash equivalent savings vehicle.

 

Why It’s Important To Coordinate Your Taxable Investments With Your Self-Directed IRA Investments

Your self-directed IRA can save you a lot of money in taxes, both in the short term as well as in the long run. If your IRA is set up as a traditional account, then (depending on certain aspects of your financial position) you may be able to take a tax deduction for those contributions. And contributions in traditional IRAs will grow on a tax-deferred basis, while the investment gains within a Roth IRA will never be subject to taxation. Many individuals are well-versed with the various tax implications on this level.

But there’s another perspective from which you may want to consider your self-directed IRA tax analysis, and this is the way that your taxable investment accounts, and investment decisions, can impact your self-directed IRA investments.

Let’s first examine just how valuable your self-directed IRA can be. Consider two hypothetical portfolios of $100,000, one a taxable account and the other a self-directed IRA. Let’s further assume that each portfolio is comprised of stock that pays dividends at a 3% rate annually (with those dividends being reinvested), and that the stock price appreciates 5% annually.

At the end of 25 years, the value of the taxable account would be approximately $525,000, while the self-directed IRA is worth over $630,000. This difference in value is attributable solely to the fact that the owner of the taxable account has to pay taxes on the dividends they receive, even if they choose to reinvest those dividends.

If the self-directed IRA is a traditional account, then you will have to pay taxes on those gains, but they’re likely to be at a lower tax rate (because you’re in retirement and perhaps no longer working full time), and they’ll only be taxed when you take the distribution. If your account is a Roth IRA, then you’ll realize the full value of the investment gains.

So one common tax optimization strategy is for an individual to place income-generating investments that would otherwise incur a tax liability into an IRA in order to avoid that liability.

On the other side of the equation, it’s important to note that there are certain tax advantages that are actually disallowed within an IRA. For example, investment interest (such as borrowing funds to purchase a stock investment, or taking out a mortgage to buy a piece of real estate) can be used to offset gains in a traditional account. But borrowing funds is considered to be outside the scope of permissible activities for self-directed IRAs, and the tax benefit of those expenses will be lost inside the retirement account.

It’s the same situation for investments that have tax advantages built in, such as municipal bonds. Because these investments would already be tax-advantaged outside of an IRA, there’s no reason (and it’s actually a missed financial opportunity) to keep these types of assets inside a retirement account.

Understanding the interplay between your taxable investment accounts and your self-directed IRA will put you in the best position to make the optimal investment decisions.

Roth Guidelines for my investment

You asked: If my PPT options a note with the intent of finding another buyer, how much if any earnest $$ does the PPT have to put down to be in compliance with the ROTH guidelines? The ROTH is not keeping the tale of the note.   I assume the same pertains for a real estate transaction. My answer:   Thanks for the question. Unfortunately, there is no good answer.   I would be a little concerned with your verbiage below, … Continue reading

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Roth Conversions and their 5 year clock

You asked:   “I converted $18,000 in a traditional IRA to a Roth IRA in 1998. I also made $20,000 in contributions over the years 1998-2010. Last year I took a distribution of $38,000. I am under age 59 1/2.Do I have any taxes or penalty on this withdraw?”   My answer:   No, as you describe the situation. Regular contributions come out first, followed by Roth conversions, and finally profits. The rules for calculating any taxable amounts from a … Continue reading

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UBIT? You Bet!

Questions: I think the answer to my question. Does Arkansas charge tax on UBIT and UDFI? in the book 2009 Multistate Guide to Regulation and Taxation of Nonprofits By Steven D. Simpson. Which is found in full online through google books at: https://books.google.com/books?id=KE5dVpNcWkwC&pg=SA3-PA9&lpg=SA3-PA9&dq=Section+512+of+the+Internal+Revenue+Code+arkansas&source=bl&ots=YFNc-ZE7U0&sig=PpYxNwFJEhq5fd920ha18OXLFkw&hl=en&sa=X&ei=ItEKVdmUOcSwggSMiIOoBQ&ved=0CC8Q6AEwAw#v=onepage&q=Section%20512%20of%20the%20Internal%20Revenue%20Code%20arkansas&f=false It says that Arkansas does not have IRS code sections 501-529, but that it does tax unrelated business income on income attributable to Arkansas. Since UDFI is Section 514 I assume that there is no state income … Continue reading

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The Basic Relationship Between Social Security Benefits And Your Self-Directed IRA

Regardless of whether you envision Social Security to be a significant component of your retirement income, or simply a helpful supplement to your self-directed IRA, it’s important to understand how the two are related. The timing and nature of distributions you take from a self-directed IRA can impact the size of your Social Security benefits, as well as the income taxes you may have to pay on those benefits.

First things first. Under current law, your eligibility to receive Social Security retirement benefits, and the amount of those benefits, is a function of your prior work experience and earnings, not how much you have saved. In other words, having a large self-directed IRA or taking significant distributions from your account during retirement won’t make you ineligible for Social Security benefits.

However, those distributions may impact the taxability of the Social Security benefits you receive. Finally, it’s important to keep in mind when you’re planning your retirement income strategy that you control when you begin receiving Social Security retirement benefits (anywhere between age 62 and age 70), and you control when you begin taking distributions from your self-directed IRA – with no limit for Roth account, and required minimum withdrawals from a traditional account kicking in at age 70½.

Early Retirement Scenarios.

Individuals who choose to retire early and begin taking their Social Security retirement benefits before their full retirement age can see those benefits reduced if their earned income exceeds a certain amount. (For 2015, this amount is $15,720.) In short, the Social Security Administration withholds one dollar in benefits for every two dollars and earnings above the this amount, and even more for earnings that are significantly higher. Distributions you take from your self-directed IRA are not considered “earned income,” and therefore do not count against this limitation.

However, when the IRS determines whether your Social Security benefits are subject to income tax, they look to your “combined income,” which will include distributions you take from any IRA that’s set up as a traditional account.

Roth Self-Directed IRA Benefits.

Significantly, distributions from your Roth IRA will not affect your Social Security benefits in any way. Just as is the case with traditional IRAs, they are not considered earned income by the Social Security administration for purposes of calculating your benefits in an early retirement scenario. In addition, they are excluded from the definition of “combined income” when considering the taxability of those Social Security benefits.

Distribution Strategies.

Given that your Social Security benefits will be increased the longer you wait to take them (with the deferred retirement credits increasing up to age 70), some individuals can maximize their total retirement income by waiting as long as possible to take Social Security, and taking distributions from their self-directed IRA in order to fund retirement living expenses. The analysis is highly individualized, and you’ll have even more options to consider if you are married and your spouse is also eligible for Social Security benefits.

But remember that you’ll only put yourself in a stronger financial position by maxing out your self-directed IRA contributions each and every year, and trying to build the largest account possible.