Ahhhhh, retirement. Have you been dreaming about it? Maybe you’ve envisioned a cozy cabin in the mountains, a peaceful bungalow by the sea or a charming farmhouse in the country. Maybe you’ve mapped out an international travel plan, decided to RV across the States or started to enjoy the thought of simply sticking close to home. Maybe it all sounds wonderful — you’re just happy contemplating all of your options.
Pausing your retirement daydreaming for just a moment — sorry to interrupt those beautiful visions! — but do you know there’s something you can set up now to boost your retirement portfolio even more? Something that’s especially ideal if you like to have more choices. Something that combines your interests and your investments. Something you can get tax advantages on for your 2023 tax returns (yes, 2023, if you set it up by April 15, 2024!).
That something is a self-directed IRA, an individual retirement account that gives you almost infinite investment possibilities and the ability to use your knowledge of investments beyond stocks, bonds and CDs — all in a tax-advantaged environment.
A great investment tool, the self-directed IRA does require a bit of extra planning and effort. So, let’s take a closer look and see if it’s an option for your retirement plan.
What is a Self-Directed IRA?
A self-directed IRA is a retirement account that lets you control, or direct, where and how you invest the money in the account. It also gives you a wider range of investment options than regular IRAs, which generally only allow you to invest in traditional assets, such as stocks, bonds and mutual funds.
With a self-directed IRA, you might choose alternative investments, such as:
- Real estate
- Precious metals, including gold and silver
- Promissory notes
- Trust deed notes
- Private company stock
- Limited liability corporations (LLCs)
- And more — the possibilities are plentiful!
What are the Benefits of a Self-Directed IRA?
A self-directed IRA truly can give you a more proactive approach to improving your investment returns by offering:
1. Flexibility
As mentioned, this type of specialized account gives you more choices when it comes to the types of assets you can have in your account. This means you are free to invest in qualified assets that you feel will bring the greatest returns or security, depending on your personal investment goals.
2. Personalization
Because you’re in control of your self-directed IRA, you can invest in assets that are in line with your expertise and interests. One of the most popular ways to use a self-directed IRA is to invest in real estate. If you’re savvy in that area and enjoy it, you can be like the clients I mentioned earlier who generated income by investing in property.
3. Diversity
Choosing to diversify your retirement portfolio — meaning you have different types of investments — reduces risk. If one of your investments fails, you have others on which to fall back. Given the fluctuations and volatility of the stock market recently, a self-directed IRA can also help you feel safer investing in assets you know and understand.
How Do You Set Up a Self-Directed IRA?
Remember earlier, when I mentioned that self-directed IRAs require a little extra planning and effort? They are unlike regular IRAs, where you can walk into a bank, quickly set up an account and allocate money from your monthly paycheck to go into the account.
With a self-directed IRA, you need to:
1. Decide on the types of investments you want to make.
At Bank of Utah, we highly recommend clients first seek the counsel of a qualified legal or financial advisor before setting up a self-directed IRA. He or she can help you make sure that the investment you’re considering will further your retirement goals.
2. Find a custodian or trustee that specializes in self-directed IRAs to administer the account.
Wait! Didn’t you say the accountholder directs and manages the funds?
The IRS requires that every self-directed IRA be administered by a registered and regulated custodian, such as Bank of Utah. A custodian or trustee only follows the direction of the accountholder, within IRS regulations, of course. That means you control where and how the funds are being invested, and the custodian performs the many administrative duties that are required for the account. Those duties include filing reports in compliance with the IRS, issuing bank statements and more.
It's important to note that custodians cannot act as an investment advisor for self-directed IRAs. That is another reason why we recommend you talking to your financial advisor before setting up this type of account.
3. Open and fund the account.
You can do this by rolling over or transferring an existing retirement plan, usually a traditional or Roth IRA, into a self-directed IRA.
At Bank of Utah, our trust officers walk you through this process. Once we help you complete the new account paperwork, then we move the cash from your existing plan to your new self-directed IRA.
4. Direct your custodian where to invest your money.
You do this by completing an investment direction form. The custodian then executes your investment instructions.
Again, it’s important to consult with your financial or legal advisor before signing the form, to ensure the assets are qualified and that you’re not triggering any prohibited transactions. Remember, your custodian is unable to provide any tax or legal advice.
What are the Tax Advantages of a Self-Directed IRA?
Another benefit of the self-directed IRA is that it is tax-advantaged, which helps you make the most of your money. Just like regular IRAs, you can choose between two types of self-directed IRAs: traditional or Roth. The main difference is when you want your tax advantages — now or later.
Traditional self-directed IRAs work this way: You can get a tax break now by deducting your contributions from your income, but you will have to pay income taxes on your withdrawal when you retire.
Roth self-directed IRAs work this way: You pay taxes on your contributions before they go into the account so you can enjoy tax-free withdrawals later, at retirement.
With both types, you can contribute any time over the life of your term, and you can only take funds out of your account without getting early withdrawal penalties when you are 59 1/2 years old.
Interestingly, if you set up and fund a self-directed IRA by April 15, 2024, it can count as a 2023 contribution. Depending on your income bracket, your contribution may be tax-deductible. It’s important to note that contributions to a self-directed IRA are limited to annual amounts. For 2023, the amount is $6,500 for those under age 50, with a $1,000 catch-up contribution for those over 50. (For 2024, the amount is $7,000 and $8,000, respectively.)
One last tax tip: In some cases, typically with real estate investments, you can avoid capital gains tax. You only pay taxes when you pull money out of the IRA account for personal use. However, in some cases, you may be subject to Unrelated Business Income Tax (UBIT) or Unrelated Debt Financed Income (UDFI), depending on the set up and terms of the investment. Your IRA professional, legal or tax advisor can explain these scenarios in detail.
A Final Thought
Before you get back to daydreaming about how you’ll spend retirement, spend some time now considering a self-directed IRA. I know it’s been a lot of information to take in; after all, it is a complex investment tool. Our Bank of Utah trust officers can give you the answers you need, though, and can help guide you through the set-up process when you’re ready.
*Investments made into self-directed IRA accounts are not FDIC-insured, are not insured by any federal government agency, are not a bank deposit and may lose value.
Brenda Lambert is a vice president and senior trust officer for Bank of Utah’s Personal Trust Department.
