Pay No Tax with a Self-Directed IRA Account
In a typical 401k or IRA account, investors place their money in their retirement accounts and leave the investing of their money up to an account custodian. The custodian is the company or individual who is responsible to make investment decisions for the retirement account holders. Sometimes they do a good job. Sometimes they don’t. Often times they beat inflation just by a couple points. That’s nothing to brag about but it’s usually a good decision for people to set up retirement accounts early on in life, contribute consistently, and let it grow over time.
However, once the account is set up, the investor has no say on where their money is invested. The investor can choose whether the account is traditional or Roth and they can determine the risk level and general portfolio of the trades. That’s about it. There is an alternative, however, and it is called a self-directed retirement account.
With a self-directed retirement account, the investor takes the responsibility of trading on him or herself. That means that the investor directs where the retirement account money is invested. So the investor can choose the mutual fund or stocks if they would like, they can also direct the account to invest in real estate. Some accounts are even checkbook controlled so the investor can write checks directly from their retirement account.
The advantage of using a self-directed retirement account to invest in tax liens and deeds, rather than using a personal bank account, is that taxes are deferred the same way the original retirement account was set up. If it’s a Roth IRA, for example, the investor is taxed on the front when the money is placed in the account, but not when the money is pulled out of the account when the money matures.
Another advantage is that the investor can use retirement funds that they wouldn’t have access to otherwise. Those funds might be sitting idle or barely making any money, so the investor can choose to direct some of that money to tax deeds or tax lien investments.
Set UpYou may already have a 401k through your current employer and you may already have an IRA account. The thing that you need to check for each of those accounts is whether they are self-directed and if they allow for real estate investments. Some limit where you can invest your own money. If your account is not self directed or does not allow for real estate investments, then you can roll that money over to an account that is self directed or that allows for real estate investments. Sometimes you will be charged a fee or penalty to make the transfer. If you’re able to roll your money into the right type of account through the same company, then you may be able to avoid those fees.
If you’re starting from scratch, then you need to decide where to set up your account and what type of account to set up. The most common is a self-directed Individual Retirement Account (IRA). For a list of companies that offer self-directed retirement accounts, please refer to our website or speak with one of our support agents and they can provide it to you. You can also set up a company, like an LLC and set up your IRA through your LLC. That’s very simple to do in most states.
Types of AccountsThere are two primary IRA accounts that you can choose from; traditional IRA accounts and Roth IRA accounts. The difference between the two accounts is the point in time where the investor is taxed. Contributions to Roth accounts are made with after-tax assets, all transactions within the IRA have no tax impact, and withdrawals are usually tax-free.
Contributions to Traditional IRA accounts are made on pre-tax assets. All transactions and earnings within the IRA have no tax impact, and withdrawals at retirement are taxed as income. Roth accounts have become popular because you are not taxed on the growth made in the account, whereas traditional accounts you are taxed when you pull the money out of the account but you are not taxed before putting the money in the account.
When setting up your account with the custodian, make sure to have an open dialogue to discuss which option is the best one for your situation.
Once you have it set up, you will need to fund the account. The investor is limited to the amount that he or she can contribute to the account every year. But it is possible to set up multiple accounts to get more money into retirement accounts each year. Once the investor has funded the account and has checkbook control, the investor can make investments in the name of their LLC.
When the investment matures, the money is put directly back into the IRA. Because the investor never takes that money into personal accounts, the investor is not taxed like normal income. That is how the investor avoids being taxed on that money right away. The investor continues that process of making investments through their self-directed IRA, depositing the money directly back to the IRA, and then reinvesting over and over to maximize the return.