What Is an IRA Rollover?

In its simplest terms, an IRA Rollover is when you move assets from one retirement account into an IRA. For example, you have a 401(k) at a job you are leaving. You can choose to leave your assets there, or roll them over into an existing (or new) rollover IRA. It’s fairly easy to do and can be done directly or indirectly.

There are basically two types of rollovers: Indirect and Direct. A Direct rollover, also referred to as a trustee-to-trustee transfer is the easiest and safest way to roll over funds. An Indirect rollover gives you more flexibility, but there are some risks involved.

Indirect Rollover vs. Direct Rollover

Deciding on how you want to move your funds is a personal choice. As stated above, the direct transfer of funds from one retirement account to another is easiest. However, be aware that indirect rollovers can have income tax implications if not completed within the specified time frame. You simply request your plan administrator to transfer funds from your current plan to the trustee of your IRA. You can rollover funds from any type of plan including a 401(k), 403(b) or another IRA.

An indirect rollover is different in that you receive the funds first, and not the new IRA. Instead of sending funds directly to the IRA, you will receive a check. If your intention is to just move funds to the new account, you can cash the check and fund the new account immediately. However, you do have some leeway to use those funds. In fact, you have 60 days to deposit that money into the new plan (more on that later).

Read this: 401(k) Rollovers & Possible Tax Consequences

Reasons for an IRA Rollover

The two main reasons for rolling funds into an IRA are switching jobs and looking for better investment options or lower fees from an employer sponsored retirement plan. When leaving a job with an employer’s retirement plan, rolling over funds into an IRA can provide greater investment flexibility and consolidation benefits. If you hop around from job to job, looking for the right fit, you may accrue many retirement plans.

No matter how long you are employed by a business, it’s always best to take advantage of their retirement plan, if offered. However, once you find the perfect job, what are you going to do with all those previous plans? The best thing is to roll them over into one account. You’ll thank yourself at tax time and when you hit retirement.

The other time you may wish to rollover funds is when you’re looking for another provider. Your current one may have suited you fine at first, but now you want to explore other investment options. Many IRA Financial clients take advantage of the IRA rollover to start investing with a Self-Directed IRA. Since you are limited in investment options with a more traditional custodian, a rollover is the perfect way to start investing in alternative assets. A Self-Directed IRA allows you to invest in just about anything you want.

Choosing an IRA Provider

When selecting an IRA provider, it’s essential to consider several factors to ensure you find the right fit for your retirement savings needs. Here are some key considerations:

• Fees: Look for providers with low account fees, as well as no hidden fees. Avoid providers with excessive account balance fees. High fees can eat into your retirement savings over time, so it’s crucial to choose a provider that offers competitive rates.
• Investment Options: Consider providers that offer a wide range of investment options, including stocks, and mutual funds, as well as alternative assets, like real estate and cryptos. A diverse portfolio can help you manage risk and maximize returns.
• Customer Service: Choose a provider with a reputation for excellent customer service, including online support, phone support, and in-person support. Good customer service can make managing your retirement account much easier.
• Reputation: Research the provider’s reputation online, reading reviews and ratings from other customers. A provider with a strong reputation is more likely to offer reliable and trustworthy services.
• Services: Consider providers that offer additional services, such as retirement planning, investment advice, and tax guidance. These services can provide valuable support as you plan for your retirement.

It’s essential to compare the features and fees of each provider to determine which one is best for you. By carefully evaluating your options, you can find a provider that aligns with your retirement goals and helps you build a secure financial future.

Funding a Self-Directed IRA

A Self-Directed IRA allows you to invest in alternative assets, such as real estate, cryptocurrencies, and private companies. To fund one, you can use one of the following methods:

• Contributions: You can contribute up to $7,000 in 2024 and 2025 ($8,000 if you are age 50 or older) to an IRA. These contributions can help you build a diverse portfolio that includes both traditional and alternative investments.
• Rollovers: You can roll over funds from a 401(k) or other qualified retirement plan into a Self-Directed IRA. This process allows you to transfer your retirement assets without incurring taxes or penalties, provided you follow the IRS guidelines.
• Transfers: You can transfer funds from an existing IRA to a Self-Directed IRA. This method is similar to a rollover but typically involves moving funds between IRAs rather than from a 401(k) or other employer-sponsored plan.

It’s essential to note that SDIRAs have specific rules and regulations, including the requirement to work with a custodian and to follow IRS guidelines for investing in alternative assets. By understanding these rules and working with a knowledgeable custodian, you can take full advantage of the investment opportunities offered by a self-directed IRA.

Rollover Rules

There are a few rules that can make an IRA rollover a little tricky. Failing to adhere to these rules can result in penalties and the need to pay taxes on the distributed amount. These apply to the indirect rollover mostly:

Withholding Penalty

If you receive funds personally from your administrator, the IRS will impose a withholding penalty, which can have significant income tax implications. The amount can be 10% of an IRA withdrawal or 20% from other accounts, such as a 401(k). There are no taxes withheld for a direct transfer. Also, there are no taxes withheld for a Roth IRA. The penalty is the IRS’ way of telling us to not take possession of funds for a rollover. Lastly, the entire amount (including funds that were withheld) must be deposited into your IRA.

60 Day Rollover Rule

Earlier, we mentioned you have 60 days to complete IRA rollovers from an old account. When that grace period is up, any amount not deposited into the new IRA will be treated as a distribution. It will be added to your income for the year, taxed and, if you are under age 59 1/2, you’ll get hit with a 10% early withdrawal penalty. Unless you absolutely need that money, it’s always better to opt for a direct transfer.

IRA One-Rollover-Per-Year Rule

According to the IRS, “…you can make only one rollover from an IRA to another (or the same) IRA in any 12-month period, regardless of the number of IRAs you own.” Prior to 2015, you could do as many rollovers as the number of IRAs you owned. Now, you can only do one IRA rollover in any 12-month period. For example, if you performed a rollover on June 1, 2024, you cannot do another one until June 2, 2025.

This only affects indirect rollovers and not direct transfers of one IRA to another. Moreover, this does not apply to traditional IRAs to Roth IRA rollovers, also known as conversions.

Tax Implications to Know

When rolling over a 401(k) or other qualified retirement plan to an IRA, it’s essential to understand the tax implications. Here are some key considerations:

• Direct Rollovers: A direct rollover from an employer-sponsored plan to an IRA has no tax implications. The funds are transferred directly from one account to another, maintaining their tax-deferred status.
• Indirect Rollovers: An indirect rollover involves taking a distribution from the old plan and then depositing it into the IRA within 60 days. This type of rollover is subject to income taxes and a 10% early withdrawal penalty if you are under age 59½. Additionally, 20% of the distribution will be withheld for taxes, which you must make up when depositing the full amount into the new IRA.
• Tax Withholding: If you take a distribution from a 401(k) or other qualified retirement plan, 20% of the distribution will be withheld for taxes. This withholding can complicate the rollover process, as you will need to replace the withheld amount to avoid taxes and penalties.
• Tax Advisor: It’s essential to consult with a tax advisor to determine the best course of action for your specific situation. A tax advisor can help you navigate the complexities of rollovers and ensure you make the most tax-efficient decisions for your retirement savings.

By understanding these tax implications and seeking professional advice, you can make informed decisions about rolling over your retirement accounts and avoid costly mistakes.

Conclusion

An IRA Rollover is an important tool to utilize. It can help consolidate all your old workplace retirement plans into one IRA. Further, it allows you to shop around for a plan that best suits your needs. However, it’s important to be mindful of all the rules surrounding an IRA Rollover.

The bottom line – rolling over your retirement account can help you consolidate funds, reduce fees, and access better investments. However, understanding the rules is crucial to avoid costly taxes and penalties.

Frequently Asked Questions

The Importance of Asset and Creditor Protection

Creditor protection for retirement plans depends on your state of residency, and whether the assets are yours or you inherited them. It’s also important to consider the implications of child support obligations on IRA funds in the event of bankruptcy, as creditors may pursue these funds to satisfy child support debts.

IRA asset & creditor protection can help protect your assets from lawsuits, creditors, liens, and more. You should protect the assets within your IRA before claims or liabilities. It’s often too late to protect yourself when a claim occurs.

With a Self-Directed IRA LLC, also known as a Checkbook IRA, you receive stronger asset and creditor protection. By using an LLC that your IRA owns, you gain an additional layer of limited liability protection. Thus, if you make investments with a Checkbook IRA, the asset & creditor protection is stronger than if you make the investments on your own. Using an LLC better protects your retirement assets from creditors inside or outside of bankruptcy.

Types of IRAs and Their Protections

Traditional IRAs and Roth IRAs

Traditional IRAs and Roth IRAs are two of the most common types of Individual Retirement Accounts (IRAs), each offering unique tax benefits and rules for contributions and withdrawals. Traditional IRAs allow for tax-deductible contributions, meaning you can reduce your taxable income in the year you make the contribution. The funds in a traditional IRA grow tax-deferred, and you only pay taxes when you withdraw the money, typically during retirement. This can be advantageous if you expect to be in a lower tax bracket when you retire.

Roth IRAs, on the other hand, require contributions to be made with after-tax dollars. While this means you don’t get an immediate tax break, the funds grow tax free, and qualified withdrawals are also free of taxes. This can be particularly beneficial if you anticipate being in a higher tax bracket in retirement.

When it comes to creditor protection, both traditional and Roth IRAs enjoy significant safeguards under federal law. The Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) of 2005 provides an exemption for IRA funds up to $1,512,350. However, it’s important to note that this protection does not extend to inherited IRAs, and the level of protection can vary depending on state laws.

Self-Directed IRAs

Self-Directed IRAs offer a broader range of investment options compared to traditional IRAs, allowing you to invest in assets such as real estate, cryptocurrencies, and private companies. This flexibility can be a significant advantage for those looking to diversify their retirement portfolio beyond stocks and bonds.

One of the key benefits of a Self-Directed IRA is the potential for enhanced creditor protection through the use of a Limited Liability Company (LLC). By establishing an LLC that owns the IRA, you add an extra layer of limited liability protection. This structure makes it more challenging for creditors to access the IRA assets, providing an additional safeguard for your retirement savings.

Inherited Retirement Account

Inherited retirement accounts are generally not protected under the Bankruptcy Act. Therefore, your Inherited IRA may be subject to creditor attack inside of bankruptcy. If the creditor attack occurs outside of bankruptcy, turn to your state statute to determine whether a creditor who is after you personally can also go after your IRA. It is advised that you speak to a tax attorney/professional in your state beforehand even though most states will protect your account.

Bankruptcy Abuse Prevention and Consumer Protection Act

BAPCA (Bankruptcy Abuse Prevention and Consumer Protection Act) became effective for bankruptcies that were filed after October 17, 2015. The Act gave protection to debtor’s IRA funds by exempting funds from most unsecured business and consumer debts. An unsecured debt is essentially a loan that is not backed by an underlying asset. The exemption provides unlimited exemption for IRAs under section 408(a).

IRA’s Federal Protection for Bankruptcy

Effective April 1, 2022, the maximum aggregate bankruptcy exemption amount for IRAs increased from $1,362,800 to $1,512,350. This exemption amount is subject to cost-of-living adjustments (COLAs), having risen from an initial exemption limit of $1,000,000 as enacted within BAPCA. Rollover IRAs enjoy certain protections under federal bankruptcy law.

Funds rolled over from employer-sponsored plans into a rollover IRA are not counted toward creditor protection caps, differentiating them from other types of IRAs, such as Inherited IRAs, which do not share the same protections.

IRA Creditor Protection Outside of Bankruptcy

The extensive anti-alienation protection that applies to a 401(k) does not extend to an IRA. This includes a Self-Directed IRA arrangement under Internal Revenue Code section 408. Therefore, you must turn to state law for any attacks outside of bankruptcy for any type of IRA, such as traditional and Roth IRAs. A simplified employee pension (SEP) IRA is also a viable option for self-employed individuals or small business owners, adhering to the same withdrawal rules as a traditional IRA.

If you have creditors after you personally and you are not filing for bankruptcy, look at your state statute. Most states will provide unlimited protection– however, some states, such as California and Nevada have restrictions on what will be protected within your retirement account. In other words, you will not receive full protection in every state. A savings incentive match plan (SIMPLE IRA) allows both employers and employees to contribute to retirement funding, with employer contributions being either non-elective or matching based on employee salaries.

The above rules apply to individuals who are experiencing personal attack. If your IRA makes an investment and is being attacked, the creditor will only be able to go after the IRA and not you. If you have an LLC, the creditor can only go after what is inside of the LLC, nothing outside of the LLC.

Summary of IRA Protection by State

Please see chart at IRA Financial Group

For help reading the state statute, it is highly advised to hire an attorney or tax specialist. The attorney will explain what creditors can and cannot obtain from your IRA.

Important Note: IRAs are exempt only to the extent necessary to provide for the support of the judgment debtor when the judgment debtor retires and for the support of the spouse and dependents of the judgment debtor, considering all resources that are likely to be available for the support of the judgment debtor when the judgment debtor retires.

IRA Asset Planning

The bulk of an individual’s savings are within individual retirement accounts. For example, the 2005 Bankruptcy Act protects IRA funds by exempting funds from most unsecured business and consumer debts inside of bankruptcy, and state statute often provides great protection towards IRAs outside of bankruptcy. Because of the significant federal and state protection IRAs receive, such as the Self-Directed IRA, this presents opportunities to protect your assets by establishing a Self-Directed retirement plan.

A Roth IRA offers significant tax advantages, including tax-free withdrawals during retirement, making it a preferred option for individuals expecting to be in a higher tax bracket upon retirement.

For example, if you leave an employer who provides a qualified retirement plan, rolling your assets over from the employer plan into an IRA may create asset protection issues. If you live in a state where you have no asset and creditor protection, or your IRA has an excess of $1.2 million in assets, you may benefit by leaving the assets in the company-qualified plan.

IRA assets that you leave to a spouse will likely receive creditor protection if you re-title the IRA in the name of your spouse.  However, if you plan to leave some of your IRA funds to your family, other than your spouse, your beneficiaries may not receive creditor protection. However, this depends on where the beneficiaries live. For any beneficiaries other than your spouse, you should leave the IRA assets in a trust. As a result, you must name the trust on the IRA custodian Designation of Beneficiary Form on file.

Protecting Your IRA from Divorce

Divorce can pose a significant risk to your IRA assets, as they may be subject to division during the settlement process. However, there are strategies you can employ to protect your IRA from being divided. One effective approach is to set up a Self-Directed IRA, which can invest in less liquid assets such as real estate or private companies. These types of investments can be more challenging for a spouse to access and divide.

Another robust strategy is to establish a trust, such as a Cook Islands trust or a Nevis trust, to hold your IRA assets. Trusts can provide an additional layer of protection, making it more difficult for a spouse to claim the assets during a divorce. This approach can be particularly effective if you have significant retirement savings that you want to shield from potential division.

It’s crucial to consult with a financial advisor or attorney to determine the best strategy for protecting your IRA in the event of a divorce. These professionals can help you navigate the complexities of divorce and IRA protection, ensuring that your retirement assets remain secure. By taking proactive steps, you can safeguard your retirement funds and ensure they are available for your future needs.

Frequently Asked Questions

You might ask, aren’t all IRAs “self-directed?” In a sense, they are, since you get to choose your investments. But try investing in real estate, precious metals or hard money loans with an IRA from your local bank. They’ll say no once they finish laughing at you!

Here, we’ll explain what a Self-Directed IRA really is and how it can supercharge your retirement savings. It’s a strategy savvy investors utilize, but regular folks don’t know much about. With just a little bit of knowledge and some money to spare, anyone can have a comfortable retirement.

What is a Self-Directed IRA?

A Self-Directed IRA is a regular IRA that has a world of investment opportunities. No longer are you limited to what your local bank or brokerage firm or the popular online sites offer you. You’re not stuck with traditional investments, such as stocks, bonds and mutual funds. Typical financial institutions make money off the investments they push on you, along with fees. They don’t make money if you invest in nontraditional assets. Therefore, they don’t offer them to you.

Moreover, most of the popular institutions say they offer self-directed IRAs. Be sure to read the fine print though! They also limit your investment opportunities. Further, you usually need to get permission to make an investment. Not exactly self-directed is it? Real self-direction doesn’t limit your investment choices, nor does it require permission. After all, it’s your money and you should invest it in whatever YOU see fit. With a Self-Directed IRA, you can invest in almost anything. Some of the most popular Self-Directed IRA investments include real estate, cryptocurrency, precious metals, private placements, venture capital investments, farmland, wine, and more! Best of all, you can still invest in traditional investments and maintain total control over your retirement.

Roth IRA vs Self-Directed Roth IRA

A Roth IRA allows IRA holders to enjoy tax-free distributions. This is because the Roth IRA was funded with after-tax dollars, meaning you don’t receive an upfront tax-break, but all income and gains on your investment will be tax-free when you take a qualified distribution (in order for a Roth IRA distribution to qualify, the IRA must be opened for at least five years, and the IRA holder must be age 59 1/2 or older). Roth IRAs help avoid paying taxes on withdrawals, making them an attractive option for many investors.

Many retirement investors use their Roth IRA to purchase traditional investments, like stocks, bonds, CDs, mutual funds and the like. The breadth of investments you can make with your IRA is typically determined by the company that holds the account. For example, if your Roth IRA is held by a bank or financial institution, you will most likely only be limited to make tax-free traditional investments.

Before deciding what type of Self-Directed IRA to open, it is important to consider the difference between a traditional IRA and a Roth IRA. With a traditional IRA, there are no income limits. However, with a Roth IRA, you have to meet the income requirements. If you make too much money, you may need to consider a Backdoor Roth IRA.

Another thing that needs to be considered before selecting a traditional IRA or a Roth IRA is RMDs. Required Minimum Distributions occur when the individual reaches 73. If you have a traditional IRA, regardless of if it is self-directed, you must begin taking RMDs at 73. Failure to take an RMD can result in tax consequences.

Since Roth IRAs are funded with after-tax money, you do not need to take RMDs! Your Roth balance can continue grow unhindered until you decide to withdraw from the account. Of course, if you don’t need the funds personally, you can pass your IRA to a beneficiary, just make sure he or she know the rules surrounding an Inherited IRA.

Self-Directed IRA Benefits

Invest in What You Understand

Americans became frustrated with the equity markets after the 2008 financial crisis. Thankfully, we have seen the financial markets rebound since then. Yet, many investors are still somewhat shell-shocked from the market swings. They are not 100% sure what goes on in Wall Street and how it all works.

Real estate, for comparison, is often a more comfortable investment for the lower and middle classes because they grew up exposed to it. Whereas the upper class are more familiar with Wall Street and other securities.

We always hear people talk about the importance of owning a home, and the amount of money one can make by owning real estate. 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. With a Self-Directed IRA, you can make real estate and other alternative asset investments avoiding the frustration of paying taxes on your profits.

Diversification

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, many of us have most of our savings connected to the stock market.

In fact, over 90% of retirement assets are invested in the financial markets. Investing in non-traditional assets, such as real estate, offers a form of investment diversification from the equity markets. With a more diversified Self-Directed IRA, it is less likely that your assets move in the same direction. However, diversification does not assure profit or protect against loss. Nevertheless, the use of non-traditional asset classes can help protect your portfolio when the market is down and prevent you from losing more than the market.

Inflation Protection

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 humans 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.

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.

For example, if someone has an IRA worth $250,000 at a time of high inflation, that $250,000 will be worth significantly less or have significantly less buying power. This can mean the difference between retiring and working the rest of your life.

Many investors have long recognized that investing in commercial real estate can provide a natural protection against inflation. This is because rents tend to increase when prices do, acting as a hedge against inflation.

Related: Do Self-Directed IRAs Have Income Limits?

Hard Assets

Many non-traditional assets, such as real estate and precious metals are tangible hard assets that you can see and touch. With real estate, for example, you can drive by with your family, point out the window, and say “I own that”.

For some, that’s important psychologically especially in times of financial instability, inflation, or political or global upheaval.

If you are looking to use your retirement funds to make alternative asset investments and expect to have a high level of transaction frequency (i.e. rental properties), are concerned about liability (real estate), wish to have greater control over your IRA, or are concerned about privacy, then the self-directed IRA LLC is the smart choice.

Learn More: Alternative Investments in an IRA

Tax Deferral

Tax deferral literally 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 accumulate tax-free until the investor or IRA owner withdraws the funds and takes possession of them.

As long as 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 do withdraw your IRA funds in the form of a distribution after you retire, you will likely be in a lower tax bracket and be able to keep more of what you accumulated.

So, with using a traditional IRA retirement savings vehicle:

• You don’t pay taxes on the money you invested
• You may pay taxes at a lower rate when you finally do “take home” your money

If the funds remain in the account, they grow without taxes eroding their value. This enables assets to accumulate at a faster pace, giving you an edge when saving for the long term.

Disadvantages of a Self-Directed IRA

Lack of Liquidity

Depending on what you choose to invest in, you may not be able to move your funds as you see fit. For example, if you invest in real estate, this is a long-term growth asset and generally is accompanied by a contract. Changing this investment will take some time. Using a Checkbook Controlled Self-Directed IRA can mitigate this problem.

Having a well-balanced portfolio is the best route. Balancing slow-growing investments with some more liquid options.

Inability to Receive Investment Advice

A Self-Directed IRA custodian is not permitted to give investment advice. While a Self-Directed IRA allows you to invest in traditional and alternative assets, custodians cannot tell you what to invest in. Instead, the purpose of a Self-Directed IRA is to give investors control over their retirement accounts.

Paperwork and Hidden Fees

It would help if you kept in mind that the custodian of your account or any other financial companies you may hire to assist you may charge some hefty fees. It is essential to do your homework to avoid any unnecessary expenses. Of course, it doesn’t matter investment you’re making, you will have to do paperwork. Whether you do it, or your custodian, it has to get done!

Self-Sabotage and Complications

The IRS highly regulates Self-Directed IRA accounts to prevent fraudulent accounts and investors. Be sure that you are well-read in the IRS guidelines for self-directed IRA accounts to avoid the risk of tax penalties or account disqualification altogether. Learning about prohibited transactions, such as not reporting account changes to your custodian or accessing your funds before retirement.

You will also need to do your homework on disqualified people, meaning anyone who may benefit from your Self-Directing IRA account must abide by the rules laid out. It would be best if you were well-versed in off-limit assets like life insurance, collectibles, and sentimental items. Doing your research before making any investment is smart and will benefit you in the long run.

Understanding the rules is crucial to avoid complications and penalties. These rules govern investment options and highlight specific prohibited transactions and disqualified persons that can affect your IRA investments. By being well-informed, you can maintain the tax-advantaged status of your account and steer clear of potential pitfalls.

Private Ownership

Your Self-Directed IRA account is protected against bankruptcy and can be passed down to the next generation, but there are still some risks of losing your investments. For example, if you invest in a start-up company and they fail, you lose all the money you invested in that company. By being mindful of the high-risk investments in your portfolio, try to be diverse without spreading your funds too thin.

Choosing a Self-Directed IRA Custodian

Choosing the right Self-Directed IRA custodian is crucial for the success of your retirement savings. A custodian is responsible for holding and administering your account, ensuring compliance with IRS regulations, and providing guidance on investment options. When selecting a custodian, consider the following factors:

• Experience: Look for a custodian with extensive experience in handling Self-Directed IRAs and alternative investments. An experienced custodian will be well-versed in the nuances of managing diverse assets, from real estate to private equity.
• Fees: Compare the fees charged by different custodians, including setup fees, annual fees, and transaction fees. Understanding the fee structure will help you avoid unexpected costs and maximize your retirement savings.
• Investment Options: Ensure the custodian offers a wide range of investment options, including alternative assets such as real estate, private equity, and precious metals. A diverse array of options allows you to tailor your investment strategy to your financial goals.
• Customer Service: Evaluate the custodian’s customer service, including their responsiveness, knowledge, and willingness to help. Good customer service can make a significant difference in managing your Self-Directed IRA effectively.
• Reputation: Research the custodian’s reputation online, checking for reviews, ratings, and any potential red flags. A custodian with a solid reputation is more likely to provide reliable and trustworthy service.

Understanding IRA Rules

Self-Directed IRAs are subject to various rules and regulations set by the IRS. Understanding these rules is crucial to avoid penalties, fines, and even the loss of tax benefits. Here are some key IRA rules to keep in mind:

• Contribution Limits: The annual contribution limit for Self-Directed IRAs is $7,000 in both 2024 and 2025, or $8,000 if you are 50 or older. Staying within these limits is essential to avoid penalties.
• Prohibited Transactions: Self-Directed IRAs are subject to the “no self-dealing” rule, which prohibits borrowing money from the IRA, selling property to it, and other interactions. Engaging in prohibited transactions can lead to severe tax consequences.
• Disqualified Persons: Self-Directed IRAs prohibit entering into deals with specific relatives, including parents and children. Transactions with disqualified persons can result in penalties and disqualification of the IRA.
• Unrelated Business Income Tax (UBIT): Self-Directed IRAs may be subject to UBIT if they generate income from an active trade or business. Understanding UBIT is crucial to avoid unexpected tax liabilities.
• Required Minimum Distributions (RMDs): Traditional Self-Directed IRAs are subject to RMDs, which require you to take a minimum distribution from your account each year starting at age 73. Failing to take RMDs can result in significant penalties.

It’s essential to consult with a financial advisor or tax professional to ensure you understand and comply with all IRA rules and regulations.

Investment Options for a Self-Directed IRA

Self-Directed IRAs offer a wide range of investment options, including alternative assets such as:

• Real Estate: You can invest in direct property ownership, real estate investment trusts (REITs), and real estate crowdfunding. Real estate investments can provide steady income and potential appreciation.
• Private Equity: You can invest in private companies, startups, and small businesses. Private equity investments offer the potential for high returns but come with higher risks.
• Precious Metals: You can invest in gold, silver, platinum, and other precious metals. Precious metals can act as a hedge against inflation and economic uncertainty.
• Cryptocurrency: You can invest in Bitcoin, Ethereum, and other cryptocurrencies. Cryptocurrencies offer high growth potential but are highly volatile.
• Mutual Funds: You can invest in a variety of mutual funds, including index funds and actively managed funds. Mutual funds provide diversification and professional management.

When investing in a Self-Directed IRA, it’s essential to conduct thorough research and due diligence to ensure you’re making informed investment decisions. You may also want to consider consulting with a financial advisor or investment professional.

Self-Directed IRA vs. Self-Directed IRA LLC

In order to expand your investment opportunities, you must establish a Self-Directed IRA. There are two types of Self-Directed IRAs.

1. Custodian-Controlled IRA- A standard Self-Directed IRA
2. Checkbook IRA – Self-Directed IRA LLC

What’s the difference between the two? A custodian-controlled IRA is offered by some large financial institutions. However, they often restrict the types of investments you can make and you will need custodian consent on all investment decisions.

Whereas a Checkbook IRA is the true form of self-directing your individual retirement account. With “checkbook control,” there’s no need for custodian consent. You’re in charge of what investments you wish to make – when you want to buy and when you want to sell. It’s the ultimate retirement vehicle for IRA investors who want control and the opportunity to invest in alternative assets.

Self-Directed IRA Setup

Setting up a Self-Directed IRA is easier than you may think. Let’s take a look at what it involves:

1. Choose an IRA Custodian or Trust Company

If you choose an IRA custodian, such as a bank or brokerage firm, make sure they allow you to invest in alternative assets, like real-estate and cryptocurrency. Such an example is IRA Financial Trust. You gain checkbook control, and as a result, complete freedom to do what you want with your investments. Of course, you must always be aware of the prohibited transaction rules. Additionally, you should be aware of any fees a Self-Directed IRA custodian may charge. At IRA Financial, we charge a flat fee.

2. Fund Your New IRA

The second step in setting up a Self-Directed IRA (SDIRA) is to fund your IRA. You can do this one of three ways:

1. Transfer – Transfer funds from one IRA to another. Your current custodian will transfer the funds to your new Self-Directed IRA passive custodian.
2. Rollover – Do you want to move money from a qualified retirement plan to fund your SDIRA? You can do a direct or indirect rollover. The preferable option is a direct rollover of retirement funds. The funds from your previous IRA go to your new custodian – not to you.
3. Contribution – This is an option, however it’s the least effective, because annual IRA contributions limit are so low.

Traditional IRAs, on the other hand, offer similar funding options but are generally easier to open and manage, providing a range of investment choices without the complexity of self-directed investments.

3. Decide if you want to Establish an LLC (Limited Liability Company)

You will need to form an LLC, also known as a limited liability company. The IRA owns the LLC, but you’re the manager. Your funds are transferred to the LLC and this is how you can make investments (through the LLC).

4. The LLC Operating Agreement

To accomplish a Self-Directed IRA setup, you will need the most important SDIRA document: the LLC operating agreement. It includes:

• Special tax provisions regarding “investments retirement accounts” and “prohibited transaction rules” pursuant to IRC sections 408 and 4975.
• Additionally, it will include special management provisions because the LLC is managed by a manager and not a member.

5. LLC Bank Account

The fifth step to setting up a Self-Directed IRA is to establish an LLC bank account. You will need a few documents to do this:

• LLC article of formation
• Tax ID number
• Self-Directed IRA LLC Operating Agreement

6. Fund the LLC Bank Account

Let your IRA custodian know that you wish to have your funds sent to the new IRA LLC bank account. It will move over tax-free in exchange for 100% interest in the limited liability company.

Setting up a Self-Directed IRA usually takes approximately 10 days.

These are the six necessary steps to perform a Self-Directed IRA setup. With this structure, you will receive:

1. Checkbook Control: Because you’re manager of the LLC, you receive checkbook control over your IRA funds/assets. You can make whatever investment you want (as long as it’s IRS approved) and you don’t have to rely on custodian consent.
2. Tax-free Income & Gains: The LLC is owned by the IRA, therefore it will be treated as a disregarded entity. As a result, no federal income tax return is necessary. All income and gains from your investments are tax-free.

Tax Reporting for Your Self-Directed IRA

Self-Directed IRAs are subject to various tax reporting requirements. It’s essential to understand these requirements to avoid penalties and fines. Some key tax reporting requirements include:

• Form 5498: This form reports contributions made to your Self-Directed IRA, including annual contributions, rollovers, and the fair market value of the account. It’s crucial to ensure accurate reporting to avoid discrepancies.
• Form 1099-R: This form reports distributions from your Self-Directed IRA, including withdrawals and RMDs. Proper reporting of distributions helps in calculating the correct tax liability.
• Form 990-T: This form reports Unrelated Business Income generated by your Self-Directed IRA. If your IRA generates “UBI,” timely filing of Form 990-T is necessary to avoid penalties.
• Form 1065: This form reports the income, deductions, and other financial information of a partnership or multi-member LLC invested in your Self-Directed IRA. Accurate reporting ensures compliance with IRS regulations.

It’s essential to consult with a tax professional to ensure you’re meeting all tax reporting requirements and avoiding any potential penalties or fines. Proper tax reporting is crucial for maintaining the tax-advantaged status of your Self-Directed IRA.

Conclusion

As you can see, the benefits of a Self-Directed IRA are immeasurable compared to other IRAs. The freedom of investing in what you want, when you want, will lead to retirement success. Whether you want to invest in real estate, peer-to-peer lending, or cryptocurrencies, the opportunities await.

To learn more about all the benefits of a Self-Directed IRA, please contact one of our IRA experts @ 800.472.1043!

Frequently Asked Questions

Self-Directed IRA Prohibited Transactions

IRA owners must fully understand the regulations surrounding IRAs, particularly Self-Directed IRAs, to avoid disqualification. They must be aware of prohibited transactions and adhere to legal guidelines to ensure the status of their IRAs is not jeopardized.

The Internal Revenue Code (the Code) does not state what investments you can make, only what investments you cannot make. Under IRC section 4975, the Code states that the IRA holder cannot purchase life insurance or collectibles (art, stamp, rugs, etc.) with his or her IRA funds.

In general, Self-Directed IRA prohibited transactions fall under three categories:

1. Direct prohibited transaction
2. Self-dealing prohibited transaction
3. Conflict-of-interest prohibited transaction

Understanding Self-Directed IRA Prohibited Transactions

Definition of Prohibited Transactions

A prohibited transaction is any improper use of an IRA account or annuity, as defined by the Code. This includes any transaction that benefits a disqualified person, such as a fiduciary or family member, or involves self-dealing or receiving indirect benefits.

Prohibited transactions can result in severe tax consequences, including the disqualification of an IRA account. The IRS takes these rules seriously to ensure that retirement funds are used solely for their intended purpose—securing your financial future.

Direct Prohibited Transaction

This type of transaction involves a disqualified person and his/her retirement account. An example of a direct prohibited transaction is as follows:

Mark uses funds from his Self-Directed IRA to purchase an interest in an entity that his father owns. This transaction is between two disqualified persons (Mark, the IRA holder, and his father, a lineal descendant). Furthermore, it personally benefits one of the disqualified persons.

IRA-owned property must remain distinct from personal assets, and engaging disqualified persons in transactions related to these properties is not allowed to prevent any indirect benefits that could violate IRS rules.

Self-Dealing Prohibited Transaction

A self-dealing prohibited transaction occurs when an individual uses his or her IRA income or assets for personal gains. For example, Pam uses her Self-Directed Roth IRA funds to make an investment in a company she controls. Ultimately, this transaction will benefit her personally.

The IRS prohibits the use of retirement funds for the benefit of the IRA holder’s personal interests. It is crucial to keep personal funds and IRA-held assets separate to avoid prohibited transactions.

Conflict-of-interest Prohibited Transaction

This prohibited transaction occurs when a disqualified person, who is also a fiduciary, and is involved in a transaction regarding the income or assets of the individual’s IRA. For example, France uses her IRA funds to loan money to a company she owns a small interest in. She also manages and controls the daily operations, therefore has a close connection to the investment.

The Prohibited Transaction rules were created to encourage people to save for retirement and increase their retirement funds through tax-free or tax-deferred growth. However, it also prevents individuals from taking advantage of tax benefits for their personal account.

Disqualified Persons

Another prohibited transaction is the engagement of IRA funds with a disqualified person. The majority of Self-Directed IRA prohibited transaction rules pertain to transactions with such persons. The reason that transactions with disqualified persons are prohibited is because the IRC views such dealings as suspicious, therefore should not be allowed.

Understanding the legal boundaries of IRA investment is crucial, as certain investments, like life insurance policies and collectibles, are not permissible under IRS regulations.

The definition of a disqualified person extends in a variety of scenarios that can be complex. Disqualified persons include the IRA holder and his/her lineal descendants or ascendants (parents, children, etc.). It also includes entities of which disqualified persons own 50%.

Who is a Disqualified Person?

A disqualified person is an individual who is prohibited from engaging in transactions with a retirement plan, which includes:

• The IRA owner and his/her spouse
• The IRA owner’s direct ancestors, such as parents and grandparents
• The IRA owner’s descendants, such as their children and grandchildren, and their spouses
• Any entity in which the IRA owner has a 50% or greater interest
• Fiduciaries of the IRA, such as the custodian or administrator

Disqualified persons cannot engage in transactions with the IRA, except in certain circumstances. Transactions with disqualified persons are considered prohibited and can result in penalties and taxes for the IRA owner. Understanding who qualifies as a disqualified person is crucial to avoid inadvertent prohibited transactions and protect your retirement funds.

Prohibited Investments

The IRS dictates what is NOT permitted for IRA investments. Examples of prohibited IRA investments include:

• Collectibles (such as artwork, stamps, rugs, antiques, and gems)
• Certain coins
• Life insurance contracts
• S corporation stock

These investments are considered prohibited because they are not allowed to be held in an IRA account. Self-Directed IRAs have restrictions on investments, including prohibited investments, which include investments that are not federally legal (like marijuana). It’s essential to be aware of these limitations to ensure your IRA remains compliant and avoids any potential penalties.

Permitted Investments

While the IRS does not provide guidance on permitted investments for self-directed IRAs, it is generally understood that IRAs can invest in a wide range of assets, including:

• Stocks and bonds
• Mutual funds
• Real estate
• Private equity
• Limited liability companies (LLCs)
• Limited partnerships (LPs)

However, it is essential to note that even if an investment is permitted, it may still be subject to prohibited transaction rules if it involves a disqualified person or self-dealing. It is recommended to seek advice from a CPA or other professional to navigate permissible investments and dealings with disqualified persons. By doing so, you can maximize the potential of your self-directed IRA while staying within the bounds of IRS regulations.

Internal Revenue Code Provisions

Below are some of the IRC provisions. Each of these rules fall under different Code sections.

• Prohibiting IRAs from investing in life insurance contracts.
• Referencing tax on prohibited transactions.
• Defining an IRA’s loss of tax-exempt status upon engaging in a prohibited transaction.
• Describing the effect of pledging an IRA or any IRA assets as security for a loan.
• Expressing impermissible investment in collectibles.
• Describing unrelated business taxable income.
• Imposing tax on unrelated business income.
• Describing an unrelated trade or business.
• Swanson v. Commissioner (1996)

Frequently Asked Questions

Bottom Line

A Self-Directed IRA offers incredible investment flexibility, but breaking the IRS prohibited transaction rules can cost you big. Always consult a professional before making investments involving family members, businesses, or personal assets. Have a question about the rules? Contact us today to become a smarter investor!

How Does a Backdoor Roth IRA Work?

1. Make a Non-Deductible Contribution – Contribute after-tax money to a traditional IRA.
2. Convert to a Roth IRA – Transfer the funds from the traditional IRA to a Roth IRA, ideally soon after contributing to avoid taxable gains.
3. Pay Taxes If Necessary – If your traditional IRA has pretax funds, part of the conversion may be taxable due to the pro-rata rule.

Pros of a Backdoor Roth IRA

Tax-Free Growth & Withdrawals – Once in a Roth IRA, your investments grow without tax, and qualified withdrawals are tax free in retirement.
No Required Minimum Distributions (RMDs) – Unlike traditional IRAs, Roth IRAs don’t require RMDs, allowing your investments to grow longer and unhindered.
Ideal for High-Income Earners – If you make too much to contribute directly to a Roth IRA, this strategy gives you access to its benefits.

Cons of a Backdoor Roth IRA

Potential Tax Implications – If you have existing pretax IRA funds, the conversion could result in a tax bill.
IRS Complexity – Mistakes in execution could lead to penalties or additional taxes.
Possible Future Rule Changes – Congress could eliminate the loophole, limiting future conversions.

Is a Backdoor Roth IRA Worth It?

A Backdoor Roth IRA is worth considering if:

You’re a high-income earner who wants tax-free withdrawals in retirement.
You don’t have significant pretax IRA funds that could trigger a large tax bill.
You’re comfortable handling the IRS paperwork or working with a tax professional.

If these conditions apply, a Backdoor Roth IRA can be a smart wealth-building tool. However, if you have a large pretax IRA balance, the solution may not be a fit for you. Other factors include your age, your current/future income, and current financial situation may make the choice harder. Speaking with a financial advisor may be advantageous.

Self-Directed IRAs provide essential benefits, like flexibility and tax advantages. In the last several years, the number of self-directed retirement accounts has grown significantly. Today, there are approximately 50 million IRAs totaling about $9.3 trillion. Self-directed accounts offer investors the flexibility and control to manage their own investments, rather than relying on traditional market fluctuations.

With your Self-Directed IRA, you decide when to buy, and sell and what investments you wish to make. As a result, you better diversify your retirement portfolio and gain the ability to invest in asset classes you feel confident about.

Why Choose a Self-Directed IRA?

This type of IRA allows investors to use their IRA funds to make diverse investments. Many IRA investors believe they can only use an IRA for traditional investments, such as bank CDs, the stock market, or mutual funds. Fewer investors know that the IRS permits investments like real estate to be held inside individual retirement accounts.

The two main advantages of using a Self-Directed IRA to make investments are that you can invest in what you know and trust, and all the income and gains are tax-deferred or tax-free in the case of a Self-Directed Roth IRA. Consulting a financial advisor can provide valuable insights on financial, legal, or tax matters, enhancing your overall investment strategy.

Types of Self-Directed IRA and Roth IRA Accounts

You can establish a Self-Directed IRA with:

• Pretax (traditional) IRA
• Roth IRA
• SEP IRA
• SIMPLE IRA

In addition to these, traditional and Roth IRAs offer unique benefits and flexibility for retirement planning.

A Self-Directed IRA is essentially a vehicle that allows you to use your IRA funds to make investments banks or traditional financial institutions do not provide. A Coverdell Education Savings Account is another tax-advantaged option that allows tax-free distributions for qualified educational expenses, making it a valuable tool for both K-12 and higher education. Another option is the Self-Directed Health Savings Account, which helps pay for medical bills, while saving for retirement.

What Are Self-Directed IRAs?

There are essentially two different types of Self-Directed IRAs that we will focus on: the Custodian Controlled SDIRA, and the Checkbook IRA, also known as a Self-Directed IRA LLC. Understanding the Self-Directed IRA rules is essential to avoid penalties and maintain the tax-advantaged status of your account.

Custodian Controlled Self-Directed IRA

First, you have the custodian-controlled Self-Directed IRA. This type of IRA gives investors more options than a self-directed plan a financial institution offers. A special IRA custodian will serve as the custodian of the plan. Most custodians make money by opening and maintaining IRA accounts keeping them in IRS compliance. They do not offer financial investment products or platforms.

With a custodian-controlled Self-Directed IRA, IRA funds are typically held with the IRA custodian. The custodian will then invest the funds into traditional or alternative assets at your direction. For example, if you wish to purchase a piece of real estate, the custodian will be a part of the entire process.

This “standard” Self-Directed IRA structure is popular with retirement investors who don’t plan to invest in an alternative asset that involves a high frequency of transactions, such as private fund investments.

Checkbook IRA

The second type of Self-Directed IRA offers “checkbook control.” Also known as the Self-Directed IRA LLC, a special purpose limited liability company (LLC) is established, which the IRA owns and the IRA holder (you) manages. Because you are the manager of the LLC, you have the authority to make investment decisions on behalf of your IRA. You don’t need the consent of a custodian to make a transaction.

With a Checkbook IRA. all your IRA funds will be held at a local bank in the name of the IRA LLC. Therefore, if you want to make any kind of transaction, you simply write a check straight from the bank account. You can also wire the funds and similar way to move funds to the final destination. This means you no longer have to deal with custodian delays and hefty transaction fees. Further, because of the aspects of the LLC, you are afforded more privacy for your transaction.

Self-Directed IRA Investment Options

Traditional Investments

Traditional investments are a cornerstone of many retirement planning strategies, offering stability and growth potential. These investments include:

• Stocks: Individual stocks or stock mutual funds can be held in a self-directed IRA, providing opportunities for capital appreciation and dividend income.
• Bonds: Government and corporate bonds can offer a steady income stream, making them a reliable choice for conservative investors.
• Mutual Funds: A variety of mutual funds are available, offering diversification and professional management, which can help mitigate risk.
• Exchange-Traded Funds (ETFs): ETFs offer flexibility and diversification, tracking various market indexes and sectors, making them a versatile addition to any portfolio.
• Real Estate Investment Trusts (REITs): REITs allow individuals to invest in real estate without directly owning physical properties, providing exposure to the real estate market with the liquidity of stocks.

These traditional investments can provide a solid foundation for a Self-Directed IRA portfolio, balancing risk and return while offering the potential for steady growth.

Alternative Investments

Alternative investments offer a way to diversify your portfolio portfolio beyond traditional assets. These investments include:

• Real Estate: Direct property ownership, such as rental properties or fix-and-flip projects, can be held in a Self-Directed IRA, offering potential rental income and long-term appreciation.
• Private Equity: Investing in private companies or startups can provide the potential for high returns, though it comes with higher risk.
• Precious Metals: Gold, silver, and other precious metals can be held as a hedge against inflation or market volatility, providing a tangible asset that retains value.
• Cryptocurrencies: Bitcoin and other cryptocurrencies offer the potential for high returns and diversification in a rapidly evolving market.
• Crowdfunding: Platforms like Kickstarter allow individuals to invest in projects or businesses, providing a unique opportunity to support innovative ventures and potentially reap financial rewards.

Alternative investments can provide a unique opportunity for growth and diversification in a Self-Directed IRA, allowing account owners to explore a broader range of asset classes.

Creating a Diversified Portfolio

Diversification is crucial when creating a Self-Directed IRA portfolio. By spreading investments across different asset classes, individuals can reduce risk and increase potential returns. A diversified portfolio can include a mix of traditional and alternative investments, such as:

A financial advisor can help individuals create a diversified portfolio tailored to their investment goals and risk tolerance. By including a mix of traditional and alternative investments, individuals can create a diversified self-directed IRA portfolio that aligns with their retirement goals and risk tolerance. This strategic approach to retirement planning can help ensure a more secure and prosperous future.

Self-Directed IRA Services

There are two important Self-Directed IRA services that every retirement investor must be aware of:

1. Choosing the right IRA custodian
2. Navigating the IRS-prohibited transaction rules

Navigating these rules is crucial to avoid penalties and maintain the tax-advantaged status of your account.

1. Choosing the Right Self-Directed IRA Custodian

A Self-Directed IRA custodian (passive custodian) allows you to engage in non-traditional investments but generally does not offer investment advice or serve as a fiduciary.

Not all Self-Directed IRA custodians are the same. For one, not all allow for checkbook control. Also, custodians have different fee schedules. Some, such as IRA Financial, charge a flat annual fee with no asset valuation fees. However, others charge a fee based on the value of the IRA.

One of the more important services is the efficiency with which the IRA custodian can open and fund the account. This is by way of a transfer or rollover. Roth IRAs offer unique benefits, such as tax-free growth and withdrawals, making them an attractive option for many investors.

2. IRS Prohibited Transaction Rules

The Internal Revenue Code (IRC) acts as a guide to prevent IRA holders from triggering prohibited transactions. However, the IRC does not describe what investments a self-directed IRA can make. It does, however, describe what the IRA cannot invest in. If the IRA does not purchase life insurance or collectibles, or engage in a prohibited transaction outlined in IRC Section 4975, then you can invest.

When it comes to navigating the prohibited transaction rules, it is important to work with an IRA custodian who can help you understand whether the transaction you want to make will be a violation of the rules.

The good news is that establishing a Self-Directed IRA is now easier than ever. The key is choosing the right custodian that will perform all the required services efficiently and cost-effectively. While traditional IRAs offer accessibility and ease of setup, Self-Directed IRAs provide broader investment capabilities for experienced investors.

Frequently Asked Questions

Bottom Line

A Self-Directed IRA offers more investment flexibility and control but requires careful management to stay compliant with IRS rules. Choosing the right custodian and investment strategy can help maximize tax advantages and retirement growth. Be sure you understand the different types of Self-Directed IRAs before settling on a custodian and account structure. You’ll be glad that you did!

Do you still have questions about which type of Self-Directed IRA or services to choose? Contact us at any time! You can also fill out the form to speak with an IRA specialist who is always on-site to answer any of your questions.

Max Out Your Contributions to Boost Your Roth IRA

The IRS sets annual contribution limits for Roth IRAs, which can change from one year to the next due to cost of living adjustments (COLA). For 2025, the contribution limit is $7,000 (or $8,000 if you’re 50 or older), which is the same cap as 2024. To make the most of your Roth IRA:

• Set up automatic contributions to ensure you reach the annual max.
• Prioritize early contributions to allow for more time in the market.
• Use “windfalls” (such as tax refunds, bonuses, or side hustle income) to make lump-sum contributions.

Take Advantage of the Backdoor Roth IRA

If your income exceeds the Roth IRA eligibility limits, you can still contribute using a Backdoor Roth IRA. For 2025, you cannot directly contribute to a Roth if your income is above $165,000 if you are a single filer, or $246,000 if you are married filing jointly. Those limits are $161,000 and $240,000 respectively for 2024.

A Backdoor Roth IRA involves the following steps:

1. Contributing to a traditional/pretax IRA.
2. Converting those funds to a Roth IRA.
3. Paying taxes on any earnings before the conversion.

This strategy is a great way for high earners to benefit from Roth tax advantages.

Invest Wisely for Long-Term Growth

A Roth IRA is not just a savings account—it’s an investment account. Choosing the right investments can significantly boost your long-term gains. When you opt for a Self-Directed Roth IRA, you can invest in alternative, as well as traditional, investments. Consider:

• Low-cost index funds for diversification and steady growth.
• Exchange-Traded Funds (ETFs) for broad market exposure.
• Real estate has long been the #1 alternative investments for self-directed investors.
• Cryptocurrency offers risk takers a chance for large windfalls.

Since Roth IRA withdrawals are tax free, it’s a great place to hold investments with high growth potential. Consider:

• Placing stocks, growth funds, and “alts” in your Roth IRA.
• Keeping bonds and income-generating assets in taxable or traditional IRA accounts.
• Rebalancing your portfolio periodically to stay aligned with your goals.

Avoid Early Withdrawals

Obviously, the biggest advantages of a Roth IRA is that your earnings grow tax free, but this benefit is significantly reduced if you withdraw funds too early. While you can withdraw your contributions at any time without penalties or taxes, withdrawing your investment earnings before age 59½ can result in a 10% early withdrawal penalty plus income taxes, unless you qualify for an exception. Exceptions include first-time home buyer (limited to $10,000 lifetime), qualified medical expenses, and higher education expenses.

Strategies to Avoid Early Withdrawals

To ensure your Roth IRA remains untouched and continues growing, consider these strategies:

1. Build an Emergency Fund – Some experts say that you can use your Roth has an emergency fund since contributions can be withdrawn at any time. Others argue that a high-yield savings account may be better. The choice is yours, but plan on saving 3-6 months of you salary for emergencies.
2. Use Other Investment Accounts – If you need access to funds before retirement, consider using a taxable brokerage account instead of withdrawing from your Roth IRA.
3. Plan for Major Expenses – If you anticipate large expenses (such as buying a home or paying for college), save for them separately in a 529 plan or other account.
4. Utilize Loans or 401(k) Borrowing – While not ideal, borrowing from your 401(k) may be a better alternative to withdrawing from your Roth IRA, since it won’t permanently deplete your retirement savings.

The Cost of Early Withdrawals

Withdrawing earnings early can have a significant long-term impact. For example, if you withdraw $10,000 at age 35, you’re not just losing that amount—you’re also losing decades of compound growth. Assuming a 7% annual return, that $10,000 could have grown to over $76,000 by age 65 if left untouched.

By avoiding early withdrawals, you give your Roth IRA the best chance to grow and provide a secure, tax-free income in retirement.

Consider a Roth Conversion Ladder

A Roth conversion ladder is a strategic way to move money from a Traditional IRA or 401(k) into a Roth IRA over time, minimizing taxes and allowing for penalty-free withdrawals before age 59½. It’s a popular strategy for early retirees who want to access their retirement funds without triggering a 10% early withdrawal penalty.

The Roth conversion ladder strategy involves transferring a portion of your pretax IRA and/or 401(k) funds and converting them to a Roth IRA every year. Keep in mind, each conversion has it’s own five-year requirement. So, year six you can withdraw year one funds, and year seven would allow for tax-free distributions of year two funds, and so on. The tax burden of the conversion will be spread out meaning your tax bill won’t be as bad. Keep in mind, you need to be age 59½ or older to enjoy tax- and penalty-free use of your funds. If done correctly, it allows you to access your retirement savings penalty free while optimizing taxes.

Final Thoughts

A Roth IRA is one of the most powerful tools for tax-free retirement growth, but simply opening an account isn’t enough—you need to maximize its potential. By maxing out contributions, investing wisely, avoiding early withdrawals, and leveraging strategies like the Backdoor Roth IRA or a Roth conversion ladder, you can significantly boost your Roth IRA’s value over time. And, since there are no required minimum distributions (RMDs), you can use it as a legacy-building tool.

The key to success is consistency and strategic planning. The earlier you start and the more you optimize your investments, the greater your tax-free wealth will be in retirement. Whether you’re just beginning or looking to refine your approach, taking action today will set you up for long-term financial security.

Understanding Self-Directed IRAs

A Self-Directed IRA (SDIRA) is a type of individual retirement account (IRA) that allows the account owner to invest in a broader array of assets compared to traditional IRAs. SDIRAs are designed for savvy investors who want to diversify their retirement portfolio with alternative investments, such as real estate, precious metals, and private placements. With a Self-Directed IRA, the account owner has direct control over the investments and can make decisions on how to manage the account.

SDIRAs are available as either traditional or Roth IRAs, and they offer the same tax benefits as “regular” IRAs. However, SDIRAs require greater initiative and due diligence by the account owner, as they are responsible for managing the investments and ensuring compliance with IRS rules.

What is an IRA Custodian?

By law and pursuant to Internal Revenue Code (IRC) Section 408, you must set up an IRA at a bank or other financial institution, or authorized, state-regulated trust company. The IRA trustee, or custodian, is the company that administers the plan. They are essential to maintain the tax advantages of the plan. Traditional plan assets are tax-deferred, meaning you don’t pay taxes until you withdraw funds. Roth plans are funded with after-tax money and all investments grow tax free.

The custodian holds the account’s investments for safekeeping. Further, they ensure the plan follows all rules set forth by the government, in particular, the Internal Revenue Service (IRS). Failure to adhere to these rules may lead to the disqualification of the IRA. If that happens, you lose all the benefits of investing with an IRA.

Why Do You Need a Special Custodian?

As we mentioned, not all Self-Directed IRA custodians are the same. You can go to virtually any bank or financial institution to open a Self-Directed IRA. However, most “big box” custodians will limit what you can invest in. Many only allow for traditional investments, such as stocks and mutual funds. Therefore, you will need a special custodian, such as IRA Financial, if you want to invest in non-traditional assets, also called alternative assets. These include real estate, precious metals, cryptocurrencies and hard money loans.

Traditional institutions don’t make money when you buy alternatives. They make their money by selling you traditional investment products or by holding onto your cash. On the other hand, Self-Directed IRA custodians make their money by simply setting up the plan for you, and by administration fees.

Generally, a Self-Directed IRA custodian will not try to sell you a product. Further, they do not provide investment advice. Essentially, they maintain the plan for you and give you the freedom to invest in whatever you see fit. Of course, you should always consult with a financial advisor to make sure your investments fit your personal goals.

Custodian Fees and Services

When selecting a Self-Directed IRA custodian, it’s essential to consider the fees and services offered. Custodian fees can vary widely, and some custodians may charge higher fees for certain services. Here are some common fees associated with self-directed IRAs:

• Setup fees: These fees are charged when opening a new Self-Directed IRA account.
• Annual fees: These fees are charged annually to maintain the account.
• Transaction fees: These fees are charged for each transaction, such as buying or selling an investment.
• Maintenance fees: These fees are charged for ongoing account maintenance.

When evaluating custodian fees, it’s crucial to consider the services offered. Some custodians may provide additional services, such as investment advice or account management, which may be included in the fees. Others may charge extra for these services.

Risks and Challenges of Self-Directed IRAs

While Self-Directed IRAs offer the potential for higher returns and greater diversification, they also come with unique risks and challenges. Here are some of the key risks and challenges to consider:

• Investment risk: Self-directed IRAs allow investors to invest in alternative assets, which can be riskier than traditional investments.
• Lack of liquidity: Some alternative investments, such as real estate or private placements, may not be easily liquidated.
• Regulatory risk: Self-Directed IRAs are subject to IRS rules and regulations, and non-compliance can result in penalties and fines.
• Fraud risk: Self-Directed IRAs can be vulnerable to fraudulent schemes, such as Ponzi schemes or investment scams.

To mitigate these risks, it’s essential to work with a reputable custodian and to conduct thorough due diligence on any investment. Additionally, investors should carefully review the fees and services associated with the custodian and ensure that they understand the risks and challenges associated with Self-Directed IRAs.

Choosing the Best Self-Directed IRA Custodian

Choosing your custodian involves many factors. The first question an IRA owner should ask is if they are a member of the Retirement Industry Trust Association (RITA). RITA is the organization that is responsible for the continuing education of all regulated Self-Directed IRA custodians. The best of the best custodians are members of RITA.

Next, you want to ensure they know what they are doing! Expertise in all matters of self-directed plans is imperative, especially checkbook control. Checkbook control gives you, the investor, the freedom to make any IRS-approved investment anytime you want! Alternatively, custodian control will allow you to make alternative investments, however, you have to get your custodian’s consent before investing. This can cause needless delays. Obviously, your custodian should be well versed on all IRS rules concerning IRAs.

Lastly, you should know the fee structure of the custodian you choose. Here at IRA Financial, we feel you should never pay asset valuation fees. You should not have to pay more because of successful investments. There should only be one, flat fee you need to pay to maintain the plan, no matter the account balance. Lastly, there shouldn’t be a minimum balance requirement. Everyone is entitled to make the most out of his or her retirement savings. Self-directed plans are not just for the wealthy!

Frequently Asked Questions

Putting it All Together

Choosing a Self-Directed IRA custodian should not be taken lightly. You do not want to randomly choose one based on little information. The cost for setting up the account will vary greatly. Just because one is cheaper (or more expensive) does not tell you anything about their service, expertise and experience. Do your homework before signing up.

Finding the right answers to these questions are critical in choosing the best Self-Directed IRA custodian. Work with a qualified financial planner, do you research, and educate yourself before choosing a custodian. If you have any questions, feel free to contact us at 800.472.1043. We’re here to answer any questions you may have!

Unrelated Business Taxable Income is the “gross income derived by any organization from any unrelated trade or business regularly carried on by it.” Typically, an exempt organization will not be taxed on its income from activities that are charitable or educational. Such income is exempt even when the activity is a trade or business. However, certain types of investment income, such as dividends, interest, and capital gains, may be exempt from UBIT when associated with IRAs.

However, to prevent tax-exempt entities from competing unfairly with taxable entities, tax-exempt entities are subject to the UBTI tax. This is the case when the entity derives its income from a trade or business that has no relation to its tax-exempt status.

IRC 501 allows tax exemption to a number of organizations, such as non-profits. However, if the organization engages in activity unrelated to its business, and generates income from said activity, it may be liable for UBTI tax.

Understanding UBTI and UBIT

Definition and Purpose

Unrelated Business Taxable Income (UBTI) and Unrelated Business Income Tax (UBIT) are crucial concepts for tax-exempt entities, including Self-Directed IRAs, to understand. UBTI refers to the income earned by a tax-exempt entity that is not related to its exempt purpose. UBIT, on the other hand, is the tax imposed on this income. The purpose of UBTI and UBIT is to ensure that tax-exempt entities do not unfairly compete with taxable businesses and to prevent them from accumulating unrelated business income without paying taxes.

Tax-exempt entities, such as non-profits and IRAs, enjoy significant tax advantages. However, when these entities engage in activities that generate income unrelated to their primary exempt purpose, they must pay taxes on that income. This ensures a level playing field between tax-exempt and taxable entities, preventing tax-exempt organizations from gaining an unfair competitive edge.

UBTI Tax – A Dual Purpose

As you can see, UBTI has a dual purpose:

1. Prevent tax-exempt businesses from competing unfairly with taxable organizations
2. Prevent them from engaging in business unrelated to its primary business objectives

There are many tax advantages that come with an IRA. One example is tax-free gains until you make a distribution. Most passive income investments will not be seen as UBTI. However, funds you generate from income that is UBTI taxable, and goes back into the IRA, is subject to UBTI tax. Tax-exempt organizations must pay tax on UBTI exceeding $1,000 to ensure compliance and maintain a fair competitive landscape. For example, the operation of a gas station by an LLC or partnership that a Self-Directed IRA owns will likely be subject to the UBTI tax.

UBTI vs. UDFI

UBTI also applies to UDFI. “Debt-financed property” refers to borrowing money to purchase real estate. In a case like this, the income attributable to the financed portion of the property will be taxed. Income generated from investments in a tax-exempt account, especially when leveraging debt, can trigger taxes under UDFI and UBIT regulations. Gain on the profit from the sale of the leveraged assets is also UDFI unless the debt is paid off more than 12 months before it’s sold.

There are a few exceptions from UBTI tax. They relate to the central importance of investment in real estate. Some examples include:

• Dividends
• Interest
• Annuities
• Royalties
• Most rentals from real estate
• Gains/losses from the sale of real estate

The rental income you generate from the real estate that is “debt-financed” loses the exclusion. That portion of income becomes subject to UBTI. As a result, if the IRA borrows money in order to finance the purchase of real estate, the portion of rental income attributable to the debt is taxable as UBTI.

What Triggers UBTI?

UBTI is triggered when a tax-exempt entity, such as an IRA, earns income from a business or investment that is not related to its exempt purpose. This can include income from partnerships, limited liability companies (LLCs), and other business entities. For instance, if an IRA invests in a partnership that operates a business, the income generated from that business is considered UBTI.

Additionally, rental income can trigger UBTI, especially if it involves leasing equipment or property that is not directly related to the entity’s exempt purpose. Investments in master limited partnerships (MLPs) and limited partnerships (LPs) that use leverage can also result in UBTI. These scenarios highlight the importance of understanding the sources of income and their relation to the entity’s exempt purpose to avoid unexpected tax liabilities.

Calculating UBTI

Calculating UBTI involves determining the gross income earned by the tax-exempt entity from its unrelated business activities. This includes income from partnerships, LLCs, and other business entities, as well as rental income and income from MLPs and LPs. Once the gross income is determined, deductions for business expenses, losses, and depreciation are subtracted to arrive at the net income.

The net income is then subject to UBIT, which is calculated using the tax rates applicable to corporations. For example, if a tax-exempt entity earns rental income from a property that is not related to its exempt purpose, the net income after deductions will be subject to UBIT. It is essential to note that UBTI can be complex and may require consultation with a tax professional to ensure accurate calculation and compliance with tax laws.

Failure to file Form 990-T and pay required UBIT by the IRS filing deadline can result in penalties. Therefore, it is crucial for tax-exempt entities to understand UBTI and UBIT to avoid tax liability and maintain their tax-exempt status. Consulting with a tax professional can help navigate the complexities of UBTI and ensure compliance with all relevant tax laws.

UBTI Tax on the Solo 401(k) Plan

Internal Revenue Code Section 511 taxes “unrelated business taxable income” at the UBTI Tax Rate applicable to corporations or trusts, depending on the organization’s legal characteristics. Generally, UBTI is:

• Gross income from an organization’s unrelated trades or businesses
• Less deductions for business expenses
• Losses
• Depreciation,
• Similar items directly connected therewith

A Solo 401(k) Plan is not subject to UBTI tax. Internal Revenue Code Section 515(c)(9) permits a few organizations to make debt-financed investments without being taxed. This includes qualified pensions, such as the workplace 401(k) plan and the Solo 401(k) plan. 

When using a Self-Directed IRA in a transaction that will trigger the UBTI tax, the IRA is taxed at the trust tax rate because an individual retirement account is considered a trust. For 2025, a Self-Directed IRA subject to UBTI is taxed at the following rates:

• $0 – $2,550 = 10% of taxable income
• $2,551 – $9,150 = $255 + 24% of the amount over $2,550
• $9,151 – $12,500 = $1,839 + 35% of the amount over $9,150
• $12,501 + = $3,011.50 + 37% of the amount over $12,500

Real Estate UBTI Implications for Tax Exempt Entities

There is no formal guidance regarding UBTI implications for a Real Estate IRA. However, there is a lot of guidance on UBTI implications for real estate transactions by tax-exempt entities. Income generated from investments in a tax-exempt account, especially when leveraging debt, can trigger taxes under UDFI and UBIT regulations.

Commonly, gains and losses on dispositions of property will not be included unless the property is inventory or property that’s up for sale to customers in the ordinary course of an unrelated trade or business. The exclusion covers gains and losses on dispositions of property used in an unrelated trade or business as long as the property was never on sale to customers.

To reiterate, the following are transactions that may be unrelated business activity:

1. The use of non-recourse loans to buy real estate with a Self-Directed IRA.
2. Investment in an active business (i.e., restaurant) operated through a pass-through entity, like an LLC.
3. Making an investment in a private equity firm operating active businesses through pass-through entities.
4. An investment in master limited partnerships (MLPs) though a pass-through entity.
5. Investing in an investment fund that is using debt for investment purposes.

Get in Touch with a Tax Professional

Do you still have questions regarding the UBTI tax and how it may affect you and your investments? Contact IRA Financial at 800-472-1043.

What is Socially Responsible Investing?

Socially responsible investing, also known as sustainable or ethical investing, seeks to generate financial returns while promoting social and environmental good. This investment strategy considers both financial performance and a company’s adherence to environmental, social, and governance (ESG) criteria. Factors include:

• Environmental: Climate change mitigation, renewable energy, pollution control, and resource conservation.
• Social: Labor rights, diversity, community impact, and human rights.
• Governance: Ethical leadership, transparency, and shareholder rights.

The primary goal of socially responsible investing is to invest in companies or funds that align with your values, while avoiding those involved in practices you find objectionable, such as fossil fuels, tobacco, or firearms.

What is an IRA, and How Does It Work?

A Self-Directed IRA (SDIRA) is a tax-advantaged retirement account that is used to make traditional, as well as non-traditional (alternative) investments, including mutual funds, real estate, cryptos, and private placements. IRAs offer two different tax treatments:

1. Traditional IRA: Contributions are tax-deductible, and earnings grow tax-deferred until withdrawal during retirement, at which point they are taxed as regular income.
2. Roth IRA: Contributions are made with after-tax dollars, but qualified withdrawals during retirement are tax free, so long as you are at least age 59 1/2 and any IRA has been open for at least five years.

Furthermore, there are two types of SDIRAs which allows you to choose the type of control you need.

• Checkbook Control: With a “Checkbook IRA,” an LLC is utilized by the plan, giving you full control of your IRA funds. Consent from your custodian is not needed. You simply write a check to make an investments.
• Custodial Control: When you don’t need total control of your IRA funds, your custodian makes the investment on your behalf. Generally, investments take longer to be finalized.

Why Combine Socially Responsible Investing with an IRA?

1. Align Investments with Personal Values
   By incorporating socially responsible investing into your Self-Directed IRA, you can ensure your retirement savings contribute to causes you believe in, such as clean energy, equitable labor practices, or gender diversity in leadership.
2. Potential for Competitive Returns
   Studies have shown that ESG-focused investments often perform as well as, if not better than, traditional investments over the long term. Companies with strong ESG practices tend to be better managed and face fewer regulatory and reputational risks.
3. Tax Advantages
   Combining SRI with an IRA allows you to enjoy the tax benefits of the account while making a positive impact with your investments.
4. Long-Term Impact
   Retirement accounts are designed for long-term growth, making them a powerful tool for driving systemic change through sustained investment in responsible companies.

Steps to Get Started with Socially Responsible Investing in an IRA

1. Define Your Values and Goals – Start by identifying the issues that matter most to you. Do you want to combat climate change? Support gender equality? Promote fair labor practices? Clarifying your priorities will guide your investment decisions.
2. Research ESG-Focused Funds – Many mutual funds and ETFs are designed with ESG criteria in mind. Look for funds that align with your values and have a track record of strong performance.
3. Put Your (IRA) Money Where Your Mouth Is – Invest in companies that practice socially responsible investing either directly or through crowd-funding platforms.
4. Monitor and Rebalance Your Portfolio – Socially responsible investing is not a set-it-and-forget-it strategy. Regularly review your portfolio to ensure it remains aligned with your values and financial goals.

Challenges and Considerations

While socially responsible investing offers many benefits, there are some challenges to be aware of:

Defining “Responsibility”

What qualifies as socially responsible can vary widely depending on personal values. For example, a company might score high on environmental issues but fall short on labor practices. It’s essential to weigh the trade-offs.

Higher Fees

Some ESG funds come with higher expense ratios compared to traditional funds. Carefully review costs to ensure they don’t erode your returns.

Greenwashing

Some companies claim to be sustainable without truly adhering to ESG principles—a practice known as greenwashing. Perform due diligence to ensure investments meet genuine ESG criteria.

Limited Options

Self-directing you retirement funds put you in control in the types of investments you can make. Just make sure to work with IRA provider who offers the one you wish to make.

The Future of Socially Responsible Investing in IRAs

The demand for socially responsible investing is expected to grow as younger generations prioritize ethical considerations in their financial decisions. Technological advancements and improved transparency in ESG reporting will make it easier for investors to assess the social and environmental impact of their portfolios. Furthermore, regulatory changes may incentivize companies to adopt sustainable practices, broadening the range of responsible investment opportunities.

Socially responsible investing with a Self-Directed IRA allows you to align your retirement savings with your values without sacrificing financial performance. By defining your priorities, researching options, and building a well-diversified portfolio, you can make a positive impact while securing your financial future. While challenges like greenwashing and limited options exist, they can be navigated with due diligence and careful planning.

Whether you’re new to investing or a seasoned pro, integrating socially responsible investing into your retirement is a meaningful way to support causes you care about while working toward your long-term financial goals. As the landscape of socially responsible investing continues to evolve, the opportunities to invest with purpose are greater than ever.