Learning A Little Bit More About Self-Directed IRA – Episode 303

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[00:01] Welcome to the Prosperity Podcast. In today’s episode of the Prosperity Podcast, we’re going to be speaking about self-directed IRAs. And there may be many questions that you have to understand what they are, how they operate and how it will affect you and your finances. So to get those questions answered, we’re going to turn to Kim. Hello, Spencer. Happy to share this information with everybody because self-directed IRAs are such a hot topic and they really are so beneficial and I’m so grateful that they exist. And it’s interesting. I’m trying to think when I first started learning about these, it was, I think, fairly early in my career because I’ve always had clients that had mostly real estate, but

[00:50] in particular, just things outside of the normal mutual fund 401k cash in a bank financial space. And so a self-directed IRA is a tool that enables people to have not normal things in an IRA. And that’s the easiest way to put it. And it is very interesting because there is a real downside or risk around the self-directed IRA arena, especially with real estate. And so let’s talk about that first and then we’ll come back around and talk about the benefits of the self-directed IRA and how you can get one in the very incredibly important order of which you do a self-directed IRA in working with your investments. Wonderful. Now, one of the risks and one of the things that people often talk about and think

[01:44] of is the tax implications. So I’m sure we’re going to jump into that. Let’s understand what the risks are. So when you have a self-directed IRA, it is simply an IRA. It’s not any different than other IRAs. You can have self-directed Roth IRAs. You can have self-directed inherited IRAs. You can have self-directed trend, traditional IRAs, transfer IRAs. I mean, all kinds of IRAs can be self-directed. And essentially what it is is an IRA at a trustee or a custodian that allows for you to choose your investments. Now the large brokerage houses have jumped on this bandwagon. And yet there’s a difference between a self-directed IRA say at Fidelity or Vanguard or Schwab and a self-directed IRA at a trustee or custodian that’s specifically dedicated

[02:36] to self-directed IRAs. And of course, people can choose their investments and IRAs. I think when people hear that, they think, well, I already have that. But choosing means literally choosing from a very, very wide array of assets, not just choosing from a particular mutual fund or stock selection. And it’s interesting, you know, the term custodian or trustee, I think a lot of people are not really aware that an IRA is technically, potentially, and I’m not actually sure of all the legal ramifications of this, but it’s technically potentially not really ours because if you’ll look at your statement on your IRA, self-directed or regular, it says for the benefit of. And so the custodian is the owner technically.

[03:27] And I think this is one of these areas not to get into conspiracy theory, but I think this is one of the areas where people have legitimate concerns about the government being able to take over that money at some point in the future if they need it is because this language of for the benefit of is right there on the statements. That being said, the custodian, I don’t know a better word to help people understand what that is, but the custodian or the trustee is the caretaker of the IRA. And every IRA that you have has a custodian or a trustee. And it could be, like I said, a brokerage house, like a name that you would recognize, or it could be some unheard of name. And you may not even really be aware that there is a custodian or trustee.

[04:16] You may be thinking about, well, my IRA is invested in XYZ asset. Well, there’s also an ABC custodian of whatever name. Is that making sense so far? This makes sense. OK, so you asked about the tax benefits. Well, when you have an IRA and let’s say you also have a 401k, this is the most normal area of question around the tax. You have a 401k or a four or three be at an employer. You’ve now left that employer and you want to roll. The term is roll. It could be transfer, but you want to roll the 401k into an IRA and that transaction is not taxable and it is also not penalized. So as we are aware, if you take money out of a qualified plan is the larger umbrella for all of these terms, then you get a 10%

[05:07] penalty if you’re under 59 and a half. Well, not if you roll that money from a 401k to an IRA, including a self-directed IRA. So this is a non taxable transaction and it is a non penalty transaction. OK, that makes a lot more sense. And so now people understand more or less how the ownership is working. We’ll say the control of it. OK, and then we understand the tax implications associated. What may be going across people’s minds is the synchronization of it or the steps, how this should happen and roll out. Absolutely. Let’s do that detour into the real estate area. That’s problematic first before we get into the steps. Sounds good, because I think one of the most immediate things people go to that have such an interest in real estate in our whole country

[06:00] just thinks that real estate is the most fantastic investment these days, which is fine and fun. And I love that and support that. And it’s one of the worst assets to put in an IRA. And there are many, many real estate gurus out there training about various aspects of real estate investment that are talking about using IRA money. And it would be self-directed IRA in this case to do real estate deals. And it’s not that you can’t. And it’s also not that you shouldn’t. But it’s something to be very, very careful with. And in most cases, I think there are better choices. And here’s why. Real estate owned directly has very beneficial tax law. We get deductibility of interest. We get depreciation.

[06:49] We get capital gains tax versus income tax. Let me say that again. We get capital gains tax treatment of selling properties instead of income tax treatment. Capital gains taxes are at lower rates than income taxes are. And those are all what we would call beneficial real estate law. Well, if you take a piece of real estate and put it into any kind of IRA, it would most likely be a self-directed IRA. You have now moved that beneficial real estate law off of your ability. You don’t get to use that anymore. And instead, you use IRA tax law. So now you cannot deduct any of the interest. You cannot depreciate any of the property and you cannot get capital gains tax treatment. You pay income tax. And so this is something actually Tom Willwright of Wealthability

[07:43] and I have discussed often because we both have a lot of real estate knowledge, we have a lot of appreciation for real estate. We love real estate, just not in an IRA. And so, again, not that you can’t do it. And in particular, with the bridge loan environment, I see the bridge loans and often a bridge loan is used with real estate. I see the bridge loans being put into self-directed IRAs fairly often. And that’s OK, especially the bridge loans that do not have any ownership connected with them, where they’re just receiving income. That’s less problematic. And again, the you can put the real estate in there, even if there is ownership. There’s one other very nuanced area, and I’m not sure I can even get the name

[08:32] right, but there’s it’s unrelated business taxable income. There’s a aspect of the tax code that is unrelated business taxable income. I think sometimes it’s just unrelated business income shortened to UBI. And we’d have to ask Tom Willwright, the tax expert, to elaborate on this. But the bottom line is that if you have too much income, which real estate can create inside an IRA, it can actually get taxed if it’s unrelated. And so I’m not exactly sure how that works. I just know that Tom Willwright doesn’t feel like real estate should be in self-directed IRAs. And so I agree with him. That’s a good way to look at it. Now, you were mentioning before we talked about the real estate piece that there are steps and those would be interesting to hear.

[09:19] Yes, yes, very, very important. So thanks for hanging in there with us through this first part. The steps, the order of which you go about getting a self-directed IRA are very critical. And here’s why the investment must be chosen first and the self-directed IRA trustee second, because investments only work with certain self-directed IRA trustees and certain self-directed IRA trustees only work with particular investments. And so you don’t really care who your self-directed IRA trustee or custodian is. It doesn’t matter in my earlier example. Whoever ABC custodian is, is ABC custodian. You’re going to pay him a little bit of money and we’ll talk about fees here in a minute. And then they’re going to print a piece of paper for you or an online account.

[10:13] And that’s all they’re going to do. You care much, much more about where your dollars are invested. And if you do this backwards, you’re at risk of having to move your IRA again and pay fees to open up an account again because you didn’t do it in the right order. And it’s a common mistake. So you want to pick your investment first and then just go with whoever trustee they’re already working with. Because the word approve is a little odd because it’s it’s not approve, like say that the investment is OK. That’s not what approve means. But the self-directed custodians have to approve the investments. And so if you have investment X, Y, Z, and then your custodian ABC doesn’t work with them, you have to take it through an approval process,

[11:05] which sometimes they won’t even do like they’ll just say, no, we don’t. They’re not on our list. Done. Sometimes they will approve it, but it’s a very long process. It’s a hassle. And it’s very much up to the whim of whoever’s stamping the paper. And so it’s not a process that you want to go through. And so if you do move it in, in essence, if you get the order incorrect, you’re going to be penalized because there’s at least the payment of time, but then also a physical payment and stress of having to, you know, change companies and whoever is going to manage that. Yes. And usually another setup fee. So let’s talk about the fees for self-directed IRAs. They tend to be a little bit higher than regular IRAs.

[11:47] So if you look at your regular IRA statement, it might be 35 to 45 dollars a year. That’s a common IRA fee for just having the custodian do the work. And so a lot of times people are not even aware of this because their mutual funds are just paying that fee and they don’t even see it. Or maybe they see it and don’t pay attention to it. With the self-directed IRA, for two reasons, the dollar figure is a little higher. So it tends to be around two to three hundred dollars. I see four to five hundred dollars quite often. So somewhere in that two to five hundred dollar range is a typical setup fee for just opening a self-directed IRA. And then the annual fees can be seventy five dollars a year, all the way up to two or three hundred dollars a year.

[12:31] And so not only is a little bit more, which might make you pay a little more attention to it, but many times the investments inside a self-directed IRA are not liquid. And so the fee cannot be paid from the investment. The fee has to be paid from either cash inside the IRA that you keep separate or a credit card. And in the past, I used to have people pay their self-directed IRA fees with a check so that they could get that fee as a deduction, because you used to be able to deduct the fee to open the account and also the annual fee that’s not allowed anymore. And so it’s just easier in today’s world to just give the custodian a credit card and not have to try to worry about keeping a little bit of cash.

[13:16] And what about next year? And how long am I going to keep this investment? I don’t know. And trying to figure all that out since not deductible. Anyway, I think most custodians these days accept credit cards. They didn’t used to. And so you put your credit card on file. They ding your credit card every year for your self-directed IRA fee and away you go. Are there any other fees or gotchas that people should be looking out? It’s interesting that you bring that up. Not other than regular IRA rules, which we typically know about. But let’s just quickly state them. You have to leave the money in until you’re 59 and a half. Some people think it’s 65. No, it’s 59 and a half today. That could change.

[13:56] And then you have to start taking the money out at 70 and a half. And for many people, this is not problematic. They’re going to want to be using that money anyway. It’s technically the the year after you turn 70 and a half. And based on the tax return, it gets a little problematic in terms of counting the months. But the the simple approach is at 70 and a half. You have to start taking it out. It’s called a required minimum distribution at that point. And it’s actually a very low number. So for a lot of people, it’s not that big of a deal. However, as in all things, there’s a prosperity economics approach that differs from the typical financial planning industry in this space. And that is that we believe that an IRA is the worst asset to die with.

[14:41] And so for a lot of our clients, we encourage them to start taking withdrawals at 59 and a half. Whereas the typical financial planning approach defer, defer, defer and don’t take anything out until 70 and a half. And then at 70 and a half, only take out the minimum. We disagree with that very, very much. If you die with an IRA, your family then has to pay all of the tax that you deferred. Furthermore, there are absolutely impossible rules to keep up with as it relates to an inherited IRA. And they’re tricky and problematic. And so it’s not designed to be tricky, but they just are. They’re they’re just there’s a lot of them and they’re odd. And I just had an estate planning attorney tell me the other day,

[15:25] I can’t stand IRAs. There’s such a pain to deal with within families. So as a general rule, we ask people to get their IRA spent down. And that means just at 59 and a half to start withdrawing money, paying the tax and moving those assets into after tax account, a taxable equivalent. So you asked if there were any other tricks. I do want to reiterate again, a self-directed IRA fee is going to be a little higher than a regular fee. And it opens the door for us to handle the wonderful investment space that we deal with every day known as alternative investments. And so many people are surprised by this. But yes, you can put life settlements in self-directed IRAs. Yes, you can put bridge loans in self-directed IRAs.

[16:16] Yes, you can put mineral rights and other aspects of bridge loans into self-directed IRAs. And so all of the alternative investments that we work with are available for IRA money. OK, so it sounds like for our listeners, if this is something applicable to them, one, they need to make sure that they have the sequence correct to they need to understand some of the perimeters of the box that they’re going to be in, the 59 and a half taking out money at that age instead of waiting. And then they need to understand that, yes, they can use the self-directed IRA for alternative investments. I’d say the biggest one is this. If you’ve been listening and you have questions, the best thing you can do is send an email to Kim.

[17:03] And in the subject line, say help with what would the subject line be? Self-directed IRA. There you go. Self-directed IRA. Send the email to help or hello at partners for prosperity dot com. And Kim can answer those questions for you. And if you feel like it’s a unique situation and something that is only to you, an email is one of the best ways to get that answer. Would you agree? Absolutely. And I’ll add one little PS, and that is that the favored custodian slash trustee that we work with happens to work with the bulk of our alternative investments. So if you’re unsure of where you want to invest your money and you must move your IRA for whatever reason, sometimes there is a work requirement.

[17:50] Maybe you’ve left an employer and they want you to roll it right away. Or maybe your IRA custodian is closing its doors and you need to move it. We have one preferred custodian that’s just circumstance, just happenstance that deals with about 80 percent of our alternative investments. And so you can park the money there and be very confident that there will be a place to invest it, which essentially goes against what we just said in terms of order. And yet we already know where we’re going with it. So it’s an acceptable time to go backwards on the order. Wonderful. And to get the name of that company, send an email to Hello at Partners for Prosperity Subject Line Custodian Self-Directed IRA. Does that work?

[18:35] That works. Perfect. And for all of you listeners, we’ll make sure to put show notes in here so you can get the link to that email address and stick around for another episode. Thank you for listening to the Prosperity Podcast. To take control of your money and have it work for you, visit us at partnersforprosperity.com. If you liked this episode, make sure you subscribe and leave a review.