A self-directed IRA can be a great investment tool, especially if you want to expand your portfolio and take control of your retirement goals.
But if you really want to maximize your efforts – and avoid unnecessary taxes and penalties along the way – you’ll want to take note of these seven IRA investment rules.
1. You Can’t Directly or Indirectly Profit From Transactions Made
Through your SDIRA.
SDIRAs are set up to help account holders save for retirement, and though one day you’ll reap the benefits of your efforts, profits earned through your SDIRA must go back into the account — not to you.
This is a particularly important IRA investment rule for investors who want to use an SDIRA to purchase real estate, as rent or profits from real estate sales can’t be used as a source of income.
2. Transactions With Disqualified Persons Are Prohibited.
The IRS prohibits transactions between the account holder and what they consider “disqualified” persons. If you do engage in a transaction with a disqualified person, you’ll need to pay a 15% tax on the amount involved, for each taxable period. If the issue is not corrected, then you’ll have to pay a 100% tax on the amount.
Disqualified persons include family members — i.e., grandparents, parents, spouse, children, grandchildren. The term also applies to the account provider or custodian, employees, or any individual with 50% or more interest.
3. Annual Contributions Are Limited.
Each year, the IRS sets IRA contribution limits, and any contributions above that limit will be taxed. Contribution limits vary based on the type of IRA you open. For instance, the 2020 contribution limit for both Roth and traditional IRAs traditional is $6,000, or $7,000 for account holders who are 50 years of age or older.
However, Roth IRA contribution limits can change based on your modified annual gross income (AGI) and your filing status. An individual filing as head of household, for example, will have a reduced contribution limit if their AGI is between $124,000 and $139,000.
4. You May Be Penalized For Withdrawing Funds Early.
IRAs are designed to help investors save for retirement, and so it’s typically a good idea to avoid making an early withdrawal. To deter account holders from making an early withdrawal, the IRS penalizes account holders who take out funds before the age of 59 ½.
If you withdraw funds before that age then you may face a 10% penalty. Funds can also be considered part of your taxable income and therefore subject to taxation during the year in which they were withdrawn.
There are some exceptions to this rule, however. For instance, funds aren’t taxed if they’re withdrawn as corrective distributions; used for higher education expenses or first-time home purchases; or to cover some medical expenses, depending on your AGI.
5. Some Investments Are Prohibited.
Though SDIRAs offer far more investment options than other investment vehicles, there are some assets that are prohibited. This includes investment in life insurance as well as investment in assets that are classified as “collectibles.” This includes artwork, gems, stamps, antiques, and coins.
6. You Can’t Use Real Estate Purchased Through Your SDIRA For Personal Use.
SDIRAs are great for investors who want to leverage real estate as part of their retirement strategy. However, if you’re planning on purchasing a home, office space, or other types of property for personal use, then you’ll need to think again.
The IRS prohibits investors from using SDIRA funds to purchase property for personal use. That means you can’t use your SDIRA to buy a family home, vacation house, or office space for your business. Similarly, SDIRA funds can’t be used to purchase property that your family members will use.
7. Your Self-Directed IRA Options Include More Than Traditional and Roth IRAs.
Self-directed IRAs can take the form of a Roth or a traditional IRA, but some investors may be surprised to find there are other alternatives.
At Horizon Trust, we work to align investors with their goals, and that may mean setting up a Roth or traditional IRA or one or more of the following:
- Solo 401K
- SIMPLE IRA
Just keep in mind that contribution limits apply to your collective contributions, not per account.
Whether you’re considering opening a self-directed IRA or you already have funds invested, the key to success if practicing due diligence and being aware of rules and guidelines. Investing with these seven IRA investment rules in mind can help you make educated decisions about your future.