What Is a Self Directed IRA?
The IRS recognizes certain accounts as having a tax-sheltered advantage when the owner is saving money toward retirement. As money is put into the account, a person is allowed to make investment decisions about that money and not worry about capital gains as the balance grows. Self-directed IRAs must follow certain compliance regulations to keep assets sheltered from penalties or unwanted distributions.
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Definition
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A self-directed IRA is an IRA that allows the owner to make the investment choices he feels are most appropriate to his retirement plans. The money in a self-directed IRA grows tax-deferred. If you pull money out of a self-directed IRA prior to age 59-1/2, the distribution amount is added to your adjusted gross income, as is a 10 percent penalty on the distribution. If you wait until age 59-1/2 to take distributions, you are not assessed this penalty.
Investment Options
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Self-directed IRAs allow you to invest your money according to the allowed investments at the trustee you choose. You are allowed to transfer to a different trustee if you are unhappy with your options or the service you receive. These investment options include securities, real estate, annuities or bank accounts. This means you can invest in stocks, bonds, time certificates, rental properties or mutual funds.
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Required Minimum Distributions
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When the owner of a self-directed IRA reaches age 70-1/2, she will be required by the IRS to take regular systematic distributions. As a rule of thumb, this amount is approximately 10 percent of the IRA value. This is adjusted based on spousal age and can be less if your spouse is significantly younger than you. The reason is that the self-directed IRA is considered the income source for you as a couple, and needs to exist through your spouse's lifetime as well.
Traditional or Roth
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You have the option to make your self-directed IRA a traditional IRA or a Roth IRA. Traditional IRAs grow tax-deferred. The money that is used to fund the account is deducted from the adjusted gross income of the owner in the year the contribution was made. When money is withdrawn, the distribution is added to the adjusted gross income.
Roth IRAs are funded from post-tax money. This means there is no tax deduction. The owner of the self-directed IRA can withdraw money tax-free, provided that he holds the IRA for a minimum of five years. Since tax was already paid on the principal, the required minimum distribution does not apply to Roth IRAs.
Other Considerations
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Self-directed IRAs can be transferred to other people under special circumstances. In the event of a divorce, if the IRA is required to be split among the couple as part of the divorce court order, the IRA can be transferred into an (ex)spousal IRA. The ex is able to invest the money as she desires once the self-directed IRA is funded.
A self-directed IRA can also be transferred to another person in the event of death. While a spouse can become the beneficiary, he is also allowed to take over the self-directed IRA. This allows the widow(er) to continue to use the money while gaining tax benefits by not having to automatically liquidate the entire account upon death.
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