Banks, brokerage firms and mutual fund companies all serve as custodians of individual retirement accounts (IRA). Self-directed IRA custodians provide greater flexibility by holding marketable securities such as stocks, bonds and exchange-traded funds in IRA accounts – not to mention other alternative investments such as real estate, private notes and precious metals.
Avoiding prohibited transactions when investing with an IRA in privately held assets requires careful planning and compliance with IRS regulations.
1. Self-directed IRAs
Self-directed IRAs (SDIRAs) are individual retirement accounts that allow investors to choose how their investments will be managed. An SDIRA allows an account holder to purchase various assets such as real estate, private placements, promissory notes and precious metals; but it should be remembered that these types of investments carry greater risk compared to publicly traded securities due to decreased levels of information, more volatile markets and potential fraud promoters or lack of liquidity.
SDIRAs require greater initiative and diligence from account owners; failing to adhere to rules could incur severe tax implications; it’s recommended to seek help from a financial or tax advisor when setting up and managing one of these accounts.
2. Traditional IRAs
IRAs are an increasingly popular savings vehicle for retirement savings, allowing you to deduct contributions on a pre-tax basis while paying taxes when withdrawing or increasing investment growth – typically when retiring.
Typically, withdrawing money from an IRA before reaching age 59 1/2 requires paying an early withdrawal penalty of 10% in addition to federal and state income taxes. There may be exceptions such as first-time home purchases or unreimbursed medical expenses that exempt you from these penalties.
Your traditional or Roth IRA can be opened with almost any financial institution – banks, credit unions and investment firms alike. Most IRA accounts invest in securities like mutual funds or stocks which can fluctuate in value over short periods. Anyone with earned income is eligible to contribute an IRA, although tax deduction limits apply (in 2023 this limit increases to $7500 for people aged 50 or over). You can take either an active or passive approach to investing with either a broker or robo-advisor.
3. Roth IRAs
Roth IRAs provide various tax benefits in your retirement savings efforts. Deciding between Roth or Traditional will depend on factors like your tax bracket, projected retirement tax rate and financial goals.
Traditional IRAs are an excellent way for those whose income exceeds the IRS contribution limits to save for retirement and potentially pay taxes in later life. You’re required to make minimum withdrawals at age 73 which may result in taxes being due upon withdrawals from this account.
If you anticipate being in a higher tax bracket at retirement or have significant deductions from a workplace plan, a Roth IRA could make sense for you. Just be wary not to dip into your pretax savings; otherwise penalties will apply and could reduce long-term savings potential.
4. Rollover IRAs
IRA rollovers are used to transfer funds between tax-advantaged accounts. They’re typically created from distributions from employer-sponsored retirement plans such as 401(k), 403(b)s or government 457(b).
In order to avoid taxes and penalties, IRA rollovers must be completed within 60 days. The easiest way is through direct rollover, where funds are sent directly from plan administrator to new account. This method provides greater safety as you will avoid handling distribution yourself – which would require taxes be withheld as well as incurring an early withdrawal penalty of 10% under age 59 1/2.
Indirect rollovers typically involve receiving a check payable directly to you from the plan administrator for your balance and depositing it within 60 days into a new IRA. Income taxes may be withheld; you can recoup them on your tax return. No matter which form of rollover is chosen, contributions up to annual contribution limits remain available to be contributed towards.
