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Diversify Investment Portfolio for Retirement: Consider Converting 401K and/or Roth IRA to Self-Directed IRA

October 31, 2017

Diversification is one of the most powerful concepts available to investors. Your retirement portfolio benefits from having a variety of holdings, including of stocks, bonds, ETFs, mutual funds, and alternative investments. Diversification aims to maximize return by investing in different areas that would each react differently to the same event. That is, some assets zig while others zag. For example, bond prices rise during recessions, periods that usually sees bearish stock markets. Most investment professionals agree that, although it does not guarantee against loss, diversification is the most important component of reaching long-range financial goals while minimizing risk.

avoid risk

An alternative investment is an asset that is not one of the conventional investment types, such as stocks, bonds and cash. Alternative investments include private equity (aka private company stock), real estate, notes/mortgages, precious metals, tax deeds/liens, life insurance policies, etc.

Self-Directed Investing

Americans are known for a fierce independent streak, which helps explain why about 54 million of us direct our own investments. We like calling our own shots, and self-directed investing allows us to allocate our money to the assets we choose in the amounts we determine. In other words, you have complete control over the assets you own. An increasing number of investors are learning about and buying alternative investments for their retirement portfolios, and self-directed IRAs provide a tax-deferred gateway to owning alternative assets.

Self-Directed IRAs (SDIRAs)

Here is some important background regarding IRAs.

  • You can own multiple IRAs, as long as your total annual contributions don’t exceed the legal limit. In 2017, that limit is $5,500, or $6,500 if you’ve reached age 50.
  • Every IRA must have a custodian or trustee other than the owner. The custodian’s job is to buy and sell the assets in the IRA, to manage contributions and distributions, and to ensure that contributions don’t exceed the limit.
  • Custodians such as brokers and banks will generally handle conventional assets. You need to create a self-directed IRA if you want to invest in alternative assets. This means you pick custodians who can manage your alternative investments. You would use a real estate custodian to handle your IRA’s property investments, and a precious metals dealer for you gold and silver investments. However, as explained below, you can establish an LLC within an IRA to self-direct all investments and render the custodian passive.
  • A traditional IRA allows you to deduct your contributions and lets your investments grow tax-deferred until you withdraw them. You may have to pay penalties on distributions before age 59 ½. Distributions from your traditional IRA are treated as ordinary income. You must begin taking distributions from your traditional IRA starting at age 70 ½.
  • A Roth IRA doesn’t provide a tax deduction, but it does allow your investments to grow tax-free, and you pay no taxes on distributions as long as you follow the rules. You never have to withdraw from your Roth IRA, no matter your age.
  • You can open a self-directed IRA that owns a limited liability company (LLC) that is owned by the IRA-owner (you). In this way, the custodian is completely passive. The custodian’s only job is transfer IRA contributions or rollovers to the LLC, and has no say on what you decide to own in your IRA. This gives you “checkbook control” over the assets in the IRA. In other words, you can write a check from the LLC to purchase any type of asset for your IRA.

IRAs vs 401(k)s

A 401(k) is an employee retirement plan that qualifies for tax breaks similar to those for IRAs. 401(k)s provide for higher contribution levels, which can include contributions from the employee and the employer. A self-employed person can set up a Solo IRA and make contributions as both an employer and employee. The maximum 401(k) contribution for 2017 is $54,000 ($60,000 if you’ve reached age 50), of which $18,000 ($24,000) can come from the employee. A traditional 401(k) provides tax deductions on contributions, a Roth 401(k) does not.

Direct Transfers from 401(k)s

When you reach retirement age or leave your job, you can directly transfer your 401(k) to an IRA, including a self-directed IRA. The process is straightforward:

  1. Open your IRA or self-directed IRA. It can be a traditional IRA or a Roth IRA.
  2. If desired, have the new IRA open an LLC that you own.
  3. Ask your 401(k) administrator to give you an up-to-date account statement.
  4. Fill out the administrator’s Direct Rollover Certification Form specifying that you want part or all your 401(k) assets transferred to a specified IRA.
  5. If applicable, have your IRA custodian transfer the assets to the LLC owned by the IRA.

The advantage of performing a direct transfer is that the assets move from 401(k) administrator to the IRA custodian. This absolves the administrator from withholding 20 percent of the distribution for taxes. If you withdraw the assets yourself, you have only 60 days to roll them over into an IRA to avoid paying taxes on them, and you will be subject to the 20 percent withholding. You can cash out some or all the assets in the 401(k) before the transfer, or you can transfer the assets intact.

Direct Rollover IRA to Self-Directed IRA

You can move money or other assets from an IRA to a self-directed IRA in pretty much the same way as you would for a 401(k) transfer to an IRA. The difference is that you can perform the transfer at any time. Simply establish the self-directed IRA (with or without an LLC) with an appropriate custodian and the fill out the paperwork for a trustee-to-trustee transfer from the IRA to the self-directed IRA.

Caveats

  1. You can transfer tax-free a traditional 401(k) or traditional IRA to a traditional IRA, including a self-directed IRA. You can also transfer traditional accounts to a Roth IRA or Roth IRA LLC, but you will have to pay taxes on the transferred amount.
  2. Individuals may generally transfer a Roth IRA or rollover eligible qualified retirement plan assets into a self-directed Roth IRA LLC structure. Individuals may not rollover Roth IRA funds into a qualified retirement plan, such as a Solo 401(k) Plan or a pre-tax IRA account, such as a traditional IRA or SEP IRA.

Summary

The three biggest reasons to have a self-directed IRA are:

  1. Portfolio diversification
  2. Asset control
  3. Tax-deferral

A self-directed IRA is just another way investors can diversify their portfolio and build wealth for retirement.

 

Author by Tracy Stein – Prime Pinnacle Investments

tracy stein

www.primepinnacle.com

tracystein@primepinnacle.com

Office# 855-387-7463