TAX-FREE INVESTING USING A SELF-DIRECTED IRA LLC
One of the significant advantages of using a Self Directed IRA LLC to make investments is that all income and gains generated by the business will be tax-deferred until distributions are taken or in the case of a Roth IRA tax-free!
Traditional IRAs and the Power of Tax Deferral
A Traditional IRA primarily is a tax-deferred retirement savings vehicle. Tax is generally deferred on Traditional IRA contributions and earnings until the year the IRA owner takes a distribution. An individual under the age of 50 may make a $5,000 annual tax-deductible contribution to a Traditional IRA. Whereas, an individual over the age of 50 is permitted to make a $6,000 annual tax-deductible contributions to a Traditional IRA.
The benefits of making a tax-deductable contribution is simple. For example, if you are in a 30% income tax bracket and you contribute $5,000 to a Traditional IRA in a year, that's $5,000 of your salary on which you're not paying taxes on this year; so you will be able to reduce your annual income tax bill by approximately $1,500 ($5,000 x 30%). In other words, you will receive an income tax deduction for the $5,000 contribution, which will save you approximately $1500 in tax payments. By making tax deductable contributions you are essentially paying yourself to save for your retirement.
By using a Self Directed IRA to make investments, the IRA owner is able to defer taxes on any investment returns, thus, allowing the IRA owner to benefit in three ways. The first benefit is tax-free growth: instead of paying tax on the Self Directed IRA returns of an investment, tax is paid only at a later date when a distribution is taken, leaving the investment to grow tax-free without interruption. The second benefit of tax deferral is that a Self Directed IRA investment is usually made when the IRA owner is in his or her highest income earning years and is thus subject to tax at a higher tax rate. The third benefit is the ability to defer taxes on investments in the face of increased federal income tax rates. With tax rates at a historical low (the highest income tax bracket in 1986 was 50% and in 2000 was 39.6%), the likelihood of higher federal income tax rates in the near future are significant, especially with the financial strain the baby boomer generation is expected to have on the federal budget. Thus, the ability to defer tax on investments until the IRA owner is 701/2 and likely in a low income tax bracket makes a Self Directed IRA LLC a highly attractive investment vehicle.
The following example illustrate the powerful advantage of tax-deferred contributions and compounding through a Self Directed IRA versus taxable making contributions to a taxable account:
Joe is 40 years old and makes a $5000 contribution to an IRA. Joe is in a 30% federal income tax bracket. Joe uses a Self Directed IRA LLC with "Checkbook Control" to invest his funds and receives a 6% annual return. When Joe retires at age 70, his $5,000 contribution would be worth $21, 609.71. If Joe invested the $5000 personally, the account would only be worth $14,033.97.
Roth IRAs and the Power of Tax-Free Investing
The Taxpayer Relief Act of 1997 created the Roth IRA. The main distinction between a Traditional IRA and a Roth IRA is that Roth IRA contributions are nondeductible and thus, are distributed tax-free. More importantly, the earnings in a Roth IRA may also be distributed tax-free if certain requirements are met.
The primary tax benefit of using a Self-Directed Roth IRA LLC with "Checkbook Control" is that all income and gains associated with the investment will flow back to the Roth IRA tax-free! So long as the IRA holder is over the age of 591/2 and the Roth IRA account has been established for longer than five years, a Roth IRA holder is not required to pay tax when receiving Roth IRA distributions. What this means is that all income, gains, and appreciation with respect to a Self Directed Roth IRA LLC investment can be distributed to the Roth IRA holder tax-free!