The Differences Between a Traditional IRA and a Roth IRA

Choosing the correct account for yourself and your family may seem complicated and confusing, but you only have a few options when it comes to how you wish to be taxed. Below we share a comparison between a Traditional IRA vs a Roth IRA.

Traditional vs. Roth

  • Traditional: You may potentially receive a write-off on your taxes for contributions, determined by your household income. The funds then grow tax-deferred by revenue and dividends generated from your investments. Upon retirement age (59.5) you can begin distributing funds from your Traditional IRA without penalty, but this income will be added to your gross household income, so you will have to pay taxes on these funds. You can, if you wish, wait to distribute any funds from your account until 70.5 years old. At that point, the IRS rules say you must begin taking Required Minimum Distributions or RMD’s. This is basically the government’s way of saying, you received a write-off when you put these funds into this account we need to make sure to get our taxes before you pass away. I know, somewhat morbid!
  • Roth: You do NOT receive a write-off on your taxes for contributions. The contributions you make to this account are “after-tax dollars.” However, you will get to grow your retirement money tax-free, forever! Like the Traditional IRA, the funds then grow by revenue and dividends generated from your investments. After age (59.5 and 5 years of the account being opened) you can take a distribution that is both penalty and tax-free. This tax-free distribution increases your NET household income. This is also an excellent choice for an estate planning tool, as you do not have to take any RMD’s, at any age. You have already paid your taxes. You are free to do what you wish with your distributions.

* High-income households: your financial advisor may tell you that you do not qualify for a Roth. There is something called a backdoor conversion that you can contribute to a Traditional and not receive a write-off, then convert the next day to a Roth. There is never a no iif this is the account type you want!

These are the primary differences between Traditional and Roth retirement accounts. There are some other rules that may or may not apply to you depending on your household income. Please speak to a Mountain West IRA representative if you wish to learn more.

Are you interested in learning more? Here is a no cost, no obligation webinar for you to check out: Alternative Asset Allocation Model

What Type of Retirement Plan Do You Have?

Do not overlook your retirement and assume your financial planner has your best interests at heart. You need to be educated and take control of your retirement. Over the next month, we will be going in depth about the differences inherent among common retirement terms.

What types of retirement accounts are there?

Employer Plans

  • If your retirement plan is offered through your company, they may call it a 401(k), 403b, 457, Thrift Savings Plan; there are many other names depending on the type of company you are working for. The employer determines if there is the option to contribute to a Traditional account or Roth (I will cover these differences next week). Employer plans often have a pre-determined set of investments that the employees can invest in. Some employers allow for employees to choose high-risk or low-risk and the company’s financial planner will do what best suits that person’s risk assessment. Most companies do not allow for employees to rollover/direct rollover their retirement plan to invest in alternative options. This leaves the employee trapped with the decisions the employer has available.
  • I’m retired, or I have left the company now what?
    Once you are no longer employed by the company, they will prompt you to rollover your IRA to another Custodian, distribute, or some plans may allow you to set up a distribution plan upon retirement. If you are interested in using your retirement account for investing, you will choose a rollover or direct rollover option. At this point, you can establish an IRA with Mountain West IRA and begin looking for an investment! The IRS will see a rollover or direct rollover and, if done in a timely manner, this will not be a taxable event. Most employer retirement plans will not withhold taxes if the funds are going directly into another qualified retirement plan. You should speak to your plan administrator for specific details.
  • You can review the complete IRA Starter Kit process here

Individual Retirement Accounts (IRAs)

  • Individuals who do not have the opportunity to participate in an employer plan should definitely look into IRAs. Even if you can contribute to your employer plan, an IRA may be a better fit for you. You can contribute to a Traditional IRA or in a Roth IRA because you are making the decision. You can also decide if common stocks/mutual funds are the route for you or if alternative assets are a better fit. IRAs are qualified retirement accounts that have contribution limits. However, if you need additional funds for an investment, you can transfer IRAs you currently hold, or rollover funds from your employer plan, to add to the amount you have available to invest.
  • You can look into each type of plan here, or you can watch our webinar on Which IRA is Right for You here.

Are you unsure what type of account you currently have? This information is typically found near your name on the first page of your statement. If you need help, you can submit your statement to accounts@mwira.com, and we can assist you!

How to Double Your Retirement Overnight

The following is a hypothetical model based off of an investors figures he figured on this actual property.

Back in 2007, the average IRA that was transferred to a self-directed IRA was about $200,000. After the crash in 2007-2008. The average value of IRAs decreases to about half, thus putting the current value at $100,000.

We will be walking through this example of a $200,000 IRA in a real-life scenario to show you how you can double your retirement overnight.

The investor purchased a rental property at the height of the market in the name of his IRA. The investor is utilizing a self-directed IRA where he can purchase alternative assets, NOT taking a distribution from your retirement account.

The property was purchased for $180,000 in a self-directed IRA coupled with a non-recourse loan. The investor was able to leverage the funds in his IRA to purchase an investment property.

What the investor had to put down on this property to qualify for a non-recourse loan was $63,000. The remainder was a loan from the bank in the investor’s IRA. The IRA will have a mortgage and a deed of trust that goes inside of the IRA. The investor does not own the property, the IRA does.

The market value on the day that IRA closed on the property increased the value to $217,000. Let’s break down how this happened; $180,000 on the property and $37,000 cash. The day before the value was $100,000.

If you recall the original value before the crash was $200,000, then the market crashed which brought the value of the IRA to $100,000. The current value was able to double overnight by using other people’s money through a non-recourse loan.

When the investor calculated this investment he chooses to calculate the value of the investment now and projected value in the future to determine when and if he would like to sell the property.

The investor projected about a 3% capital appreciation on this property per year. This percentage is based on the market value of the property at the time of purchase ($180,000). The property should make about $5,400 per year and the investor plans on holding this property for 10 years. After 10 years, the capital gain is estimated to be $54,000.

At this point, we are 10 years after the purchase. The investor’s calculations are almost spot on, the calculations fell a little below 3% but has caught up recently. The original idea was to sell this property after 10 years.

The value of the property and cash in the self-directed IRA is now $271,000. Remember, the investor started with only $100,000 in this IRA. You may be saying, “yes, but there is a loan on the property.” You are correct. However, the investor paid more than the minimum of $700 per month on the loan. This property is currently producing $1,350 per month in income. The net income has been about $900 after setting aside money for property taxes, management fees, and repairs that must be paid by the IRA. After 10 years of paying more than the minimum, the balance is now at $40,000. If the property would have been sold at 10 years for the IRA would receive $231,000 – the investors IRA only put $63,000. That is about 30% per year average annual return on this investment in a tax-sheltered self-directed IRA.

Here is a table to show how the IRA doubled overnight:
2007 IRA account value $200,000

 

After crash IRA account value $100,000

 

Investment Property Purchased:
Funds from IRA $63,000

 

Funds from non-recourse mortgage $117,000

 

New value of IRA + Cash Funds $180,000 + $37,000

 

Long-term Investment Calculation*:
Capital Appreciation at 3% times 10 years $54,000

 

10-year appreciation $271,000

 

Loan Payment at $900 per month (-$40,000)

 

IRA Tax Advantages Appreciation $231,000

 

*Estimated by investor, not advice

If you would like to learn more please visit our webinar, Alternative Asset Allocation Model 

Benefits of a Checkbook IRA

Cheque | Blog | Mountain West IRA

To maximize your IRA investment options, it is essential to have a retirement plan that allows you to select your own alternative IRA investments. Self-directed IRA’s allow you the freedom to invest in what you know. At Mountain West IRA we can help you with that. Your IRA can invest in real estate, private stock, notes or mortgages and even Partnerships & Joint Ventures. The list can be as diverse as your imagination and only limited by the IRS rules in place for IRA investing.

Self-Directed IRA LLC 101:

1. An LLC is a legal organization that provides the advantages of a partnership while limiting legal liability of the individual partners much the same way a corporation does.

2. An Investor can use a self-directed IRA to invest in LLCs.

3. It is not necessary to create an LLC to invest in your IRA.

4. An IRA invested in an LLC tends to be complex and requires careful management to avoid tax penalties and/or prohibited transactions.

5. When setting up an LLC for your IRA, you should always consult with a lawyer who is familiar with ERISA law.

So, what are the benefits of investing in an Self-Directed IRA LLC?

1. Speed

Normally, when making a transaction through your retirement account you would need to contact us here at Mountain West IRA as your third-party administrator. This requires some paper work, possibly some check processing or wiring of funds, and depending on the type of investment, there will be forms, You can skip all of this when you establish and LLC, and set up checkbook control with your IRA. An IRA LLC gives you easy access to your funds so you can react quickly in a volatile market, and easily take advantage of a time sensitive investment. Many investment transactions will be much quicker and can be as simple and expedient as writing a check.

2. Cost Benefits

Who doesn’t want a way to pay lower fees? Checkbook control can help you avoid the transaction fees and check-writing fees normally associated with any self-directed IRA. Also, if you own multiple investments in your LLC, rather than paying bookkeeping fees on each asset, Mountain West IRA only charges you for that single asset, the LLC.
So, an LLC with checkbook control may actually help you save money, which leaves more funds available for investing.

3. Control and Freedom

Once you identify an investment you want to purchase, you can just write a check. You don’t have to fill out paperwork or get approval from Mountain West IRA. If you have performed your due diligence and are ready to invest, you can take care of it yourself.
If you have an LLC, your Self-Directed IRA is truly in your hands. You are the one who is in total control of how your IRA operates, you have the freedom to choose how and when to invest.

Prohibited IRA Transactions and Holdings

There are many choices when deciding how to invest your self-directed IRA. There are also rules that you need to be aware of before investing.  Violating the rules on transactions prohibited in your self-directed IRA can make your IRA account subject to risks and penalties. These transactions are prohibited because they are considered as providing immediate financial gain to you or other disqualified persons.

 A disqualified person includes the account holder, their spouse, descendants, investment advisors/managers and any corporation, partnership, trust, or estate in which the holder had a 50 percent or greater interest.

As a Self-Directed IRA holder, you may not:

  • Borrow money from or lend to the IRA
  • Sell, exchange or lease property to the IRA account or from the account to yourself
  • Use the IRA as a security for a loan
  • Transfer plan income or assets to disqualified persons
  • Lend account money to disqualified persons
  • Extend credit on their IRA to disqualified persons
  • Furnish goods, services, or facilities to disqualified persons
  • Allow fiduciaries to obtain or use the plan’s income or assets for their own interest

There are also prohibited holdings in a self-directed IRA. These include:

  • Collectibles
  • Metals other than gold, silver and palladium bullion
  • Gems
  • Stamps
  • Coins
  • Alcoholic beverages and other tangible personal property as defined by the Secretary of the Treasury

There is an exception to the coin holding. Your IRA can invest in one, one-half, one-quarter, or one-tenth ounce U.S. gold coins and certain gold, silver, palladium, and platinum bullion.

In general, a self-directed IRA account is extremely flexible, however, it is important to stay within the guidelines as the penalties can be significant.  As one of the nation’s leading independent self-directed IRA and 401(k) administration companies, Mountain West IRA not only guides investors through the process of establishing a self-directed IRA account, but also ensures accounts are maintained to avoid prohibited transactions.