The last few years have been a wild ride for investors, real estate and stock market investors included. But as we survey the opportunities that present themselves, there is a constant. At the time of writing this guide, there has been a blank slate providing investors the opportunity to plunge in and get started in Self-Directed IRAs.
Much to the charging of the stock market, real estate has been and always will be the “constant” available. Constant in the fact that ultimately everyone will need real estate; whether we are investing in our first rental or starting our business, we all need real estate in our lives.
In the last couple of years, self-direction has taken a big leap forward in credibility. The internet has been a powerful force in spreading the word about the concept of self-direction and giving investors the tools to make informed choices. We have all discovered that we cannot sit back and place our money with a stockbroker and assume that our money will double every 7 years. Our world involves too many unknowns to hope that our investments will just go up. Self-direction allows investors to study various assets and the risks and rewards associated with investing.
In addition to a complicated economy, our governments are tax and fee happy which continues to erode the gains that we investors strive to make. Did you know that if you live in Iowa or sell property in Iowa, the state wants 8.98% of the entire gain? In Florida, while we have no income tax, there is a transfer tax of .007 of the value of the asset ($500,000 property sold equals $3500 to the State of Florida). The feel good sense of having “no taxes” disappears quickly when you have to pay a “fee” instead.
Self-Directed IRAs, 1031 Exchanges and other tax reduction techniques are power tools to save investors money and, more importantly, build wealth. Let me give you an example of the advantage of a tax favored vehicle like a self-directed IRA. In this example, it is assumed that during the investment period all income will be reinvested in the asset. Also, at retirement it is assumed that money will not be withdrawn as one large amount, but distributed over the life of the taxpayer at hopefully a lower tax rate.
Example – Tax Free Strategies:
Let’s say you start at age 35 and put $5,000 in a traditional IRA annually for 25 years and assume you average that baseline return of 7%. When you are 60 years old, the account will be worth $338,282. Now let’s assume the same facts but this time you invest the money in a nontax deferred investment like a standard mutual fund, and you pay your taxes on the annual returns at a rate of 25%. With the non-IRA asset, the account will be worth $194,997. A twenty-five year savings of an extra $143,000 is what I am calling “wealth building” with the right tools. By paying annual taxes on the earnings, the investor is eroding his/her reinvestment potential. Annually there is less principal to grow, causing a lower balance after the 25 years. Pretty sweet huh?