As an investment vehicle, the Individual Retirement Account (IRA) has been an unparalleled success ever since its creation by Congress in 1975 with the ERISA Act. Since then, permutations of the same basic tax-friendly structure have arisen, but none are viewed better by Jason Hartman than the self-directed IRA. John Bowens of Equity Trust joins Jason for a discussion on the topic on episode #341 of The Creating Wealth Show.
Equity Trust was founded by Richard Desich Sr., a stockbroker, in 1974. He essentially created the idea of a self-directed IRA, which was approved by the IRS in 1983. What Jason really likes about this type of investing is that it hews closely to his 3rd Commandment for Successful Investing (always be a direct investor).
As the nation’s largest custodian of self-directed IRA accounts, Equity Trust holds more than $13 billion in assets for clients. The company’s specialty is to help investors find profitable alternatives to the stocks, bonds, and mutual funds approach of traditional brokers. As Jason reminds us frequently, transaction fees and other expenses associated with Wall Street brokers serve best to separate an investor from his or her profit.
According to the IRS and Wall Street, real estate is an “exotic” investment. Bowens points out that Equity Trust helps investors participate in buying not only land but actual exotics like tropical tree farms, tax liens, and alpaca farms. For the purpose of this interview, Jason sticks to real estate.
The Benefits to Self-Directed IRA Investing
The first benefit to investing inside ANY type of IRA vehicle is that your money is allowed to grow tax free until you withdraw it at retirement. The Roth IRA is slightly different but that goes beyond the scope of this interview. This strategy allows an investor to take advantage of a magical little thing called compounding. You invest pre-tax money into your IRA, let it grow for decades without tax interference, then take it out to live on in retirement. The money will be taxed at prevailing capital gains rates upon withdrawal. As financial planning professionals will tell you, the secret to creating wealth is to keep Uncle Sam out of the mix while the money accumulates.
Another benefit, and perhaps even more important, according to Jason, is that a self-directed IRA allows you to decide what to invest in. You decide when to buy and sell. Ultimate control lies with the investor. It’s silly to do it any other way. Traditional Wall Street stock brokers have this bad habit of churning accounts with needless transactions just to generate more profits for themselves.
How to Turn Your IRA into a Self-Directed IRA
According to Bowens, the process of converting any other sort of IRA into a self-directed IRA is simple. The most common scenario is when an investor has IRA funds deposited with a traditional broker. All you have to do is a regular rollover into an Equity Trust (or other self-directed IRA custodian) account. It’s not a tax event and won’t cost you anything besides $50 to create the new account with Equity Trust.
Investing in Real Estate with a Self-Directed IRA
For years, the IRS didn’t like the idea of people buying real estate inside an IRA. There didn’t seem to be any good reason for this other than they thought it was “messy.” Stocks, bonds, and mutual funds are easy to think about. They don’t involve mortgages and third parties. But the tax man finally came around and now investors can dump stocks and pack their portfolios with income investment properties. But how does it work? It’s actually easy.
The first thing to realize is that at no time is your property titled to the custodian (Equity Trust or someone else). As the sole beneficiary to the account, the investor owns the property just as he or she would a handful of stocks. Once a suitable property is located, cash flows out of the account and the title deed goes in. From there, an investor can rehab, wholesale, or buy and hold the property as an income-producing asset. Upon sale of the property, there is no capital gains tax.
Jason queried Bowens about the issue of checkbook control, which refers to the ability of an investor to be in charge of all recordkeeping and reporting issues associated with the account. While the IRS doesn’t strictly prohibit this, Equity Trust believes the spirit of the law intends for an IRA account to be an arm’s length transaction, and that it’s safer for the investor if a third party maintains all records. While the IRS has not yet seen to barge into the checkbook control issue, it could at any point.
How Much Does it Cost?
Long time listeners of The Creating Wealth Show know that Jason harbors a mighty grudge against traditional brokers who nickel and dime investors to death with a barrage of charges, fees, and administrative costs. So how much does Equity Trust charge for services? As Bowens illustrates, it’s pretty straightforward.
You’ll pay a $50 setup fee to get started. There is also a single management fee based on the size of the account. For assets amounting up to $1 million dollars you pay about $400 annually. Once your account crosses the $1 million dollar barrier the fee rises to $1,850. That’s it. The cost structure is simple and modest compared to traditional Wall Street brokers.
The Bottom Line
The amazing statistic about self-directed IRAs is that only 2% of Americans presently take advantage of them. When you take into account the incredible tax advantages and increased level of control over your account, you really should! While Jason has a positive opinion of Equity Trust, and they are the big boy on the block, feel free to seek out other custodians for your investment money.
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The Jason Hartman Team