Self-Direction Part 1 of 4



This blog begins a 4-part series on the real estate investing technique of self-direction, which creates the ability to use retirement accounts for real estate investments. This first blog will cover retirement accounts generally.

NOTE: Self-direction is an advanced real estate investing technique with a lot of nuances. This blog is meant as general information and not legal, tax or investing advice. You will certainly need more education and advice to truly understand this amazing technique.

Self-direction is when a person uses their retirement account money in investments outside of typical brokerage investment products. It is often used by real estate investors looking to use their retirement money to invest in real estate, which is not offered by their broker. In other words, they have greater ability to “direct” their money into different investments. Self-direction, then, requires more work and education on the part of the investor.

Really, any kind of retirement account can be self-directed: IRAs, 401Ks, SEPs, SIMPLEs, 403(b)s and the like. Because most Americans have IRAs and 401Ks, those are the two that will be the focus of this blog. First, let’s talk Roth v. Traditional accounts.

The terms “Roth” and “Traditional” are applied to many types of retirement accounts. Both IRAs and 401Ks can be Roth or Traditional accounts. You will need to know what type of account you have! You can look at the account paperwork and it should tell you. If it says, “Roth IRA” then you know you have a Roth account. If it doesn’t mention “Roth” then most likely it’s a Traditional. However, you should verify this with your current custodian!

A Traditional account is “pre” tax. This means you can contribute your income to the retirement account prior to paying tax on it. This saves you taxes in the year you make a contribution to the account. The money in the account then grows tax free. When you “retire” and go to take a distribution, it will then count as income and be taxed at that point. So you save taxes now, pay taxes later.

A Roth Account is “post” tax. This means you contribute your income after paying tax on the money. Thus, you won’t get the tax break in the year you contribute. Like a Traditional account, the money grows tax free. But unlike the Traditional account, the money comes out tax free! So when you retire and take distributions, that money is not taxed. This account is pay taxes now, save later.

Because of the Roth’s grow and distribute tax free, most investors try to utilize Roth retirement accounts in self-direction since there is large growth potential. Now, let’s look at IRAs v. 401Ks.

While they are both retirement vehicles that benefit individuals, there are a number of differences. And as far as contribution limits, those can change year-to-year. So, you should discuss these options with your tax and financial advisors.

Individual Retirement Accounts (IRAs) are accounts that are set up by the individual tax payer.

That means you! Anyone can set up an IRA, at any age. Most people go to a bank or broker to do this. You can set up either a Traditional or Roth, or both! They have much lower contribution limits than a 401K, so you can’t fund them as fast. You can open an IRA and make a contribution for a given tax year before you the April tax deadline for that previous tax year. So, you get a few extra months to make that happen and still get any tax break. You can start taking money out, without a penalty, when you turn 59 1⁄2. After you turn 70, you will need to start taking mandatory distributions.

401K Retirement Accounts (401Ks) are accounts that are set up by an employer on behalf of its employees. So, only a business entity (including sole proprietor businesses) can set it up. For many people, their employer offers a 401K to their employees. The employee’s contribution limits are higher than for an IRA, and the employer can match funds as well. So, it’s possible to fund a 401K much faster. All 401K contributions for a given year must be made by December 31 of that year. Thus, earlier than the deadline for an IRA contribution. A 401K has the same distribution guidelines as an IRA.

The good thing is, any business owner can set this up—that means every real estate investor can actually set up their own 401K plan to benefit themselves and their spouses.

In our next blog, we’ll start to show you how to take these accounts and turn them into self-directed accounts.

Jeffrey S. Breglio, Esq.
Breglio Law Office and REI Mastery U
(801) 560-2180

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