In Monday’s Daily, editor Teeka Tiwari introduced you to a “loophole” used by the super-rich to save a fortune on taxes.
It’s called a self-directed IRA (SDIRA).
And it’s a little-known, little-used type of retirement account that allows you to move far beyond Wall Street’s traditional world of stocks and bonds.
Wealthy investors like billionaire Peter Thiel have been using these accounts for many years now.
And in Thiel’s particular case, this loophole could potentially save him billions of dollars in taxes. (You can get the full rundown here.)
This chart shows you how…
I’ll delve into the differences between these accounts in a moment.
But looking at those numbers begs the question – why should you use anything other than a Roth IRA?
Well, it isn’t quite that simple.
The chart above only illustrates one particular scenario. And you can use it to create what Teeka calls the “holy trinity of retirement investing.”
While we favor using the “loophole” to invest in asymmetric ideas like cryptos and private equity… each type of account has its pros and cons.
You might even want to use one of each for different purposes… That’s what I do personally.
So today I want to dig a little deeper into some of the different advantages and other considerations associated with these three major types of investing accounts.
First, a couple caveats…
Tax laws are always changing… So everything here is based on current rules and tax rates.
Also, this information is for general tax purposes only and doesn’t cover every aspect of IRAs and retirement accounts… I encourage you to consult with an accountant or tax adviser regarding your specific financial situation.
At PBRG, we’re known for asymmetric investment ideas that can help you turn tiny grubstakes into life-changing gains.
These ideas include cryptos, private equities, and stocks in plant-based medicine companies.
But before you put a portion of your money into ideas that can move the needle on your net worth… you need to first protect what you already have.
Of course, retirement planning isn’t as exciting in investing in cryptos or pre-IPOs. But it’s just as important if you not only want to grow your wealth… but protect it, too.
But don’t worry. We did all the grunt work on IRAs for you. So if you want a holistic approach of building and protecting your wealth… read on.
Why Choose a Taxable Account?
If you look back at the chart above, you’ll see that a regular taxable brokerage account might end up owing far less in taxes than a traditional IRA.
That’s because long-term capital gains rates – which apply to investments held for at least one year – currently max out at 20% (with an additional 3.8% Medicare surcharge that applies to high-income people).
If you’re a buy-and-hold investor, that could make a taxable account a pretty good choice.
That’s because even if you grabbed a bargain stock at $1 a share and watched it soar to $1,000, you wouldn’t owe any taxes until you sold it.
And when you did, the most you would owe Uncle Sam is 23.8% of your profits.
In contrast, the same investment inside a traditional IRA would be subject to ordinary income rates – which currently go as high as 37%… plus the same 3.8% surcharge for high-income people.
With a traditional IRA, you also have additional restrictions on when you can withdraw your money. And if you withdraw before you turn 59½, you’ll owe an additional 10% early withdrawal penalty on the proceeds, too.
Meanwhile, a Roth account has the same age restrictions and withdrawal penalties… but otherwise results in zero taxes owed to Uncle Sam.
So in general, a single investment held for a long time is best in a Roth… pretty good in a taxable account… and probably worst off in a traditional IRA.
That’s exactly what you see in our chart.
However, let’s say your investment kicks off income – maybe dividends or regular interest payments… Or let’s say you like to buy and sell your investments a bit more frequently.
In a taxable account you’ll owe some federal taxes on that income every year… and you’ll have to pay Uncle Sam a healthy portion of your profits every single time you make a trade.
So, for many income investments and/or more frequent trading activity, either IRA is generally superior to a taxable brokerage account.
Not only do you defer or completely neutralize your taxes, but more of your money continues compounding in value over many years.
Comparing the Two Major Types of IRA Accounts
Here’s a quick review of how traditional IRAs differ from Roth IRAs.
With traditional IRAs:
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You contribute pre-tax money and can save on your current taxes by lowering your taxable income (subject to certain income caps).
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Your contributions and earnings will be subject to taxation upon withdrawal.
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And you must stop contributing and begin withdrawing money at age 70½.
Meanwhile, with Roth IRAs:
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You contribute after-tax money and thus gain no upfront tax-savings benefit… but you can withdraw your contributions at any time without a tax penalty (since you were already taxed).
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Your earnings will never be taxed again, so long as you meet the basic guidelines: eligible age of 59½ and an account established for at least five years.
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Plus, you can continue socking away money as long as you have earned income, no matter what your age. And you never have to make minimum withdrawals, even if you live to be 110.
You can fund both accounts until Tax Day of the following year (usually April 15).
And for 2021, the regular annual contribution limit for either IRA is $6,000 and $7,000 for age 50-plus… but you can’t max out both a regular and Roth IRA in the same tax year.
Your total contributions to all IRA accounts – not counting rollovers and such – must fall within the range mentioned above.
Regular IRAs have no income restriction for contributions, though the tax deductibility can be affected by your Modified Adjusted Gross Income (MAGI) and whether you’re covered by a retirement plan at work.
Meanwhile, you can only contribute to a Roth IRA if your MAGI falls within certain levels. (Or by using a “backdoor” strategy, which involves converting a traditional IRA to a Roth IRA and paying taxes in the process.)
Save on Taxes, Protect Your Wealth
When it comes to picking between a traditional IRA and a Roth IRA, the biggest factors are your current income… the tax rates you’re being subjected to (federal, state, and local rates)… plus where you expect those two things to be in the future.
For example, someone who lives in a high-tax area like New York or California right now… but plans on retiring to a no-tax state like Florida… might have a lot more reason to choose a traditional IRA than a person with the opposite life plan.
In the end, there’s really no way to have perfect information. Life is unpredictable. Tax rates change. Even the laws related to IRAs can be altered at any time.
This is precisely why I have all different types of accounts – including both traditional and Roth IRAs.
Not only am I able to match up the best types of investments for each account’s strengths, but I’m also hedging my bets on how the future will end up playing out.
So, while we might not be billionaires like Peter Thiel, the IRA/SDIRA “loophole” can save us a boatload of money on taxes.
And if you diversify your retirements assets like we suggest here at PBRG, having different kinds of accounts will protect your wealth even further.
Best wishes,
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Nilus Mattive
Analyst, Palm Beach Daily
P.S. In the most recent issue of Teeka’s Palm Beach Letter service – released just last week – he shared two crypto SDIRA options that can help you save on taxes and earn interest.
And as your cryptos move higher, so will their underlying technologies and projects… including one Teeka calls “Genesis.”
To learn more about this multitrillion-dollar project… and how you can access Teeka’s two SDIRA recommendations today… click here.