A conversational educational transcript explaining self-directed IRAs and how they differ from traditional retirement accounts. Speakers describe what assets are allowed/prohibited in self-directed IRAs, how to transfer funds between custodians without tax/penalty, and the tax advantages of investing in real estate via tax-deferred (traditional) and tax-free (Roth) accounts with example return calculations to illustrate compounding benefits.
You just have to understand as a consumer investor that you have choices. You have the ability to empower yourself to make your own decisions. You don't have to put all of your money with this particular institution and leave it in a traditional stock based portfolio or fixed income based portfolio. You have the ability to take control and there's not going to be any type of onerous taxes or penalties.
Let's start from the beginning. John, talk about a self directed ira. Explain the difference between self directed IRA and a retirement account. So they've heard us talk about it a few times, but not nearly to the extent of which we're going to talk about it today. So can you unpack it very simply for those who have retirement accounts and they're not exactly sure the difference between what they have now and a self directed account?
Yeah. So the best way to think about it for the audience is self directed is an industry term. It just tells the investor that they have the ability to self direct their retirement funds into any type of asset that they deem as a best fit for their portfolio. Now, it is important to caveat that with the notion that there are assets that you cannot invest in with your self directed ira. So no artwork, no collectibles, no Beanie Babies or pogs. You can't invest in alcoholic beverages and be a member of an S corporation with your ira. There are certain individuals that you cannot transact with. These are called prohibited transactions. Ultimately, the tax code going back to 1974, the ERISA act, was exclusive rather than being inclusive. So there's a lot more that you can do than you can't do. So the idea is investors are only limited by their own creativity. So self directed is just an industry term. The best way to think about it is let's say you have an IRA 401K, 403B, Thrift Savings Plan 457. So you have an existing retirement account and it's, it's with a custodian. Now, some people don't know who their custodian is. They're not sure. That's okay. It's easy to figure out who that is. But it's, it's with a custodian, it has to be with a custodian. And assuming that you've left that employer, or if it's just an ira, like a traditional IRA or Roth IRA or sep, SEP IRA or simple ira. Ultimately you move that into an equity trust self directed ira. And by moving that money from one financial institution to another, there's no taxes or penalties. And I say that because a lot of people get caught up in thinking that if they move their money from one financial institution to another, that there's no taxes or penalties. What I'll say, and I'll be pretty candid about this, financial institutions have gotten very creative at figuring out ways to get people's money into their ecosystem. And then it never leaves. Right. The reality is, is that's what financial services does and it's not good, bad or indifferent. Right. Everybody's got to make money. Everybody's got a business model. And I'll say there's nothing wrong with that. But you just have to understand as a consumer investor that you have choices. You have the ability to empower yourself to make your own decisions. You don't have to put all of your money with this particular institution and leave it in a traditional stock based portfolio or fixed income based portfolio. You have the ability to take control and there's not going to be any type of onerous taxes or penalties. You simply just move your money over from one financial institution into the equity Trust self directed ira. Once you're there, you then have the ability to direct your funds out to private market investments. Specifically, we're talking about real estate here. I'm passionate about real estate. I invest in real estate with my self directed accounts. I make private money loans with my self directed accounts. That's what I've been doing for a lot of years. That's what I've been teaching other people how to do. And so let's say somebody moves their $150,000 from their 401k over into a self directed Iraq and then they want to buy a house for 110,000, put $10,000 worth of rehab into it and rent it out for $1,400 a month. They move their money over, they move their money out for that investment and then all their rental income comes back into their self directed account. And the beauty of it is that they eliminate taxation on those returns. As long as they follow the rules and guidelines. There's no taxes on the rental income. And then when they sell that rental property, there's no long term capital gains tax, there's no recapture depreciation, there's no schedule ease, there's no reporting on a 1040. So what's nice about the self directed IRA is it allows an individual to be able to, A, like we've been talking about, invest in hard assets like real estate, and B, there's some pretty powerful tax advantages, like I always say, compounding interest in the absence of taxation. Yeah.
So why don't we just go down that rabbit hole, talk about the tax advantages and what you mean by the compounding interest and absence of taxation.
Yeah. So inherently a self directed ira, and really any ira, just remember self directed is an industry term. The growth in that account will either be what's called tax deferred or tax free. So the difference between the two are the account types. And I think it is important for viewers to understand that there are two different types or styles of, of accounts. You have a traditional IRA and you have a Roth ira. So a traditional ira, which is where most of the retirement wealth is in this country by the way, because people have been conditioned to put money into an account to get a tax deduction, grow it tax deferred, and then when they take the money out after the qualified retirement age of 59 and a half, that's when they pay taxes. The analogy we like to use in the industry is you either pay taxes on the seed or you pay taxes on the crop. So most people have put money into tax deferred accounts. 401ks, 403bs, thrift savings plans. These are all employer plans. Or maybe someone just has a traditional IRA or SEP IRA or simple ira. The monies are going in, they're getting deductions for that. It grows tax deferred again, when they take the money out, they pay taxes. Now tax deferred growth is still pretty powerful. If we actually put some numbers behind this. If we put $6,000 away into an account for 25 years and we apply a 12% compounding return, taxes of 30% during our working years of 25 years, and taxes of 20% when we take the money out. If we compare a traditional IRA to just taxable, meaning every year you got to pay taxes, compared to tax deferred, you'd have over $300,000 in tax savings. If you punch that into your financial calculator, you got $300,000 in tax savings. So economically, financially you can argue that a traditional IRA can be powerful in contrast to just saving taxable.
Right.
Then you go to the Roth IRA, which is the second, call it style of account. The Roth IRA didn't come about until 1997, 1998. William Roth Jr. He was the senator from Delaware that really pushed this legislation. It took him about nine times, got it passed 1998. Americans now have access to a Roth IRA. Now you will learn that high net worth individuals, or rather I should say higher income earners in 1998 weren't allowed to have a Roth IRA. And so the way the Roth IRA works is is the money that goes in is after tax, it grows tax free. And then when you take the money out, you pay 0% tax. So as long as you follow the rules, the guidelines, you're 59. After older, you pay 0% tax. So if we apply that same compounding interest formula that I mentioned in a Roth IRA, you would have $1.117 million. So if you compare the Roth to the traditional, you get over $200,000 in savings. If you compare the Roth to the taxable environment, it's over $500,000 in savings. So the Roth IRA is really, really powerful.
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