Making regular contributions to your self-directed Checkbook IRA is a great way to maximize the tax-savings of your plan.
While most people focus on the fact that a self-directed IRA allows for a broad range of investment choices such as real estate, cryptocurrencies, venture capital, and more, it is important to remember that a self-directed IRA is still an IRA at heart.
Just like any other IRA, you can contribute new money each year and build your savings on the front end. The more you have available to invest, the more you will benefit from the compounded tax-sheltering of income over time that an IRA provides.
Here are a few tips about making IRA contributions in a checkbook IRA.
All contribution limits listed below apply to the 2020 tax year.
1 – Know Your IRA Type
Individual Retirement Arrangements come in a few different flavors. Each is tailored for a certain usage and has different contribution limits. It is important to know what type of IRA you have as that will help you understand your capacity to contribute.
A Traditional IRA is the most common. A Traditional IRA can be setup by any individual and has tax-deferred status. That means funds are placed into the IRA pre-tax. Earnings in the IRA are not taxed, but when distributions are taken in retirement, they are taxable. Anyone with earned income can contribute to a Traditional IRA up to the annual limit of $6,000 for those under 50 and $7,000 for those age 50 and older.
A Roth IRA is also an individual plan with the same contribution limits as a Traditional IRA. In a Roth IRA, however, contributions are made post-tax. Any earnings and future distributions are then tax-free.
A SEP IRA is an employer linked IRA that allows for higher contributions. An employer can contribute to the SEP IRA of an employee on a profit-sharing basis up to the plan limit of $58,000. Individual contributions are not allowed. A SEP IRA has tax-deferred status. You can have a SEP IRA as an employee of a business that offers such a plan or choose to setup a SEP IRA for your own business.
A SIMPLE IRA is an employer sponsored IRA that allows for a combination of employer and employee contributions. As an employee, an individual can contribute up to $13,500 if they are under age 50 or $16,500 if age 50 or older. The employer then contributes either by matching employee contributions dollar-for-dollar up to 3% of employee compensation, or with a non-elective contribution of 2% of employee compensation.
Inherited IRA. Any of the above IRA types can be held by a beneficiary of an original account holder who has passed away. No new contributions can be made to an inherited IRA.
2 – Understanding Contribution Limits
Contribution rules can be complex. The best way to be sure you understand if and how much you can contribute is to speak with your licensed tax advisor.
If you have more than one plan, you may be limited in how much you can contribute across those plans. You may be able to contribute, but not take a tax-deduction for doing so in some cases. In employer plans the amount you can contribute is often dependent on income from the business, and you may not be able to contribute up to the maximum.
3 – If You Also Have an Employer Retirement Plan
If you or your spouse have a retirement plan such as a 401(k), 403(b), SEP IRA, SIMPLE IRA, etc. at work, that can impact your ability to deduct a contribution made to a Traditional IRA.
If you are single and your AGI is less than $65,000, you can still make a deductible contribution to a Traditional IRA up to the maximum allowable amount for your age. Between $65,000 and 75,000 a partial deduction is allowed, and the deduction is phased out entirely at $75,000 AGI.
If you are married filing jointly, a fully deductible contribution can be made if your AGI is $104,000 or less. Between $104,000 and $124,000 a partial deduction is allowed. No deduction is allowed with an AGI of $124,000 or more.
Similar limits apply if you are married and do not have access to a 401(k) but your spouse does.
4 – Non-Deductible Contributions
If your ability to deduct a contribution is limited, you can still make the full allowable contribution to a traditional IRA. The contribution amount is flagged as non-deductible on your income tax return for the contribution year. You then need to track that contributed basis as a component of your IRA over time.
The non-deductible basis has already been taxed and will not be taxed again when you take distributions from the IRA in the future. Any growth in value derived from the non-deductible amount will have regular tax-deferred status.
5 – Roth IRA Income Limits
Contributions to a Roth IRA are not tax-deductible. Your ability to make contributions to a Roth IRA is limited by AGI thresholds.
For those who are married and filing jointly, a full Roth IRA contribution can be made if AGI is less than $196,000. Between $196,000 and $206,000 there is a phase-out of the amount that can be contributed. No contribution is allowed if AGI is $206,000 or greater.
For a single filer or head of household a full Roth IRA contribution is allowed with an AGI of less than $124,000. The phase-out range is between $124,000 and $139,000. If AGI is $139,000 or greater, no Roth contribution can be made.
6 – If You Have More than One IRA
If you have multiple IRA plans, that can also impact your contribution strategy.
The maximum contribution limit for your age bracket is a single cap for your Traditional and Roth IRA. You can contribute up to the maximum to either or split the contribution across the accounts but cannot exceed the maximum.
If you or your spouse have an employer retirement plan, you may be able to contribute separately to a Traditional IRA or Roth IRA. In a traditional IRA, your ability to deduct your contribution may be limited as outlined above. In a Roth IRA, your ability to contribute is only impacted by your income regardless of whether you have access to a separate employer plan.
7 – How to Make IRA Contributions
Never place an IRA contribution directly in the LLC or Trust that is the checkbook entity for your plan. The checkbook entity is the investment of the IRA, not the IRA proper. To place what you believe to be a contribution directly it the IRA-owned entity would break the proper reporting protocol and could have negative tax consequences.
All contributions must be made into the IRA account held by the custodian of your plan. You will then request that the newly contributed funds be invested into the LLC or trust entity.
Making contributions to your IRA will not likely have a cost. Having the IRA make an additional investment into the LLC/Trust will typically cost about $40 depending on the custodian. As such, it makes more sense to contribute once or twice a year rather than monthly.
8 – When to Make Contributions
The timeline for making IRA contributions varies based on the IRA type.
In a traditional or Roth IRA, you can open the account and make contributions for the prior year up April 15th of the following year. Depending on your savings and investing strategy, it can make sense to double up. Using this method, you can contribute for the prior and current year in the window between January 1st and April 15th, then do this every other year.
A SEP IRA can be established and funded up until the tax filing date for the prior year, including extensions.
A SIMPLE IRA must be opened by October 1st of the tax year in which the plan first becomes active. Employee contributions must be made within 30 days from the end of the pay period from which the contribution is being made. Employer contributions must be made by the tax filing date for the prior year, including extensions.
Be sure to make your contribution well in advance of the deadline. Most financial institutions including your self-directed IRA custodian get very busy around tax season.
9 – Saving Makes a Big Difference
$6,000 placed into an IRA earning 10% will be worth $15,562 in 10 years. In 20 years, that original $6,000 could be worth $40,365.
If you contribute that same $6,000 every year for 20 years, the potential future value is $343,650. You will have more than doubled your $120,000 in savings over that period.
A self-directed IRA is not just a better way to control your investments. The value of continuing to add money to your plan through annual contributions is tangible. Be sure to contribute if you can.