Almost all investors are familiar with the standard options for retirement accounts; IRAs, 401Ks, 403Bs, etc. Reviewing those vehicles is not the point of this article. Instead, I want to talk about a little known method of temporarily shielding more exciting and lucrative investments from taxes through an alternative twist on the classic retirement account; the Self Direct IRA and 401K. These vehicles are particularly interesting and important to consider this time of year with tax season over, but the situation still fresh in most people's minds.
Traditional IRAs allow for only the most basic of investments; stocks, bonds, etc. Real estate generally isn't allowed (except through a publicly traded REIT structure), and 401Ks usually face similar restrictions. The specific investments vary depending on what is allowed by the custodian of the retirement account, but in most cases investors have a tough time investing in real estate, commodities, private companies, OTC companies, foreign stocks, and in some cases options and certain types of bonds.
Self directed retirement accounts change all of this by offering the same tax advantages as a traditional IRA or 401K, but allowing the individual to choose virtually any type of investment they want. Self directed IRAs allow investors to put money into three types of common investments that they could not otherwise use: (1) options, (2) gold and silver, and (3) private companies.
For investors looking to invest in these three classes of assets, self directed accounts offer an important advantage in each case.
For most options investors, many of their gains will be short term gains using high degrees of implicit leverage. For example, investors buying calls put up little in the way of cash, but are hoping for large, often short term gains. The result of this is that if the call investment pays off, the investor owes large amounts of taxes on these short term capital gains. If on the other hand, the call expires worthless, the investor has gained little benefit from the taxable loss. Self directed IRAs allow derivative securities investments such as long call purchases, and enable the investor to defer the tax hit from successful call investments.
Gold and silver are usually regarded by the IRS as collectibles and as such, investors in precious metals are subject to a completely different set of more onerous tax rules compared with investors in stocks and bonds. Many metals investors have long regarded these rules as unfair discrimination against them, or even a conspiracy by the IRS. In a self directed retirement account however, investors can purchase gold or silver, and temporarily avoid taxes associated with gains from trading in the metals. While investors can't usually hold the physical metal itself, there are certain platforms that do allow this.
Finally, for investors looking to act as angel investors or be involved in crowd funding of small businesses under the new JOBs act, self directed retirement accounts offer an important opportunity to defer taxes. Most of the time, investing in a private company immediately obligates the investor to begin filing much more complex taxes including recognizing self-employment income or in some cases royalties. However, by placing private equity investments into a self directed retirement account, the investor avoids most of these issues, usually for years, while still gaining the benefits of potentially explosive growth from investing in private companies.
While self directed retirement accounts certainly aren't for everyone, especially novice investors, if you are looking for a vehicle to make unorthodox investments while minimizing the taxes associated with these investments, a Solo/Self-directed 401K or Self Directed IRA may be a good choice.