Find out if a Self-Directed IRA is right for you:

In this segment we’re going to be talking about compounding interest in the absence of taxation utilizing a self-directed retirement account and we’re going to demonstrate this to you by utilizing a real estate investment example.

Example:

Michelle gave us this transaction where she partnered 3 IRAs within her family, for her husband, for herself and her 19-year-old daughter. Now you’ve got to make sure you do this properly. And we have another segment on partnering Multiple IRAs together.

But in this transaction they had three IRAs all partnering on a deal to buy a property for $24,000, they bought a rental property for $24,000. At the time of buying it, it had a current value of around $40,000, so they bought it at a discount for 24,000. And the present value calculation or present value figure that I’m using is $8,000 because her daughter put in $8,000 into the deal.

So it was a $24,000 property purchase in each party, mom, and dad, and then the 19-year-old daughter with her Roth IRA each put in about $8,000 for the $24,000 purchase.

We’re going to start at $8,000 and what we’re going to do is we’re going to make some assumptions, okay? This is a little bit of a hypothetical example, but we’re going to make some assumptions. We’re going to say, “Okay, if she consistently makes a 19% return on investment… ” Because right now with this rental property as it’s cash flowing, the annualized return on investment is at 19%. If we project this out over 20 years, consistently receiving a 19% return on investment, if we go over to this graph here, in her Roth Ira, she will have saved over $308,000.

What’s the difference between this Roth in this traditional and then this taxable savings? Well, we have our tax free account. We have our tax deferred accounts such as a traditional IRA. And we have our taxable savings. What do we mean by when we say taxable savings? If we buy a property, we buy an asset and it’s producing income, in a general sense, we have to pay taxes on that income.

And there’s different tax rates depending on the individual situation, whether it’s short term, long term capital gains, ordinary income taxes, and of course the individual themselves in what their current tax rate is. But all in, we’re looking at this equation here, our future value compounding interest equation. Future value equals present value times one plus R to the Nth power. That’s a number of years. Now, the one variable that we didn’t factor into this equation, and most people don’t factor in, is taxes.

If we factor in taxes using this particular example, and we put in 20%, so if I factor 20% into my future value calculation, that’s only $156,000 because each year I’m paying taxes on a percentage of my profits. Therefore, I have less buying power for my next transaction, earning 19% year over year. In a traditional IRA factoring in 20% upon the withdrawal, I’ll have close to $247,000 because tax deferred means eventually when I take the money out, I have to pay taxes. With the Roth IRA, I have over $308,000 close to $309,000.

Hypothetical example: We have someone that’s interested in lending money with their self directed IRA. Let’s say our present value is 50,000. So we’re starting with $50,000 and an IRA that’s going to be deployed for private lending opportunities. The number of years, I’m going to go ahead and plug in 20 years again. And our return on investment I’m going to say is 12%, all right? I’m going to say 12% return on investment over 20 years starting with $50,000.

This will be our tax-free Roth IRA or it could be an HSA or a CESA, that’s over $540,000 saved. So $540,000 safe. Now, if I look at the tax deferred accounts, traditional accounts, SEP IRA, simple IRA, that’s over $432,000. I got to pay some taxes when I take the money out. And then in my taxable account. And I used a 20% tax rate. If I’m lending money not using an IRA, as I’m collecting interest income, I have to pay taxes on that interest income. I will saved over $540,000 if I do it in an IRA.

Equity Trust Company is a directed custodian and does not provide tax, legal or investment advice. Any information communicated by Equity Trust is for educational purposes only, and should not be construed as tax, legal or investment advice. Whenever making an investment decision, please consult with your tax attorney or financial professional to determine whether an investment product, plan or strategy is right for you. Investing involves risk, including possible loss of principal…(read more)

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