If you have a traditional IRA, chances are that you already understand the importance of retirement savings and diverse investment choices. Have you considered taking the next step and adding physical assets like gold and silver bullion to your portfolio? Here, we'll go over the differences between traditional IRAs and self-directed IRA accounts, how precious metals investing works, and how you can safeguard your savings against stock market or currency collapse.
What is a Traditional IRA?
Traditional Individual Retirement Accounts (IRAs) were established in 1974 through the Employee Retirement Income Security Act, or ERISA. IRAs are tax-advantaged investment vehicles designed for retirement savings; money contributed to an IRA is not taxed and grows tax-free until a withdrawal is made.
Unlike 401(k) plans, Traditional IRAs are not sponsored by an employer. Rather, individuals need to qualify in order to open and contribute to their own IRA, although the qualifications are quite simple: earn taxable income and be under the age of 70 1/2. That's it. (however, your contributions may or may not be deductible depending on your income level and access to other retirement accounts)
One drawback of an IRA (relative to other retirement accounts) is that they have fairly low contribution limits. As of 2014, individuals under the age of 50 can only contribute $5,500 per year, while those age 50 and above can contribute $6,500. As with other qualified plans, a 10% tax penalty is assess if any money is withdrawn prior to the “retirement age” of 59 1/2, though there are some exceptions in the case of hardship. Withdrawals become mandatory at age 70 1/2, at which point you are also no longer eligible to make contributions.
While the investment choices for Traditional IRAs tend to be much greater than for employer-sponsored accounts, your IRA custodian still can limit what you can choose. Additionally, the Internal Revenue Service (IRS) does not allow Traditional IRA money to be invested in physical assets like real estate or precious metal bullion.
You may not take out loans from an IRA.
Traditional IRA Rollover Rules & Limitations
IRA money can be rolled over or transferred between financial institutions without incurring tax penalties, although rollovers are limited to one per 365 days. You can also use existing Traditional IRA money to fund a self-directed IRA.
There are penalties for taking distributions in cash prior to retirement age. Additionally, if you are going to attempt a rollover, it is highly recommended to elect to perform a direct rollover instead of an indirect rollover. Indirect rollovers have withholding requirements and run the risk of incurring early distribution penalties.
IRA-to-IRA transfers are the most common method of establishing self-directed IRAs with exiting qualified funds. A new account is established with an IRS approved IRA custodian who, with your consent, requests the transfer of IRA assets from your existing Traditional IRA. The custodian will then be able to accept the money and invest the assets according to your instructions.
Traditional IRA vs. Self-directed IRA vs. 401(k) vs. Other Retirement Accounts
Here is a table which illustrates how a Traditional IRA compares to other tax-advantaged retirement savings vehicles:
"Maybe" indicates that gold investment options are at the discretion of the plan provider. For example, certain 401(k) plans offer gold mutual funds or ETFs, while others do not.
Types of Gold You Can Invest in Through a Traditional IRA
As mentioned above, Traditional IRAs have plenty of investment options but can be limited by the IRA custodian and IRS rules. These are the types of investments that a standard IRA owner should be able to invest in:
Individual bonds (corporate and government)
Mutual fund shares
Exchange Traded Fund (ETF) shares
Certificates of Deposit (CDs)
Money Market Fund shares
In short, this means that you cannot invest in physical gold bullion (or any other approved investment metal) through a Traditional IRA. The simplest way to invest in gold through your Traditional IRA is to purchase stocks in gold mining companies or to purchase a mutual fund that includes mining company stocks. This strategy is referred to as buying “paper gold.” There are also gold ETFs (GLD) and mining ETFs which provide indirect access to gold investing.
Investing in Physical Gold vs. “Paper Gold”
So-called “paper gold” stocks are the shares of companies that mine, produce, and explore for gold ore. There are literally hundreds of gold stocks to choose from, and the larger companies are listed on major gold indices like the Gold Miners Index (GDX) or the BUGS Index (HUI).
Gold stocks tend to be more risky than owning physical gold. This is because, historically, gold stocks will appreciate quickly when gold spot prices rise but fall much more dramatically when the price of gold declines.
Gold stocks are also exposed to additional kinds of risk. Some examples include:
Regulatory Risk – mining and exploration companies are subject to increased regulation and taxes.
Cost of Production Risk – mining equipment depreciation, rising land values, labor cost increases, etc can all negatively impact a mining company's valuation.
Management Risk – mismanaged or overly leveraged companies can, and do, declare bankruptcy or close shop completely.
Fiat Currency Risk – when you sell securities like gold stock or shares of gold mutual funds, you are going to be compensated in a fiat paper currency. In the even of currency collapse, you may be left holding a worthless asset.
The value of physical gold has never hit zero and has retained value for thousands of years. In terms of staying power, physical gold beats “paper gold” hands down.
Benefits of Dedicating 5-20% of Your Retirement Portfolio to Precious Metals
Gold investments are a simple, safe way to diversify your retirement portfolio. Gold (along with other investment metals: silver, platinum and palladium) will help to protect your assets against stock market volatility and inflation.
Not only is gold a great hedge, but gold offers plenty of growth potential. In fact, many investors purchase gold for its growth prospects, and many analysts predict gold to continue to see gains in the future.
The total amount of precious metals in your retirement portfolio will depend on your own risk tolerance and retirement horizon. One of the best ways to set up a diversified retirement portfolio (and receive tax benefits) is to open a self-directed IRA.
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