An IRA Trust and an IRA LLC are similar to each other, which can make it challenging to decide when to choose one over the other. Today’s article can help to make such a decision much easier.
In this article:
- What Is a Self-Directed IRA?
- IRA Beneficiary Trust and SDIRA Trust
- IRA LLC vs IRA Trust
- When to Choose an IRA Trust over an IRA LLC
IRA Trust vs IRA LLC: When Should You Choose An IRA Trust?
What Is a Self-Directed IRA?
A self-directed IRA, or SDIRA, is an IRA where the account owner makes all the investment decisions for the IRA. An advantage that an SDIRA has over conventional IRAs is they can provide investors more investment options.
Unlike conventional IRAs, SDIRAs can also invest in private market securities, precious metals, cryptocurrencies, and real estate. Given the much wider range of investment options, SDIRAs require higher levels of initiative and due diligence from their owners.
Outside of setting up a self-directed IRA in an individual’s name, two common ways to do so are with IRA Trusts and IRA LLCs.
IRA Beneficiary Trust and SDIRA Trust
There are two types of IRA trusts people get confused with.
IRA Beneficiary Trust
One is an IRA beneficiary trust, which manages the distribution of the IRA’s assets to the beneficiaries of the owner. This type of IRA trust only becomes fully effectual after the owner of the IRA passes away.
It manages the assets of the owner’s IRA post-distribution. This means that the assets it receives have already been distributed from the IRA and that corresponding taxes have already been paid.
Self-Directed IRA (SDIRA) Trust
The other type of IRA trust is called a Self-Directed IRA (SDIRA) Trust. It’s set up to manage an IRA’s assets, like an IRA LLC, instead of distributing them to an IRA owner’s beneficiaries after death.
Under an SDIRA Trust, there are only two parties: the IRA and the Trustee. The IRA is both the grantor and beneficiary of the trust while the IRA owner manages the assets of the IRA as Trustee.
Because the IRA owner is the Trustee, he or she wields complete control over all investment decisions of the SDIRA Trust. Such great control qualifies SDIRA Trusts as “checkbook IRA’s.”
What is a Checkbook IRA? It’s a descriptive term used to describe self-directed IRAs. “Checkbook” refers to how much control owners have over SDIRAs, e.g., the same control they have over their personal checkbooks.
This article will focus on the second type and any mention of “IRA Trust” from this point forward refers to the SDIRA Trust.
IRA LLC vs IRA Trust
When talking about self-directed IRAs, an LLC, or a limited liability company, usually comes to mind. This is because many self-directed IRAs use LLCs to invest in alternative assets like real estate and actual businesses.
An IRA LLC is a limited liability company owned by an IRA, not the IRA owner. Having a distinct legal identity, IRA LLCs can invest in alternative assets under its name.
As mentioned earlier, an IRA Trust shares a common characteristic with an IRA LLC: complete control over an IRA’s assets. It can also invest in alternative assets under its name, such as real estate properties.
Considering how similar they are and how most SDIRAs use LLCs, why consider an IRA Trust over an IRA LLC? Here are some important reasons to choose an IRA Trust over an IRA LLC.
The total cost of putting up and maintaining an IRA LLC can be significantly more expensive than an IRA Trust. While the cost of establishing an IRA Trust can be a bit more than putting up an LLC, its overall costs can be much lower.
An IRA Trust doesn’t have to register with the State and as a result, doesn’t have to pay filing/renewal fees. It only has to pay a one-time establishment fee.
An IRA LLC has to pay an establishment fee and annual fees, both of which vary according to state. Here are the LLC establishment and annual fees for some states:
- California: $70 establishment fee and an $800 annual fees
- Delaware: $90 establishment fee and a $300 annual fee
- Florida: $125 establishment fee and about $140 in annual fees
- Illinois: $500 establishment fee and a $250 annual fee
- Massachusetts: $500 establishment fee and a $500 annual fee
- Maryland: $100 establishment fee and a $300 annual fee
- Tennessee: $300 establishment fee and at least $300 in annual fees
Because IRA Trusts aren’t required to register with the Secretaries of State, they don’t have to pay annual fees.
All states require LLCs to have a registered or statutory agent whose actual mailing address is in the same state. Regardless of whether the agent is an entity or an individual, the agent’s registered address is considered public record.
Owners of the IRAs that own LLCs may act as the IRA LLC’s agent if living in the same state. Otherwise, those owners will have to spend much more money just to hire others to be their LLC’s registered agents.
2. No Reporting Obligations
Another good reason to choose an IRA Trust over an IRA LLC is related to state reportorial requirements. To be more specific, IRA Trusts don’t have to file numerous reports with the Secretary of State.
IRA LLCs, on the other hand, need to comply with various reporting requirements of their state of registration. If they fail to comply with those requirements, they’ll have to pay more by way of penalties.
Related to the previous item, because IRA Trusts don’t have to file reports with the state, they enjoy a greater level of privacy than IRA LLCs.
4. No Registration with Other States Required
The final reason for choosing IRA Trusts over IRA LLCs is because it’s allowed to forgo registering if it intends to transact in another state.
Depending on the state, an IRA LLC from another state may need to register as a foreign entity in a different state if it intends to purchase properties there. IRA Trusts don’t have to deal with this issue.
5. Ease of Setting Up
Investors can have a much easier time setting up an IRA Trust compared to an IRA LLC. Setting up an account with a Trust company to form an IRA Trust doesn’t require a lengthy setup process because investors are not creating a legal entity, e.g., a company.
The entire process from setting up the Trust account to transferring assets or funds into the account may take up to three weeks only. If everything’s in order and the application’s submitted early, it can be as quick as one to two weeks only.
On the other hand, setting up an IRA LLC requires reserving company names, getting government approvals, and long waiting periods. The approval waiting period alone may take up to three months in some states.
When to Choose an IRA Trust over an IRA LLC
Given the monetary and reportorial advantages of IRA Trusts, and that SDIRAs do practically the same things for IRA owners, an IRA Trust will often make more sense than IRA LLCs. However, there are two instances when an LLC may be the more sensible choice than a Trust.
1. Investing in Real Estate
One is investing in properties located in States that don’t look kindly on Trust-owned real estate. In such places, property insurance can be problematic enough to make forgoing the benefits of IRA Trusts by going with an IRA LLC worth it.
2. Leveraged Investments
The other instance when an IRA LLC might be the more sensible choice is when it comes to making leveraged investments. An example of this is buying a property through a non-recourse loan.
Getting approved for financing is usually easier with an LLC structure compared to an IRA Trust. This makes an IRA LLC structure more conducive to leveraged investments than IRA Trusts.
But at the end of the day, it’s the account owner who decides which is the better option. And to make a wise choice, IRA owners should ask themselves two important questions:
- Is the chosen investment strategy more beneficial to using an IRA Trust or an IRA LLC?
- If the answer to the first question is it’s equally beneficial to both structures, do the benefits associated with an IRA Trust dwarf those associated with an IRA LLC?
While most self-directed IRAs use an LLC structure, most IRA owners may benefit more from IRA Trusts over the long run in terms of cost, compliance, and privacy. The only exceptions when investors may benefit more from IRA LLCs are investing in real estate and making leveraged investments, which may be too sophisticated for most regular IRA owners.
Do you think an IRA Trust will be more beneficial for you based on your chosen investment strategy? Let us know in the comments section below.
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