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Whether you already have a substantial 401k account or you're about to qualify for your employer's 401k program, you might be considering using your account for gold investments. If you are considering this possibility, there are several factors to understand before you can make your decision. For example, will you invest in physical gold or would you prefer to invest in gold securities? As you read the following overview, you'll be able to determine how you really want to use your retirement funds to invest in gold.
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A Basic Understanding of 401k Accounts
401k programs get their name because they are authorized in Section 401k, which was added to the Internal Revenue Code in 1978. There are specific benefits to maintaining a 401k account in terms of tax relief on contributions and withdrawals. While the majority of 401k programs are offered as a part of a comprehensive employment benefits package, you no longer have to maintain a traditional job to keep a 401k account. Newer changes to the regulations under Section 401k make it possible for small business owners and self-employed individuals to maintain their own accounts.
A benchmark of 401k accounts is that they must be managed by an independent trustee, and the trustee is required to act in the best interests of the 401k account holder. The trustee uses an accounting firm to serve as a record keeper to ensure the integrity of each account. Typically, a financial institution, such as a bank, brokerage firm, or mutual fund manager, serves as the trustee.
In executing their duties, the trustee takes on the responsibility for making investing decisions. Since they have a fiduciary duty to the account holder, they usually make conservative investments with moderate risk. They must also adhere to legal restrictions on how funds are invested in the 401k account.
This process is slightly different when it comes to managing a self-directed 401k investment account. In this type of account, the account holder can make investment decisions. However, the trustee can still veto the account holder's suggestions if they feel the risk is too high. The trustee's first priority is to comply with their fiduciary responsibility.
What Are the 3 Types of 401k Accounts?
Years ago, only one type of 401k was available to individuals seeking to invest their retirement savings. Today, there are more options, and you can choose between three different types of 401k accounts.
Traditional 401k Accounts
In this type of employer-sponsored 401k account, the employer matches the employee's contribution up to a predetermined percentage. Neither the employer's matching contributions nor the account holder's contributions are taxed. The employee's contributions are withdrawn from their pay prior to tax withholdings.
Any earnings that the account holder amasses through their investments also remain untaxed. Income tax only applies when the funds are withdrawn at the age of retirement. Alternatively, closing your plan or withdrawing before the age of retirement will subject you to income taxes on the funds. You may also face penalties for early withdrawal.
Roth 401k Accounts
A Roth 401k account deals with taxes differently, and this type of investment may be preferable depending on how you expect to grow the majority of your retirement wealth. Rather than paying taxes on the withdrawal of your 401k funds, your initial contributions are taxed. This means any capital gains you earn through investments are never taxed.
Self-Employed 401k Accounts
This type of retirement account functions like a traditional 401k in most respects. Any contributions you make will remain tax-deductible until you begin withdrawing the funds. This type of account differs in the limits of annual contributions. Since you won't have an employer matching your contributions, you can make more contributions each year to compensate for the difference.
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How Are 401k Contributions Limited?
Since you're not responsible for paying taxes on contributions made by your employer and your own contributions are also tax-free, the IRS restricts how much you can contribute each year. For the 2022 tax year, an individual could contribute up to $20,500. That limitation may rise in future years in accordance with cost of living increases.
If you have a self-employed 401k account, you can contribute up to $20,500 as the employee. Since you also act as the employer for these purposes, you can contribute up to an additional 25% of your net income as a self-employed individual. You must identify those contributions as compensation paid to the employee by the employer, making it important to maintain meticulous records.
For example, suppose you earn an annual net income of $100,000 as a self-employed individual. In addition to the $20,500 you can contribute, you can also add an extra $25,000 or 25% of $100,000. This comes to a total of $45,500 that you can contribute to your 401k for 2022.
If you're over 50 years of age, the IRS allows you to make an additional catch-up contribution. For 2022, that amount is $6,500.
Are There Restrictions on 401k Investments?
There are limitations on the types of investments that can be made with funds in a 401k account. These restrictions are in place to protect against high-risk ventures that could adversely affect the income tax-subsidized funds in the accounts.
In a traditional 401k account, the fund manager must make investment choices that comply with these restrictions. While a self-directed 401k account provides a little more leeway, the fund manager still can't let the account holder make investment choices that would compromise their fiduciary responsibility.
Even considering these restrictions, there are plenty of options for investing your 401k funds. It's common for the 401k manager to invest in mutual funds that focus on a specific category or industry. Traditionally, you may be able to use your 401k funds to invest in individual stocks, bonds, securities, or money market accounts. There are also a few different ways to use your retirement savings to invest in real estate.
When it comes to investing in precious metals, such as gold or silver, a traditional 401k account cannot hold onto physical metals. Instead, "paper gold" investments allow you to indirectly invest in gold or other precious metals. This simply means that your 401k manager will invest your money in mutual funds that focus on precious metals.
6 Reasons to Consider Investing in Gold
While there are many options when it comes to investing your 401k funds, investing in gold provides some unique advantages.
Gold Holds its Value
Paper money was traditionally backed by gold because it's a precious metal that doesn't lose value. This makes it great as a long-term investment tool.
Gold is Stronger Than U.S. Currency
While the U.S. dollar is strong in terms of its buying power, it does experience devaluation from time to time. It was at its lowest in 1998 and 2008. During those same periods, gold actually increased in value and nearly doubled its worth.
Other types of investments can be negatively impacted by inflation since these periods devalue currency. However, the value of gold increases during these same periods, giving gold investors better financial security.
Protect Against Deflation
In a recession, people spend less money and hoard more cash. Often, that cash is used to buy more gold for security, and that will drive up the value of gold in these economic downturns.
Guard Against Unstable Political Situations
When there's a change in the political structure of any government, the world economy will be shaken. This type of destabilization results in panic among investors, business owners, and consumers. Investing in gold will help you secure your finances until geopolitical situations stabilize.
Fight Supply Chain Issues
When the supply of gold diminishes, the value of your gold holdings will rise. This can happen if banks stop selling bullion or if the mining of gold is impeded.
How to Use Your 401k to Invest in Gold
The restrictions on the types of investments permitted in a 401k account prevent you from directly investing in physical gold. However, that doesn't mean you can't invest in gold indirectly. There are three ways of using your 401k account to invest in gold after retirement.
Gold Mutual Funds
These are mutual funds that solely invest in companies that explore, mine, and process gold. While the mutual fund may invest in a small amount of physical gold, the majority of investments are used to fund the companies that perform these roles.
Gold Exchange-Traded Funds
If your 401k program works with a brokerage firm, you may be able to invest in gold exchange-traded funds or ETFs. This allows you to hold stock shares in companies that do possess gold or silver bullion.
Self-Directed IRS Rollover
If you have a self-directed 401k account, you can roll your funds over into a gold IRA. This option will allow you to directly invest in gold bullion.
What is a Gold IRA?
Once you roll your 401k savings over into a gold IRA account, you can directly invest in gold bullion. This is a specific type of self-directed IRA account that allows you to invest in gold and other precious metals. With this type of account, you can invest in gold bullion as well as investing in mutual funds, ETFs, and stocks.
When it comes to investing in physical gold, there are some qualifications you must meet. You can invest in gold, silver, palladium, or platinum, but you must only purchase bars and coins that are approved by the IRS. This ensures your precious metals meet basic requirements for purity and fineness.
If you invest in gold bars, each bar must have a 99.5% purity value. In dealing with gold coins, the IRS restricts these investments by the issuing institution. The most commonly accepted issuers are American Buffalo, American Gold Eagle, Australian Gold Nugget/Kangaroo, and Canadian Maple Leaf.
The IRS will not allow you to invest in gold collectibles with your gold IRA funds. Similarly, some issuers of gold coins have been disqualified from gold IRA participation. These issuers include South African Krugerrand and United Kingdom Sovereign.
IRA Storage Requirements for Precious Metals
When it comes to physical gold holdings, you cannot directly possess the gold. Instead, your gold IRA manager must use a qualified custodian to store the gold in a secure facility. Facilities qualified to hold IRA gold by the IRS include banks, credit unions, and savings and loan institutions.
Using a "checkbook" IRA can put you in a precarious position with the IRS. That's because this type of IRA allows the manager to use a third-party gold holding company. While this does outwardly meet the IRS requirements for the storage of gold bullion, the third-party holding company is often owned by the IRA under an LLC. The LLC buys and stores the gold, but this distinction may not be enough to meet IRS requirements.
At this time, neither the IRS nor the courts have objected to the validity of these types of checkbook IRA accounts. However, that could change in the future. If there is a change, your investments could be at risk. It's safer to stick with a traditional gold IRA where you know your investments will be safe.
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What Fees Apply to Gold IRA Accounts?
Since the IRS makes exceptions for gold IRA accounts, it makes sense that they apply special fees to these accounts. Learning about these fees can help you determine if gold investing will be worthwhile for you.
These are additional fees that are set by the vendor, which means the fees can vary greatly depending on where you buy the gold bullion or coins. These are one-time fees, but you should ask about them in advance.
IRA Setup Fees
Just as you would pay a setup fee with a traditional IRA, you should also expect to pay this type of fee with setting up a gold IRA. Since this type of IRA involves the physical holding of gold bullion and coins, you should expect the setup fee to be higher.
Holding gold bullion and coins in a physical facility requires meeting special considerations. Since the IRS-approved custodian must provide additional services, you should expect to pay higher fees for the maintenance of your investments.
The custodian must meet special conditions in storing physical gold. This includes maintaining a favorable environment for the preservation of gold and ensuring the security of the gold. Providing these services could include anything from maintaining an efficient HVAC system to installing electronic security equipment. The costs for these services will be passed onto you since absorbing these costs could adversely affect the custodian.
If you decide to close out your gold IRA account, you'll need to sell your gold bullion and coins. You should expect to take a loss when compared to the gold's actual value. It won't make much sense to buy gold at the current value since the buyer will be expecting to make a profit with the gold. Whether you sell to an institution or an individual, expect to sell your gold below the market value.