What Is A Self Directed Roth IRA? (And Why You Need One)

Could a traditional Roth IRA provide a million dollar retirement nest egg?

It is doing just that for some people.

Take, for instance, former presidential candidate Mitt Romney. His IRA is reportedly worth $100 million. Moreover, the 2011 data from the U.S Government Accountability Office reveals that around 791 individuals have IRA balances between $10 million to $25 million.

Wondering how people are making so much money on their individual retirement account?

In this article, we will cover how a self directed Roth IRA can be an avenue for accomplishing that.

Here’s what we will cover in this article

  • What is a Self Directed Roth IRA?
  • How is a Self Directed Roth IRA Different From a Roth IRA?
  • Self Directed Roth IRA Rules
  • Benefits of Investing in Self Directed Roth IRA vs Traditional IRA
  • Precautions When Investing In Self-Directed Roth IRAs
  • How To Start Investing

What is a Self Directed Roth IRA?

A self directed Roth IRA gives you the ability to invest in non-traditional, alternative assets like real estate, mutual funds, and precious metals.  

Generally, brokerage firms and financial institutions only offer traditional types of investment options such as bonds, stocks and mutual funds for IRA investments. Therefore, many investors are unaware of the high-earning potential of an investment in a self directed retirement account.     

What’s more?

As with any Roth IRA, you as the account owner can build your retirement account while still enjoying the usual tax benefits.

How is a Self Directed Roth IRA Different From a Roth IRA?

A self directed Roth IRA is technically not too different from your traditional Roth individual retirement account. The same income limits and annual contribution limits apply.

The only difference is it just gives you complete control over your retirement plan.

You call the shots here - not the brokerage firms. This control allows you to diversify your portfolio through long-term investments in privately held small businesses or real estate investing that can multiply during your working years.

Self Directed Roth IRA Rules

The IRA rules governing self-directed Roth IRAs don’t differ from those covering traditional Roth IRA rules.

To qualify for a Roth IRA your adjusted gross income limits are:

  • Income less than $137,000 annually for single filers.
  • Income less than $203,00 annually for married couples applying jointly.

The maximum annual contribution limits for a Roth IRA are:

  • $6000 annually for people aged below 50.
  • $7000 annually for those above 50.

(These IRA rules for contribution and income limits correspond to the 2019 tax year guidelines.)

Benefits of Investing in Self Directed Roth IRA vs Traditional IRA

Investing in a self directed Roth IRA gives you tons of benefits over a traditional IRA investment.

#1: Invest in Alternative Assets

A self-directed Roth IRA allows you to invest not only in traditional assets, such as stocks and exchange-traded funds, but also in alternative assets, such as real estate, startups, and tax liens.

Most brokerages and custodians who deal in traditional IRA instruments don’t allow investments in alternative assets - assets that are not publicly-traded and therefore illiquid.  

#2: Make Tax Free Withdrawal

There is no income tax break for self directed Roth IRA contributions. However, all withdrawals and earnings are tax free. Traditional IRAs allow you make tax-deductible contributions but you have to pay taxes at the usual tax rate on all earnings and withdrawals

As withdrawal amounts from a retirement plan are larger than contributions, IRA investors pay more taxes with traditional IRA funds than with Roth IRA investments.

#3: No Mandatory Withdrawal

Self-directed Roth IRAs do not have any required minimum distributions or RMDs until the account owner dies (Required minimum distributions are the minimum amount of money you must mandatorily withdraw from your IRA account even if you don’t need the money and have other sources of income).

For traditional IRA holders required minimum distributions kick in at the age of 70 ½ years even if you have other income.

Precautions When Investing In Self-Directed Roth IRAs

While self-directed Roth IRAs are an appealing option, there are a few things you need to keep in mind.

#1: Know What You Cannot Invest In

There are certain prohibited transactions when it comes to the kind of assets that a self-directed Roth individual retirement account can invest in.

  • Real estate investing with your retirement account is one of the prohibited transactions if you or any disqualified party resides in, plans to reside in or use it in any way.
  • You cannot purchase private equity shares in your own business or that of a disqualified party (mentioned below) with your retirement fund.
  • You cannot lend money or assets to yourself or a disqualified party from your retirement fund.

A disqualified party can be:

  • Parents
  • Spouse
  • Children/Adopted Children and their Spouses
  • Grandparents
  • A CPA or Attorney who provides services to the plan
  • A financial advisor providing investment advice for a fee
  • Anyone exercising control over your assets and their distributions

The IRS also prohibits you from investing in life insurance contracts, collectibles (like artwork, antiques, gems, stamps, etc.) and S Corporations. For a deeper understanding of prohibited transactions by the IRS, click here.

To be safe, always discuss with a specialized financial advisor before purchasing any alternative investment options for your retirement plans.

#2: Choose Your IRA Custodian Carefully

Most traditional financial institutions aren’t well versed with the intricacies of a self-directed Roth IRA account.

They specialize only in exchange-traded funds, mutual funds and stocks. Given the complexities that surround alternative investment options, it makes sense to engage a custodian that specializes in this field.

If you’re looking to invest money in a self-directed Roth IRA account, Alto could be a good online solution.

How To Start Investing

With Alto, you can easily invest in startups, real estate and loans from our partners like Angelist, Wefunder and Yieldstreet. We also let you invest directly with private placements who aren’t part of our partner websites.

Set up takes no time and is completely online. There’s no commission or hidden transaction fees. All it takes is a low annual fee for maintenance.

With Alto, investing your retirement savings in alternative investment options has never been this transparent, easy and affordable.

To know more about how you can invest through Alto, get started here.

Start diversifying your retirement portfolio today.

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