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

Are you wondering how people are making so much money on their individual retirement account? Find out how a self-directed Roth IRA could help
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Could an IRA investment 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.

Are you 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

A self-directed Roth IRA retirement plan may not be the best option for everyone.

There are several important factors to keep in mind before you begin investing with a self-directed IRA. Investors like yourself need to know about the contribution limits, what assets you can invest in, and investment risks. This post will explore those points more in detail.

What is a self-directed Roth IRA?

A self-directed Roth IRA (a type of self-directed IRA) gives you the ability to invest in non-traditional, alternative assets like private company securities, cryptocurrency, real estate, and precious metals.

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

With a self-directed Roth IRA, as with any Roth IRA, you as the account owner can build your retirement account without any taxes on your investment gains.

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 Roth IRA contribution limits apply.

The only difference is that a self-directed Roth IRA just gives you complete control over your IRA funds and investment selections.

You call the shots with this IRA investmentnot the brokerage firms. This control allows you to diversify your retirement portfolio through long-term alternative 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 contribution 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.

What are the contribution limits for a self-directed Roth IRA?

According to the IRS, the maximum annual total contribution limits in 2021 are:

  • $6,000 annually for people aged below 50.
  • $7,000 annually for those above 50.

These guidelines in 2021 are the same as in 2020 and 2019.

Benefits of investing in a self-directed Roth IRA vs. traditional IRA

Investing in a self-directed Roth IRA gives you tons of investment options over traditional investments such as in mutual funds or stocks.

1. Invest in alternative assets

A self-directed Roth IRA allows you to not only invest in traditional investments, such as stocks and exchange-traded funds but also in alternative assets, such as real estate, startups, cryptocurrency, and crowdfunding offerings. Your investment options are expanded with a self-directed Roth IRA. 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 withdrawals

There is no income tax deduction for initial contributions to a self-directed Roth IRA. However, all withdrawals and earnings in your IRA account are tax-free. Traditional IRAs allow you to make tax-deductible contributions but you have to pay taxes at the applicable income tax rate on all earnings at the time of withdrawal. As withdrawal amounts from a retirement account typically are larger than contributions, IRA investors pay more taxes with traditional IRA funds than with Roth IRA investments.

3. No mandatory withdrawals

Self-directed Roth IRAs do not have any required minimum distributions (RMDs) until the account owner dies. Required minimum distributions are the minimum amount of money you must mandatorily withdraw from your IRA account once you reach a certain age, even if you don’t need the money and have other sources of income. For traditional IRA holders, the required minimum distributions kick in at the age of 72 (starting in 2020) 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 the property 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 IRA assets and their distributions

The IRS also prohibits an IRA holder 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 to the IRS.

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 in the intricacies of a self-directed Roth IRA account.

Traditional investments include exchange-traded funds, mutual funds and publicly traded stocks routinely held by brokerage firms and banks. These companies often refuse to custody alternative investments held in self-directed Roth IRAs. Given the complexities that surround alternative investment options, it makes sense to engage an IRA 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.

Where can you invest in a self-directed Roth IRA?

With Alto, you can easily invest in startups, real estate and loans, including through our platform partners like AngelList and EquityZen as part of your retirement plan.

Alto also lets you invest your IRA account directly in private placements that 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 of your retirement account and a flat per-investment fee.

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.

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