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

Self-Directed Roth IRA
Self-directed Roth IRAs have enabled investors like Peter Thiel to amass fortunes tax-free. Could a self-directed Roth IRA help you maximize your investments?

Originally published February 17, 2021

Roth IRAs are an attractive investment option for many investors, offering tax-free gains and distributions. Though intended to help the middle class invest for the future, the tax advantages of Roth IRAs, paired with the investment options self-directed IRAs provide, have enabled billionaires like Peter Thiel to amass fortunes tax-free.

While lawmakers are making an effort to curb the use of “mega IRA accounts,” the number of IRA millionaires is growing. In fact, a study from 2021 showed that the number of IRA accounts with balances of at least $1 million grew 64% in a year. 

Of course, the market has changed since then, but it still raises the question: Could an IRA investment provide a million-dollar retirement nest egg? In this article, we’ll cover how a self-directed Roth IRA can be an avenue for accomplishing just that. We’ll also cover:

It’s important to note that a self-directed Roth IRA retirement plan may not be the best option for everyone.

There are several key factors to keep in mind before investing with a self-directed IRA, including the contribution limits, what assets you can invest in, and the investment risks. This post will explore those points in more detail.

What Is a Self-Directed Roth IRA?

A self-directed Roth IRA is technically not too different from a conventional Roth IRA. The same income limits and annual Roth IRA contribution limits apply.

The only difference is that a self-directed Roth IRA gives you control over your IRA funds and investment selections. Most brokerages and custodians offering conventional IRA instruments don’t allow investments in alternative assets—assets that are not publicly traded and therefore often illiquid. 

A self-directed Roth IRA allows you to invest in alternative assets that offer the potential for outsized returns, such as real estate, startups, cryptocurrency, farmland, and crowdfunding offerings. You call the shots with this IRA investment—not the brokerage firms. 

This control allows you to diversify your retirement portfolio through long-term alternative investments beyond what you would be able to do with a conventional Roth IRA.

Benefits of Investing in a Self-Directed Roth IRA vs. a Self-Directed Traditional IRA

Both self-directed Roth and traditional IRAs allow investors to control their funds and investment selections. However, their tax benefits vary.

A self-directed traditional IRA is a tax-deferred retirement account, meaning investors can often contribute more upfront and potentially qualify for a tax deduction when they file their taxes. However, they will be required to pay taxes once they go to take their distributions at retirement.

A self-directed Roth IRA is a tax-free retirement account, meaning investors pay taxes on their investments upfront but distributions will be completely tax-free once they take distributions at retirement (assuming they wait until they’re 59-½ years old and have held their Roth IRA for at least five years).

While the tax-free nature of a Roth IRA is an obvious benefit, there’s another reason why Roth IRAs are often the more attractive investment option: No mandatory withdrawals.

Roth IRAs do not have any required minimum distributions (RMDs) until the death of the account owner. 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, required minimum distributions kick in at the age of 72 even if you have other income.

Read more: Traditional vs. Roth IRAs: Which Is Better?

Self-Directed Roth IRA Rules

The rules governing Roth IRA contributions are the same as for conventional Roth IRAs. However, there are specific rules about what you can invest in using a self-directed IRA.

Roth IRA Income Limits

In order to qualify to contribute to a Roth IRA, the following income limits apply for the 2022 and 2023 tax years:

Roth IRA Income Limits

Filing Status 2022 Modified Adjusted Gross Income (MAGI) 2023 Modified Adjusted Gross Income (MAGI) Contribution
Single, head of household, or married filing separately and you did not live with your spouse at any time during the year Less than $129,000 Less than $138,000 Up to the limit
$129,000 or more but less than $144,000 $138,000 or more but less than $153,000 A reduced amount
$144,000 or more $153,000 or more Zero
Married filing jointly or qualifying widow(er) Less than $204,000 Less than $218,000 Up to the limit
$204,000 or more but less than $214,000 $218,000 or more but less than $228,000 A reduced amount
$214,000 or more $228,000 or more Zero
Married filing separately and you lived with your spouse at any time during the year Less than $10,000 Less than $10,000 A reduced amount
$10,000 or more $10,000 or more Zero

Can I Invest in a Roth IRA If I’m Over the Income Limit?

While Roth IRAs do have income limits, backdoor Roth IRA conversions enable investors who have surpassed the Roth IRA income limit to transfer funds from a tax-deferred retirement account like a traditional 401(k) or IRA to a tax-free Roth IRA.

This usually involves paying a one-time tax on the converted amount. Because the transfer is considered income on that year’s taxes, some investors complete a series of backdoor Roth conversions over several years to ensure the additional income doesn’t push them into a higher tax bracket.

Read more: What Is a Backdoor Roth IRA?

Roth IRA Contribution Limits

According to the IRS, the maximum annual total contribution limits in 2022 are:

  • $6,000 annually for people under 50
  • $7,000 annually for those 50 and older

For 2023, the IRS increased the limits to account for soaring inflation: 

  • $6,500 annually for people under 50
  • $7,500 annually for those 50 and older

Prohibited Transactions in a Self-Directed IRA

There are certain prohibited transactions and disallowed investments unavailable to a self-directed IRA. Namely, you cannot use your IRA to:

  • Invest in real estate if you or any disqualified party resides in, plans to reside in, or uses the property in any way.
  • Purchase private equity shares in your own business or that of a disqualified party (mentioned below).
  • Lend money or assets to yourself or a disqualified party.
  • Invest in life insurance contracts, collectibles (like artwork, antiques, gems, stamps, etc.), non-commodity grade precious metals, and S Corporations. (Note that this does not apply to securitized collectibles.)

For a deeper understanding of prohibited transactions by the IRS, visit their site.

A disqualified party includes:

  • Parents
  • Spouse
  • Children/adopted children and their spouses
  • Grandparents
  • A CPA, attorney, or fiduciary 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

To be safe, always discuss with a financial advisor before investing in alternative assets using your retirement plans. Or, you can use your Alto IRA to invest in alternatives through one of our investment partners

Where Can You Invest in a Self-Directed Roth IRA?

Most conventional 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—like Alto. 

Alto is on a mission to democratize alternative investing. While these types of investments have often been reserved for the ultra-wealthy, everyday investors can now access the same portfolio diversification benefits on a smaller scale thanks to fractionalized ownership. E.g., you don’t have to buy a whole house to invest in real estate. 

Alto offers two different self-directed IRAs, both of which are available as Roth, traditional, or SEP IRAs:

  • Alto IRA lets you invest in real estate, farmland, startups, and more through our investment platform partners.
  • Alto CryptoIRA® enables you to buy and sell up to 200+ crypto assets through Coinbase integration. 

Open an account to get started.