Roth IRAs can be a smart investment decision if you think you’ll be in a higher tax bracket in retirement. Contributions are made with after-tax dollars, and withdrawals are tax-free.
A self-directed Roth IRA provides even more benefits, including the ability to diversify your investment portfolio with alternative assets like real estate and private equity.
If you’re considering a self-directed Roth IRA, here’s what you need to know.
What Is a Self-Directed IRA?
A self-directed IRA is a type of retirement account that gives you more control over your investment decisions. Though it shares many features of a standard IRA, like contribution limits and withdrawal rules, a self-directed IRA lets you invest in a wide range of alternative assets in addition to common ones like stocks, bonds, and mutual funds.
Alternative investment options include real estate, private equity, precious metals, commodities, tax liens, mortgage notes, limited partnerships, and even cryptocurrencies, like Bitcoin and Ethereum.
Difference Between a Traditional and Roth SDIRA
Traditional and Roth SDIRAs both allow you to invest in alternative assets, but there are key differences between the two.
| Traditional SDIRA | Roth SDIRA | |
| Contributions | Made with pre-tax dollars | Made with after-tax dollars |
| Withdrawals | Taxed | Not taxed |
| Deductibility | Contributions are tax-deductible | Contributions are not tax deductible |
| Required minimum distributions (RMDs) | Required annually at age 73 (Previously 72) | Not required |
Benefits of a Roth SDIRA for Investors
Choosing a Roth SDIRA can lead to several benefits, including:
1. Tax-free growth and withdrawals. Contributions and earnings grow tax-free in SDIRA accounts. However, since Roth contributions are made with after-tax dollars, withdrawals are also tax-free. This can be particularly beneficial if you think you’ll be in a higher tax bracket during retirement.
2. Portfolio diversification. Since Roth SDIRAs can hold alternative assets, you can diversify your portfolio and hold common assets alongside alternative assets. Further, many alternative assets have higher earning potential and are less volatile, making it easier to protect your retirement savings from unpredictable or poor markets.
3. No RMDS. Traditional SDIRAs require you to take out a required minimum distribution (RMD) each year after you turn 73. This can have tax implications and stifle your ability to invest and grow your account as you see fit. There are no RMDs for Roth SDIRAs, meaning you can withdraw funds according to your own needs.
4. Estate planning. Assets in a Roth SDIRA can be passed to beneficiaries without immediate tax implications. As such, they can play an important and efficient role in estate planning and the transfer of wealth from one generation to the next.
Roth SDIRA Income Limits
Both Roth and Traditional SDIRA have annual contribution limits, but Roth SDIRAs have an additional layer of limits depending on your modified adjusted gross income (MAGI) and tax filing status. See the table below to find your Roth SDIRA income limits.
| Filing status | MAGI | Contribution limit |
| Single/Heads of household | Less than $146,000 | $7,000 ($8,000 if 50 or older) |
| $146,000 or more but less than $161,000 | Reduced contribution | |
| $161,000 or more | $0 | |
| Married filing jointly | Less than $230,000 | $7,000 ($8,000 if 50 or older) |
| $230,000 or more but less than $240,000 | Reduced contribution | |
| $240,000 or more | $0 | |
| Married filing separately | Less than $10,000 | Reduced Contribution |
| $10,000 or more | $0 |
Roth SDIRA Prohibited Transactions
The IRS sets specific rules about the types of transactions allowed within an SDIRA account. Transactions that break those rules are considered prohibited and can result in penalties. The following transactions are prohibited within a Roth SDIRA.
- Self-dealing transactions, or those that directly benefit you. This includes using your SDIRA account to purchase property you intend to live in, maintain office space in, or otherwise use for personal benefit.
- Transactions with disqualified persons. Disqualified persons include you, the account holder, as well as your spouse, ascendents (parents, grandparents, etc.), descendants (children, grandchildren, etc.) your custodian, and anyone who has a significant interest in the ownership of an asset. For instance, you cannot use IRA funds to invest in your child’s business or allow your parents to vacation in a rental property held by the IRA.
- Prohibited investments. You cannot use your SDIRA to invest in prohibited assets, such as life insurance, antiques, art, gems, stamps, or alcohol.
If you’re unsure if a potential investment may be prohibited, speak with your account custodian or a tax professional who can help you determine if you can proceed without jeopardizing your investment account.
How to Open a Roth SDIRA
1. Choose a custodian. A custodian holds your assets, manages administrative tasks, and ensures your account complies with IRS requirements. Though many financial institutions offer standard IRAs in their suite of products, they don’t always offer self-directed accounts.
Not all custodians are equal. As you look for a Roth SDIRA custodian, make it a point to find out what type of assets they work with, and choose one that has experience with the type of asset you intend to invest in. In addition, all custodians have a fee schedule for SDIRA accounts. Compare those fees to ensure you choose a custodian with the lowest fees for your investment strategy.
2. Open and fund the Roth SDIRA account. Your custodian will help you complete the necessary paperwork to set up and open your account.
Once opened, you can fund your account by rolling funds from an existing retirement account or by transferring money from a savings or checking account. Keep in mind that money transferred from a savings or checking account will count towards your annual contribution limit, whereas funds from a rollover do not.
3. Choose an investment. When your account is funded, you can begin investing in any asset that can be held in the account. It’s important to note that SDIRA custodians do not provide investment advice or vet investment opportunities. As the account holder, you must perform due diligence before investing.
FAQ
Who is eligible to open and contribute to a Roth SDIRA?
Anyone with an earned income can open a Roth SDIRA. To contribute to a Roth SDIRA, your income must fall within the IRS-determined limits based on your tax-filing status and modified adjusted gross income (MAGI)
What are the tax implications of a Roth SDIRA?
Roth SDIRAs offer tax-free growth on contributions and earnings. And, since the account is funded with after-tax dollars, qualified withdrawals are tax-free.
Unlike traditional SDIRAs, Roth SDIRAs do not have required minimum distributions (RMDs) and funds can stay in your account for as long as you wish. If you die while your Roth SDIRA has a balance, that balance can pass tax-free to your beneficiary.
Another important consideration and difference between the two types of accounts is tax deductibility. Roth IRA contributions are not tax-deductible, though traditional IRA contributions are.
