Roth IRA

Self-Directed Roth IRA

A Roth IRA is one of the most beneficial retirement plans available. This is especially true if you expect your tax bracket during retirement to be equal to or higher than your current bracket. For example, all contributions are made after tax. The earnings—including interest, dividend income, and capital gains—grow tax free. A self-directed plan offers the same benefits. However, these plan owners choose their own assets and use alternative investments to build retirement wealth.

Funding a self-directed account is easy. You can transfer funds and assets from an existing Roth or traditional IRA and/or make an annual contribution. You can also roll over funds from a 401(k) or pension plan.

Self-Directed Roth IRA Features

  • Tax-deferred earnings, which can be distributed tax free (see requirements below)
  • Contributions can be made at any age as long as you have earned income
  • Required minimum distributions (RMDs) are not mandatory
  • Above all, you can invest in real estate, private equity, startups, gold, Bitcoin, and more

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Tax-Free Distributions

Most importantly, perhaps the greatest feature of this plan is that distributions of the contributions are tax free. Additionally, distributions of income generated by this plan are also tax free (and penalty free) as long as you are at least 59 ½ years old and have had the account for at least five years.

However, if you are under the age of 59 ½, there is a 10-percent penalty on most distributions, and the distribution may be included in your income. There are some exceptions to this rule including:

  • The plan is inherited
  • You are disabled
  • You’re a first-time home buyer
  • You pay education expenses for yourself or dependents

Understanding the Roth 5-Year Rule

You must own your Roth IRA for a period of 5 years (as defined by the IRS) before you can take penalty and tax-free distributions of earnings and converted funds in the account. Even though distributions of your contributions are always tax-free, they are not penalty-free if withdrawn inside this five-year period. Additionally, although earnings in the account enjoy tax-free growth, if you withdraw them before you have owned the account for five years you will pay tax on the earnings, plus the penalty. You’re also unable to take tax-free distributions on the earnings until you reach 59 ½ years of age, no matter how long you have owned a Roth account.

Roth Conversions

If you already have an IRA or a 401(k), you can convert part or all of those funds into a Roth IRA regardless of your income. A Roth conversion is a strategy many use to alleviate potential high income tax burdens in retirement. While income in all three accounts grow tax free, traditional IRA and 401(k) contributions are made with pre-tax dollars, and you pay tax on all distributions you take in retirement. Roth IRA contributions are made with post-tax dollars, allowing for true tax-free growth in the account because your distributions in retirement are not taxed.

If you expect to fall into a higher tax bracket in retirement a Roth account may be a good move. One important consideration is that you will pay tax on the dollars you convert from an IRA or 401(k) into a Roth account. That tax is due the year you make the conversion.

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Eligibility to Open a Self-Directed Roth IRA

Anyone with earned income can contribute directly to a Roth IRA. But, your modified adjusted gross income for 2021 must be less than:

  • Married individuals filing jointly: $208,000
  • Single or head of household: $140,000
  • Married, filing separate returns: $10,000

Note: You can move existing Roth IRA funds to a self-directed Roth IRA regardless of your income. You can also perform a Roth conversion of other retirement plan funds to bypass the income limitations. (See below.)

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Contribution Limits of a Self-Directed Roth IRA

Roth IRA 2020 2021
Annual Contribution $6,000 $6,000
Catch-Up Contribution (age 50 and older) $1,000 $1,000