Even if your cup of financial goals is already running over with short-term needs—a house, new car, student loan debt repayment—you must start building wealth now for a comfortable retirement down the road. Traditional IRAs and your company’s 401(k) are two avenues for getting to your objectives, but they are not the only ones and maybe not even the best.
Some advisors will tell you that a Self-Directed Roth IRA is your best choice if you believe taxes will be higher when you retire. But if you are like most people, you do not have a reliable crystal ball to show you what tax rates will be decades from now.
The simple fact is that a Self-Directed Roth IRA will help you build a tax-free future no matter how high or low tax rates happen to be. The funds you contribute to a Roth IRA today have already been taxed. When you retire and begin to take distributions from your Self-Directed IRA account, all of that money and any growth that accumulated over the years will likely come out tax-free.
Here is what you need to know:
What is a Self-Directed Roth IRA and why is it so popular?
A Roth IRA is a retirement account that, just like a Traditional IRA, urges you to save by offering you a tax benefit. But unlike a Traditional IRA, your contributions to the Roth are not tax-deductible. Instead, your contributions and investment earnings grow tax-free. When you withdraw the money in retirement, there is no tax due. With the Traditional IRA, there is an upfront tax deduction, but all withdrawals are taxed as income.
And along with those tax-free distributions comes another significant benefit: there are no required minimum distributions (RMDs) for Self-Directed Roth IRAs. That means you do not have to start taking your money out of your retirement account at age 70 ½ as you must with a Traditional IRA. You can keep on saving as long as you want.
How can a retirement saver build a secure tax-free future?
For 2019, individuals are allowed to contribute $6,000 per year to a Self-Directed Roth IRA. For those 50 years of age or older, there is a catch-up contribution of $1,000 for a total of $7,000.
Suppose a 25-year-old saver started adding $6,000 to a Roth and continued saving until retirement at the age of 68. Averaging a modest 6 percent annual rate of return over that period, that person will have accumulated over $1,135,000 tax-free dollars.
Are there any catches?
Well, every retirement account has rules, and the penalties for failing to abide by them can be severe. First, there are income limits, and here they are in a nutshell:
- If you are contributing for 2018 and are single, you must have a modified adjusted gross income (MAGI) under $135,000 to contribute anything to a Self-Directed Roth IRA, and full contributions are reduced starting at $120,000. If you are married filing jointly, your MAGI must be less than $199,000, with reductions beginning at $189,000.
- For 2019, the limits are higher. The modified adjusted gross income for singles must be under $137,000; contributions are reduced starting at $122,000. For married filing jointly, the MAGI is less than $203,000, with the phase-out starting at $193,000.
The second rule involves contribution limits:
- For the 2018 tax year, individual contributions are capped at $5,500 ($6,500 for 50 and over).
- In 2019, they increase to $6,000 ($7,000 for 50 and older).
One important caveat: Under no circumstances are you allowed to contribute more than you earned. For example, a person under 50 and filing in 2018 earned $4,500 for the year. Even though the contribution limit is $5,500, this individual would be limited to contributing only the $4,500 in earnings.
Consider a Self-Directed Roth IRA for more investment options
Most of those investing in a Self-Directed Roth IRA are using mutual funds. Mutual funds are fine, but they limit your investment opportunities and leave you at the mercy of a fund manager. You can take control of your investments by switching to a Self-Directed Roth IRA. When you do, the possibilities are significantly expanded.
In addition to stocks and bonds within a mutual fund, you have several alternative investments from which to choose:
- Real estate
- Private stock
- Tax liens
- Precious metals
- Joint ventures and partnerships
Alternative investments combined with a Self-Directed Roth IRA could be the answer to your tax-free (and secure!) retirement.