For many years, conventional wisdom in retirement investing has promoted stocks, bonds, and mutual funds as the primary elements of a sound investment philosophy. But the stock market decline in December of 2018 reminded investors that no bull market lasts forever. Stock market volatility scares and intimidates many investors, and they are particularly sensitive toward their retirement accounts. Some will sell their stocks and move into “safer” investments, while others abandon all planning for a secure retirement. But there are effective ways to minimize volatility without moving into certificates of deposit. Alternative investments allow retirement savers to diversify into areas that have low correlations to the traditional stock and bond investments. And those who prefer to invest for retirement using a Roth IRA will be able to take advantage of these alternative investments by opening a Self-Directed Roth IRA.
Which investments are acceptable for a Self-Directed Roth IRA?
Some of the most common alternatives include:
- Real estate: You may invest in alternative assets such as single-family and multi-unit homes, apartment buildings, condominiums, land, commercial properties, and more. Keep in mind that if you own real estate within a Self-Directed Roth IRA, you can collect rental income tax-free.
- Private equity: Some of today’s large, successful businesses began as private companies. If you find a private company that’s offering stock options, you can use your Self-Directed IRA (Roth or traditional) to purchase their stocks.
- Tax liens: You may purchase tax liens and start collecting higher-than-normal interest rates.
- Precious metals: If you are looking to diversify your portfolio properly, you can invest in a variety of precious metals that include gold, silver, platinum, and palladium.
- Private lending: When you lend money through your Self-Directed IRA, you negotiate the interest rate and terms with the borrower.
- Ventures and partnerships: These two allow individuals to join forces, spreading both the wealth and the expenses. Joint ventures are typically shorter-term arrangements with a specified time limit, while partnerships are usually for the long term.
Which investments are not allowed in your Self-Directed Roth IRA?
While the list of investments that you may have in your Self-Directed Roth IRA is extensive, there are a few items that are prohibited:
- Life Insurance: It’s hard to justify life insurance for an IRA since it’s a retirement account and has no life to insure.
- Collectibles: Artwork, coins, metals, gems, antiques, and articles of this nature are not allowed because their valuations are difficult to ascertain. IRA rules require regular account values to be reported for tax purposes, so most collectibles are prohibited. Precious metals may qualify as collectibles depending on their purity. Gold must be at least 99.5% pure, silver at least 99.9%, and platinum and palladium at least 99.95% to be IRA-eligible.
- Shares of an S-corporation: S-corporations must follow specific IRS taxation requirements, so the tax-advantaged nature of Roth and Traditional IRAs go counter to those requirements.
The advantages of a Self-Directed Roth IRA over a Traditional IRA
While the contribution limits are the same for both types ($6,000 per year or $7,000 if you are 50 or older), the Roth IRA also has income limits. Unlike the Traditional IRA, the Roth affords no immediate tax breaks on the contributions, but the real benefits for the Roth come when it’s time to withdraw the funds.
After years of contributing to your Self-Directed Roth IRA, along with tax-free dividends and the growth of the value of your account, you may withdraw your funds tax-free. And if you choose to leave the money in your account, you may do that because there are no required minimum distributions (RMD) as there are with a Traditional IRA. Your beneficiaries even have the option of stretching the distributions from your Roth over many years.
You may also withdraw your contributions at any time without taxes or penalties. And if you are at least 59 ½ and have had the Roth for at least five years, the earnings on your contributions may also be withdrawn tax-free.
When you use a Self-Directed Roth IRA to invest in alternative investments, you give yourself an additional level of diversification and more control of your retirement portfolio. These two factors, added to the tax-free advantages, are critical for protecting your funds in an uncertain financial environment.