When you consider a Self-Directed IRA, you’re inevitably going to face a choice: should you use a Self-Directed Traditional IRA or a Self-Directed Roth IRA? But we always find that before you make this choice, it’s vital that you understand the key differences. The differences might seem superficial at first, until you realize that the rules governing these two account types are very different. And they can have an enormous impact on the way you strategize to save as much money as possible for retirement.
What will you need to know? Here are a few key lessons that will help you pick whether you need a Traditional IRA or a Self-Directed Roth IRA:
Self-Directed Traditional IRA vs. Self-Directed Roth IRA: Key Differences
The most obvious difference between the two? Taxation on withdrawals. With the Self-Directed Roth IRA, you will put taxable money into the retirement account, which means that you won’t be able to deduct these contributions as you save money for retirement. But the good news is that this money grows tax-free in the account. When you’re ready to withdraw, you won’t have to pay taxes on it; that money already came out in the form of income taxes earlier on.
With the Self-Directed Traditional IRA, you’ll be making contributions that are tax deductible. This is great if you need to save money on your taxes in the short-term, but keep in mind that because the taxes aren’t paid on this money in the short-term, you’ll be expected to pay them when you take withdrawals on your account as you retire. That means that you may be paying taxes on money that’s grown significantly over the years. And though this account does allow for growth within the account, it may end up putting you in higher tax brackets when you eventually do retire. It’s something to keep in mind.
How Do You Know Which Style is For You?
There’s no single answer for whether a Roth or a Self-Directed Traditional IRA is right for you. Many personal finance experts are happy to tout the virtues of the Self-Directed Roth IRA because they know how powerful it is to pay your taxes upfront and allow for growth over the long-term. But your individual choices will vary. There’s nothing wrong with a Self-Directed Traditional IRA. It has plenty of tax benefits. It will save you money in the short term. It will make investing more flexible for you.
For many people, they will end up having more money in retirement than they do currently. For that reason, a Self-Directed Roth IRA can be a major advantage, as it allows for tax-free withdrawals on money that’s already been taxed. But keep in mind that American IRA, as a Self-Directed IRA administration firm, provides information and not specific financial advice for our clients.
Making a Self-Directed IRA Work
Why are these accounts so appealing to people? If you’re self-directing, it helps to know why so many people turn to this highly independent form of investing. One reason: it’s highly flexible. People with Self-Directed IRAs can make investments in lots of nontraditional retirement assets. They can invest in real estate and precious metals. They can invest in tax liens. They can invest in private notes. And this independence allows them to leverage their specific investment experience and knowledge to increase their overall retirement portfolio—all while working within the protections of a Traditional or a Self-Directed Roth IRA.