Many investors are confronted with a choice, at some point: Roth or Traditional? That refers to two types of IRAs. They might sound similar—particularly when it comes to their contribution limits. But the two accounts could not be more different in another respect. The Roth IRA allows an investor to put aside after-tax money to avoid having to pay taxes on the distributions upon retirement. It is essentially front-loading those taxes. The Traditional IRA does not work that way. Which leads to an important question: if this is the case, is there ever a time when a Self-Directed Traditional IRA has advantages over a Roth?
The Self-Directed Traditional IRA and the Self-Directed Roth IRA: Key Differences
The first thing we will need to explore is what delineates the Roth IRA from the Traditional IRA.
- The most important difference is when the tax advantage occurs. With a Traditional IRA, you will incur your tax advantages during the year they are made, because these contributions will be tax-deductible. But then upon retirement, that money in the Traditional IRA will need to be taxed when taken as a distribution. With a Roth IRA, you use after-tax money, or personal funds. Using these funds, you put money aside for retirement, but you do not incur an immediate tax advantage for doing so. The money is simply put in the Roth IRA. It is later, upon retirement, that your tax advantages kick in.
- You may have to check if you are eligible to contribute to a Roth IRA, paying attention to its particular rules. And if you are contributing to a Traditional IRA, you will have to look at how much you are able to deduct from a given year’s taxes. For example, NerdWallet notes that “Traditional IRA deductibility is restricted only if you or your spouse has access to a workplace savings plan like a 401(k).”
These are key differences that can impact your tax year, not to mention the way you approach your retirement strategy in the first place. And since the contribution limits are the same for IRAs, these are probably the most important differences to consider before weighing which account will be best for you.
Choosing Between a Self-Directed Traditional IRA and a Self-Directed Roth IRA
Given that you know these differences, the next step is important: learning how to choose.
You should have a good idea, if you are interested in a Self-Directed IRA, as to how you want to approach your retirement investment strategy. For instance, you may know that you want to invest in a certain type of asset, such as real estate. An investor who invests in real estate may have an idea about whether they want to reduce expenses by using a Traditional IRA and its tax-deductible contributions. Or they may simply want to maximize retirement returns with a Roth IRA. Ultimately, the choice is up to you.
A Self-Directed IRA administration firm like American IRA will not give you specific investment advice. Our job is to be a custodian on the account. But we can inform you about the nature of these accounts. That is why it is so important for you to learn on your own. Do the research. Continue consulting articles like these. Ask questions. As you do, you will not only learn the defining differences between accounts like Traditional IRAs and Roth IRAs, but you’ll get a better sense as to which kind of investment strategy will work best for you.