The Roth IRA is one of the most popular forms of investing there is, and for good reason. The advantage of using after-tax money to allow long-term retirement funds to grow tax-free is a great incentive for many investors. But what about the individual quirks of a Self-Directed Roth IRA? First, let us get one thing clear: A Self-Directed Roth IRA is the same type of account as a Roth IRA—just approached differently. Which means many of the benefits that people talk about with Roth IRAs are just as available to anyone using a Self-Directed Roth IRA approach.
Given that knowledge, let us examine the individual quirks of every Roth IRA, and what investors should most pay attention to:
Quirk #1: No Required Minimum Distributions
Not every quirk has to be a bad thing, after all. In fact, when it comes to the Roth IRA, it is rare that these quirks are bad. Nowhere is that more evident than in the fact that Roth IRAs do not have Required Minimum Distributions. And to understand why this is a good thing, let us explain RMDs.
Because many retirement plans use before-tax money (tax-deductible contributions) for funding the retirement account, the government requires that eventually you do take this money out of the account and pay taxes on it. After all, a retirement fund is not an “escape all taxes” fund. RMDs are how the government applies this: after a certain age, you are required to take funds out of the account and pay the taxes on these funds as distributions.
Roth IRAs do not have these. Why? Because the Self-Directed Roth IRA is funded with after-tax money; the money that is in the account is then already taxed and the government has no need to go in and ask that you pay more taxes on it. That money is yours for retirement, already taxed, and ready to grow. And it can continue to grow even if you reach a certain age.
Quirk #2: Smaller Contribution Limits
Many personal finance gurus extoll the virtues of the Roth IRA. But there is one reason that avid savers do not put all of their money into a Roth IRA every year. The Roth IRA simply cannot hold it all! There are lower contribution limits with Roth IRAs, which means that investors who max out their Roth IRA every year have to turn to other vehicles of investment if they’re going to put more money aside for retirement.
In 2020, for example, the contribution limits on Roth IRAs were at $6,000 for most investors. However, there are catch-up contribution limits of $7,000 for those who are age 50 or older, which is an advantage of using a Self-Directed Roth IRA for investors who are more advanced in age. Keep in mind that the IRS reports that the contribution limits will remain the same for 2021, which is a key point in retirement planning.
Quirk #3: Zero Tax Deductions
Because your Roth IRA uses after-tax money, do not count on any tax deductions when you contribute to them throughout the year. This is by design. While many retirement investors are used to the idea that the money, they set aside may be tax-deductible, the Roth IRA works in reverse. You use money that you have paid an income tax on, and you put that toward the Roth IRA. This means that the government gets its taxes up front, introducing the other advantages mentioned in this post.