If you have ever done a little bit of retirement research, chances are that you have heard of Self-Directed Roth IRAs and Traditional IRAs. And while the two might sound similar (after all, they have similar contribution limits), they are actually quite different. But what are those differences, and how do they apply to Self-Directed Roth IRAs and Self-Directed Traditional IRAs? We have put together a list of key insights in the form of answers to some of the most frequently asked questions (FAQs) about these two account types.
Question: What is the key difference between a Traditional and Roth IRA?
Answer: There are a few differences, but if you want to know the key difference that separates the Roth IRA from just about all IRAs—not just Traditional IRAs—it is that the Roth IRA allows you to save after-tax money. That means that the money you put in Self-Directed Roth IRAs should come from income you earn and income that is already taxed via the income tax. With the money put away in a Roth, you can then let the money grow tax-free in the account, provided that you pay attention to key rules like contribution limits and the age milestones associated with the account.
With a Traditional IRA, you would be using before-tax money for the contribution, which means that contributions you make are tax-deductible. While this does give you an immediate incentive for putting away money in the short term, it also means that you will have to pay income taxes on the money when you retrieve it, even after hitting retirement age.
Question: Should I get a Roth IRA or a Traditional IRA?
Answer: The Traditional IRA is the older style of account, and many people have moved to using Self-Directed Roth IRAs for its after-tax benefits. However, we cannot tell you which one you should use. That is a question for a tax professional, or maybe even simply your own research. If you use a Self-Directed Roth IRA with a Self-Directed IRA administration firm like American IRA, we will not offer you specific investment advice. What we will do is offer administration on the account to help resolve paperwork and other administrative issues associated with directing your own account.
Question: Can I have both a Roth IRA and a Traditional IRA?
Answer: The answer is yes; you can hold both. However, this is not a fancy way of getting out of the contribution limits of these accounts, as the IRS will still restrict you to contributing a certain amount towards all of your IRA accounts. For example, you could not double up on the contribution limits by holding a Self-Directed Roth IRA as well as a Self-Directed Traditional IRA. For this reason, many people choose one or the other. It’s also a way investors help keep their overall investment portfolios simpler.
Question: Are there Required Minimum Distributions on Self-Directed Roth IRAs?
Answer: One advantage of after-tax investing is that since the government already got its tax money, it does not mind if you keep the investments within the account without taking distributions upon retirement age. That means that you may not even retire as you enter retirement age, but instead may allow the money in the account to continue to build. This can be a powerful way for investors to add up even more money, especially if they want that money to spend more time collecting on compounding returns.