Fulcrum Self-Directed: Better Options for Your Retirment Savings

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Self-Directed Roth IRA

SD Roth IRA ImageSelf-Directed Roth IRAs – Believe it or not, Roth IRAs have been around since 1997.  When passed by Congress under the Taxpayer Relief Act, many thought that more individuals would flock to the Roth IRAs…self-directed or not.  While in many cases, individuals should strongly consider establishing, funding and even converting Traditional pre-tax funds into Roth, after-tax funds, to do so is probably akin to quitting cigarettes.  You see, we get addicted to qualifying for the income tax deduction when making a pre-tax contribution and give less thought to the taxes we will be paying down the road when we take out distributions.

For those willing to bite that tax “bullet”, the Roth IRA, and specifically, the self-directed Roth IRA, provide significant benefits.  Obviously,the largest benefit of establishing a Roth IRA is that if you qualify to make contributions and adhere to the tax-free qualification requirements (for length or time the IRA has been in existence and when you are able to take out distributions) for the Roth, all distributions from the Roth IRA are tax free…both your basis and gains.  Remember, your basis has already been taxes when you either made the Roth contribution or paid taxes on the conversion to Roth.  And, a Roth IRA account owner is not required to take RMDs (Required Minimum Distributions) from the Roth IRA, where a Traditional IRA account owner or beneficiaries will be required to take such RMDs.

Self-Directed or Not, What is a Roth IRA?

Generally speaking, Roth IRAs were established with the same rules governing a Traditional IRA.  Both plans have the same contribution limits, both require the IRA account owner to making contributions based on having earned income.  Further, both plans are required and have the same potential penalties associated with the plan participating in an IRS Prohibited Transaction.   Finally, while not difficult to administer, custodians of both plans are required to report the Fair Market Value (FMV) of the plans to the IRS annually.

How do Roth IRAs Differ from Traditional IRAs?

Most people initially believe that the only difference between the Traditional IRA and the Roth IRA is that: 1) contributions to the Traditional IRA are income tax deductible where the Roth contributions are not, and 2) the IRA account owner is taxed on Traditional IRA distributions where the Roth IRA account owner is not taxed on distributions.  While this is generally true, there is a bit more information that the Roth IRA account owner must keep in mind.

Yes, Roth contributions are not deductible; however, if the plan is operated in compliance with certain plan requirements, all distributions from the Roth, including any gains, profits, earnings, etc. from the plan’s investments will be tax-free.  Also, the Roth IRA account owner should keep in mind that:

1)  Since contributions are made on an after tax basis, the Roth IRA account owner is not permitted  to file an income tax deduction for the contribution.  In contrast, the Traditional IRA account owner can take this deduction.  But, and it is an important but, is the Roth IRA account owner meets all requirements, all distributions from the plan will be tax-free.

2) As noted, provided the Roth IRA account owner complies with the requirements for this IRA, all gains, earnings, profits, etc. will accrue tax-deferred and be distributed tax-free to the account owner.

3)  Speaking of these requirements, the Roth IRA owner has two.  The first being is that  the Roth IRA has been established for a period of no less than 5 years.  Secondly, in addition to the 5-year requirements, the Roth IRA account owner is greater than 59 1/2 when they take distributions from the plan.

As you can see, there is power associated with the Roth IRA.  The key consideration is whether the IRA account owner can tolerate the hefty tax bill associated with either making the Roth contribution OR more so with a Roth conversion of pre-tax funds.  Of course, this is not a decision to be taken lightly, and an individual should consult with their tax professional about the pros and cons about either establishing a Roth IRA and making after-tax contributions or paying the tax associated with a Roth conversion.  But, what is not at question is the Roth’s ability and power to generated investment gains and never pay taxes on those gains when the account owner takes distributions from the IRA.

 

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About John Park

John

As co-founder of Fulcrum Self-Directed, John Park believes in the power of self-directed plans tempered by the individual responsibility to operate the plan in compliance with IRS and DOL regulations. As such, Fulcrum Self-Directed is in a unique position to assist a client in establishing an IRS compliance self-directed plan, while guiding clients with their responsibility to operate and administer their plan.

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