What Is a Self-Directed Roth IRA?

A self-directed Roth IRA provides savers with various tax advantages, with the most notable being the opportunity to make withdrawals in retirement that are 100% exempt from taxes. Typically, the options for investments within an IRA are dictated by the holding company. Nevertheless, a self-directed Roth IRA grants individuals more flexibility in selecting investments to diversify their portfolio.

Before getting started, it is important to note that investing in a self-directed Roth IRA may not be suitable for everyone. There are certain key considerations that investors should be aware of, such as the contribution limits and eligibility criteria for self-directed Roth IRAs, as well as the permissible investment options and governing regulations. If you are unsure about whether a self-directed Roth IRA is the right choice for you, it may be wise to seek guidance from a financial advisor.

The Basics of a Self-Directed Roth IRA

A self-directed Roth IRA grants individuals the authority to dictate the investment of their money within an individual retirement account. These accounts are provided by brokerages, similar to other types of IRAs. You have the autonomy to select the brokerage that will act as the custodian for your account. Upon meeting the minimum initial deposit, if necessary, you possess the freedom to determine the investment strategies for your funds. Consequently, the designated custodial brokerage is prohibited from offering any investment guidance, allowing for complete self-direction of your account.

Self-directed Roth IRA accounts possess the same attributes as typical Roth IRAs in terms of annual contribution limits and taxation on withdrawals. However, the distinction lies in the fact that self-directed IRAs offer the flexibility to significantly enhance portfolio diversification by including alternative investments such as real estate, commodities, limited partnerships, and various other asset classes.

Key aspects of a self-directed Roth IRA that hold utmost significance are:

An annual contribution limit of $6,000 for 2021 and 2022 ($7,000 if you’re 50 or older), or your taxable compensation if your income for the year was less than this limit
Contributions that are not tax-deductible
Qualified withdrawals that are 100% tax-free
Contributions that can be withdrawn at any time, with no tax penalty
No minimum distributions required at age 72

A Roth IRA may offer more benefits to individuals who anticipate being in a higher tax bracket during their retirement compared to a self-directed traditional IRA. Withdrawals made at age 59 1/2 or later are not subject to any taxes, and there is no specific age requirement for initiating withdrawals from the account. While you won’t receive a tax deduction for your contributions as you would with a traditional self-directed IRA, this aspect may be less significant if you are contributing during years when your income is lower.

Who Can Contribute to a Self-Directed Roth IRA?

In regard to income, the IRS establishes regulations regarding eligibility for contributing to a Roth IRA, which also apply to self-directed Roth IRAs. If your income meets the criteria, you are allowed to make a contribution up to the entire annual limit for the year 2021.

You’re a single filer or head of household with a modified adjusted gross income (MAGI) of less than $125,000
You’re a married couple filing jointly or qualifying widower with an MAGI of less than $198,000

In 2022, you are able to contribute up to the complete annual limit if:

You’re a single filer or head of household with a modified adjusted gross income (MAGI) of less than $129,000
You’re a married couple filing jointly or qualifying widower with an MAGI of less than $204,000

If the MAGI of married couples filing separate returns is below $10,000 for either 2021 or 2022, they are allowed to make a partial contribution to a Roth IRA. Once the income for the year exceeds a certain limit, contributions for all filing statuses are gradually reduced. Instead of focusing on eligibility, the more important consideration for those eligible to contribute to a self-directed Roth IRA based on their income is whether they should contribute at all.

The suitability of a self-directed IRA as an account may not be ideal for every individual, as stated by Scott Butler, a financial planner at Klauenberg Retirement Solutions located in Laurel, Maryland.

Butler says that this is not a recommendation that he would give to the average or casual investor. He advises that with a self-directed IRA, there are numerous possibilities for making mistakes and falling into tax traps.

If you have a good understanding of the exclusive tax regulations pertaining to self-directed Roth accounts, it can aid in assessing if this strategy is suitable for your investments.

Self-Directed Roth IRA Tax Guidelines

To invest in a self-directed Roth IRA, it is crucial to be aware of two distinct regulations. The primary rule pertains to disqualified individuals, whereas the second rule addresses prohibited transactions. These regulations have been implemented to safeguard against any potential misuse of self-directed accounts and the associated tax benefits.

What are disqualified persons and prohibited transactions?

The disqualified person rule states that specific individuals are prohibited from participating in prohibited transactions, which refer to any improper utilization of your IRA by either yourself or another disqualified person.

Transactions that are not allowed include:

Lending money or extending credit
Furnishing goods, services or facilities
Selling, exchanging or leasing property
Using or transferring income from the plan to a disqualified person
Any act of a fiduciary dealing with your IRA money or assets in their own interest
Any receipt of consideration by a fiduciary to their own account from anyone dealing with the IRA and its money or assets

Someone who has been ruled out or deemed ineligible includes:

You and/or your spouse
A beneficiary of the IRA
Your descendants and their spouses
Plan service providers
Any company in which you own at least 50% of the voting stock
A shareholder or partner in said company who owns 10% or more of its stock

If you were to use your self-directed Roth IRA as collateral for a loan or utilize the funds to purchase a property for personal use, it would be a breach of the rule. Such a violation could result in your self-directed account losing its tax-advantaged status.

What Can You Invest In With a Self-Directed Roth Account?

In a typical Roth IRA, you may have a restricted selection of investment options such as mutual funds, index funds, exchange-traded funds (ETFs), and bond funds. Individual stocks or bonds could potentially be chosen, although they are less frequently available.

There is a wide range of options available with a self-directed Roth IRA. Examples of potential investment areas within a self-directed account are:

Real estate
Private placements
Tax liens
Partnerships and franchises
Precious metals

In contrast, there are certain assets that are not permissible to be held in a self-directed Roth IRA, such as precious stones, postage stamps, rare items, artistic creations, currency, floor coverings, and vintage objects.

According to Guy Baker, the founder of Wealth Teams Alliance in Irvine, California, individuals who are not satisfied with the ETFs and mutual funds provided by traditional custodians opt for self-directed accounts because they are risk-takers. These individuals are primarily interested in investments like first trust deeds, real estate partnerships, real estate investment trusts, and commodities like gold. It is also possible to purchase stock in privately owned businesses that are not listed on the stock exchange.

Having the ability to diversify your investment choices in a self-directed IRA enables you to explore beyond traditional investments like stocks and bonds. Nevertheless, it is important to note that certain investments you opt for with a self-directed account may entail a higher level of risk.

Bottom Line

Before you dive into self-directed investing with a Roth IRA, it is crucial to carefully weigh the advantages and disadvantages. It is essential to consider that if you lack knowledge in a particular investment or are uncertain about the tax regulations for restricted transactions, you may inadvertently cause damage to your portfolio. Therefore, take the necessary time to educate yourself on the intricacies of self-directed investing and seek assistance if necessary.

Tips for Managing a Self-Directed Retirement Plan

Take advantage of free resources and tools, such as retirement calculators , to help you determine your investing strategy and what steps you need to take to reach your retirement goals. Also, pay close attention to the fees associated with self-directed accounts and their underlying investments. While a self-directed approach could yield solid performance in your portfolio, high investment fees can nibble away at returns.
Consider working with a financial advisor to decide which investments belong in your self-directed Roth IRA and how to maximize tax efficiency. Finding a qualified financial advisor doesn’t have to be hard.

Self-Directed Roth IRA FAQs

How do I open a self-directed IRA account?

Completing the task is as simple as counting to three!

Open an Account – If you already know what type of account you’d like to open, open an account right away by selecting a local office and completing an application. Once you have completed your application, you will have to put money in your account by either transferring or rolling over funds from an existing account, or by making a contribution to your new account. The funding form is located in your application package or on the forms page of this web site. The setup of an IRA or Qualified Plan takes about one day. A transfer or a rollover may take from two weeks to 30 days, depending on the source of the funds or assets being transferred or rolled over. Cash contributions are immediately credited to your account.
Select an Investment – With a self-directed IRA, you choose your own investments.
Make an Investment – Direct IRA Innovations to purchase your investment choice with your IRA.

How much money should I deposit into my account to get started?

The amount you should initially invest depends on the nature of the deal or investment you intend to make, although there is no specified minimum.

When investing in a note that offers a fixed rate of return, it is essential to consider the expenses related to administration and servicing in order to determine the final amount that will be added to your account. In the case of renovating a property for later sale, the outcomes can vary significantly compared to a fixed rate provided over an extended duration.

It is important to note that when making a cash contribution to your account, you should verify the contribution limits specific to that account type.

If you need any help with purchasing your investments, IRA Innovations will be delighted to assist you.

Once I purchase an investment in my IRA, is it in my name?

If you use your retirement funds to buy assets, they will be titled in the name of both your IRA and yourself. For instance, if you bought a property through your IRA, the investment would be titled as follows:

IRAs that are Innovations FBO (for the benefit of) John Smith (your legal name)

How do I find out what the current contribution limits are for my retirement plan?

By logging into our site or visiting www.irs.gov, you can access information about the contribution limits for your account.

Are there investments that I cannot make with my IRA money?

On our website, we provide information about transactions prohibited by the IRS. In case you are planning to engage in a prohibited transaction, there are specific criteria and steps that must be followed to seek exemptions from the rules governing such transactions, which are applicable to both ERISA and non-ERISA plans, as well as Individual Retirement Arrangements.

Can my IRA be sued?

There is a possibility of legal action affecting your IRA. Although IRAs are not always protected from creditor claims and are always subject to federal or state taxing authorities, some states prohibit creditors from collecting funds from IRAs.

What can I purchase in my IRA besides real estate?

As long as it is not prohibited or collectible as per the Internal Revenue code, you have the option to acquire notes, commissions, options, private placements, accounts receivable, timber deeds, crops, cattle, or any other eligible item.

What is the frequency at which I receive statements for my accounts?

The typical cycles are on a quarterly basis, but you have the option to ask for a statement whenever you desire. If you choose to sign up for electronic statements, you have the ability to access your account at any given moment.

What happens to if I have to withdraw funds out of my plan for an emergency?

If there is an emergency that aligns with the hardship withdrawal rules outlined in the IRS code, it is possible to borrow funds from a plan before reaching the age of 59 ½ without incurring a 10% penalty.

Can I put away more money if I am over age 50? What are the limits?

Retirement plans have varying limits depending on the type and respective year.

How do I determine which retirement plan is best for me?

Some things to consider are:

Are you a sole proprietor or own a company that has a qualified plan or employer based IRA?
Your age.
Your contribution and deferral capability.
Whether you have common law employees.
When you wish to retire.
Your tax situation.

Make an effort to maximize your retirement savings and ensure you select a plan that offers optimal flexibility.

What are the contribution deadlines for Qualified Plans, and IRAs?

To ensure contributions for a specific year, qualified plans need to be set up by the last day of your fiscal year. If you have a calendar year ending on 12/31/2020, you must establish the plan on that date in order to make contributions for 2020. The deadline for 401(k) deferrals is within 30 days of receiving the contributions. Consequently, for the 12/31/2020 deadline, the 30-day window would follow.

SEP and SIMPLE IRA contributions may be made by the company tax deadline plus extensions, except for defaults, which follow the above rules.

There are no extensions given for IRA contributions, which must be made by April 15.

Purchasing Real Estate with Your IRA

Is it true that buying and selling real estate within my self-directed retirement plan is illegal?

The IRS and Department of Labor have never released a list of approved investments. Unless expressly forbidden, like in the case of collectibles, all investments are considered “legal”.

On our website, you will find a compilation of forbidden transactions, disqualified individuals, and collectibles. As long as you adhere to the relevant regulations, investing in real estate and other ventures is allowed.

Is it possible for me to purchase real estate with the help of a partner using my IRA?

When buying property with your IRA, you are allowed to have partners, which can include yourself, any family members, their IRAs, eligible 401(k)s, or other qualified plans. However, it is important to note that once the property is obtained through your IRA, it is prohibited to sell it to yourself or any family members. In this context, family members refer to ascendants and descendants, or their spouses.

What is the process of purchasing real estate within my retirement plan?

Find a real estate investment that falls within the parameters of what you have in your plan budget. Include the funds contributed by your partners, yourself, loans or any combination.
Direct IRA Innovations to purchase the property by completing a Buy Direction Letter.
Selected a proper escrow/title company/attorney to close the transaction, as you would with any real estate transaction.
IRA Innovations purchases the property you have specified with the funds in your retirement account.
IRA Innovations wires the funds to escrow, as required.
At closing, the title on the property is vested as shown in the closing documents.
If the property is income-producing, funds are received by and expenses are paid from your retirement account, in accordance with your instructions.

If I lack sufficient funds to purchase real estate in my IRA, what options do I have?

There are numerous choices available.

You may partner with others.
You make allowable contributions.
You may obtain debt financing through private sources or financial institutions on a non-recourse basis.
You may arrange a seller carry back loan; you may sell other assets in your IRA to raise cash to make the purchase.
You may transfer funds from other IRAs or roll over funds from qualified plans, such as 401(k), 403(b) or government 457 plans you may have had at employers where you no longer work.
If you have a profit sharing or 401(k)plan where you currently work, you may be able to make in-service withdrawals and roll those to the IRA within 60 days.

Where can I find a lending institution that offers loans for the purpose of buying real estate within my IRA?

Lenders such as private lenders, seller carry-backs, and mortgage companies typically offer non-recourse loans to your IRA. On occasion, banks and credit unions may also provide non-recourse portfolio loans to IRAs.

Is it possible for me to purchase property using my child’s IRA?

As previously mentioned, it is possible for your child’s IRA to acquire property either individually or in conjunction with your IRA or any other IRA.

Is it possible for me to utilize the funds in my previous employer’s 401(k) plan? If so, what steps should I take to do so?

If you meet the eligibility requirements, you can transfer these funds into either a traditional IRA or a qualified plan that allows for complete self-direction, such as an IRA Innovations self-directed IRA. It is advisable to reach out to your previous employer’s plan administrator or benefits department to understand if there are any specific procedures that need to be followed.

You have the option to transfer the assets from your old plan to your IRA Innovations IRA without selling them. This means that the assets from your previous qualified plan, 401(k), or other plan will be transferred as they are into your IRA. It is possible that there may be limitations imposed by the fund provider, broker, or annuity company regarding such transfers. Your former employer will inform you about any restrictions that apply.

Making other investments with your IRA

Is it possible to combine my retirement plan funds with other plans when purchasing mortgages?

You have the option to utilize any alternative plans, accounts, personal funds, and assets as partners in order to acquire mortgages.

Getting a Loan in Your IRA

What is the process for obtaining a loan from my IRA?

Under no circumstances are you allowed to borrow funds personally from your IRA. Such an action would be considered a prohibited transaction. However, you are permitted to lend money to individuals or corporations as long as they are not disqualified persons.

How can I locate the appropriate lender?

Non-recourse lending is typically not done by large institutional lenders, whereas lenders can encompass mortgage lenders, personal lenders, credit unions, and community banks.

Lenders can also request extra collateral to reduce the loan to value ratio. If they are not disqualified, you have the option to offer third party guarantors or other properties as collateral.