If you haven’t investigated the difference between a Roth retirement account and a traditional IRA, it’s time that you did. Put simply, a Roth IRA can help you keep more of what you earn via the potential for tax-free growth and tax-free withdrawals in retirement. Tax-free is always good. With a Roth IRA, every penny you withdraw in retirement stays in your pocket, and none of it goes to Uncle Sam.
Roth IRA investment rules dictate that as long as you’ve owned your account for 5 years and you’re 59½ or older, you can withdraw your money when you want to, and you won’t owe any federal taxes.
Roth IRA Basics
You take after-tax dollars, which is money you’ve already paid federal, state and withholding taxes on, and put them into your Roth IRA account. You then choose your investments. Any earning gains on your investments grow tax-free.
The benefit of a Roth IRA is that your withdrawals during retirement are tax-free because you already paid taxes on the money before putting it into your IRA. That is, as long as you wait until you’re 59½, and have had the account open for at least five years (counting from the tax year of your first contribution).
Two key factors to understand upfront are that there are income limits to who can make Roth IRA contributions. However, even if you exceed the income limit, you can still convert traditional IRA contributions into a Roth retirement account. Given the high inflation of 2022, the IRS has boosted the amounts that you can contribute to retirement saving in 2023. For a Roth IRA, single taxpayer phaseouts for 2023 start at $138,000 of income. For those married filing jointly, it’s $218,000.
Anyone can convert eligible IRA or 401k assets to a Roth IRA regardless of income or marital status. You can do an eligible rollover distribution from your old 401k directly to a Roth IRA. You will owe taxes on the amount of pretax assets you roll over. But you also have several options. You can do a full conversion of all the funds at one time. You can do a partial conversion and keep some of your funds in a traditional IRA. Or you can stretch out a full conversion over time to spread the impact of paying the taxes over months or years. You may want to do a partial conversion if:
- Reporting an entire conversion will bump you into a substantially higher tax bracket. Keep in mind that if you only get bumped up slightly, say, from 25% to 28%, the conversion benefits might still outweigh the difference in income tax.
- You don’t have enough cash available outside your retirement account to pay the taxes for a full conversion. It’s important to pay with non-IRA assets because you can incur a 10% early distribution penalty if you’re under 59½, and you will lose the benefits of tax-free growth on the amount you take out. The fee you pay could very well eliminate the advantage of converting in the first place.
If you do convert to a Roth IRA, you’ll need to complete IRS Form 8606 to report your “basis” (if any) in your traditional IRA and to report your taxable conversion income to the IRS. If you are interested in further exploring the conversion of traditional retirement funds into a Roth retirement account, please make an appointment today to talk with one of our experts.
Roth accounts are all about the potential tax savings!
What Makes a Roth IRA So Attractive to Investors
If you think you’ll be in a higher tax bracket when you retire than you are now, a Roth IRA may be more beneficial than other retirement accounts, such as a traditional IRA. The reason is you’ve already paid taxes on your contributions, so your higher tax bracket won’t result in a high tax bill when it’s time to enjoy your hard-earned money. Another reason the Roth IRA is attractive is rising inflation. Inflation erodes the value of money over time. If you pay taxes now, you won’t have to pay them in retirement, when taxes may be higher.
Other benefits of a Roth IRA include the following:
- No required minimum distributions: Account holders of Roth IRAs aren’t subject to the required minimum distributions (RMDs) required from a traditional IRA or 401k starting at age 72. This means Roth IRA account owners don’t have to withdraw distributions at any point while they’re alive — unlike with traditional IRAs or 401ks. However, inherited Roth IRAs are subject to RMDs unless you’re inheriting it from a spouse. There are special rules in those circumstances.
- No income tax on inherited Roth IRAs: If you pass a Roth IRA to an heir, they enjoy tax-free withdrawals as long as the account was held for at least five years at the time of the account holder’s death.
- You can combine strategies by contributing to a Roth in addition to a Solo 401k.
- Easy withdrawals: You can withdraw the money you contributed at any time without taxes or penalty. Only the early withdrawal of earnings will typically be taxed or penalized.
- Flexible timing: You can choose when and how much you contribute to a Roth IRA. For example, you could contribute $6,000 on the first day of the year or split up your contributions throughout the year.
- Extra time to contribute: You have until that year’s tax deadline (usually April 15) to contribute for the previous calendar year.
- Tax-free distributions: Once you hit 59½, and have held the account for at least five years, you can take distributions, including earnings, from a Roth IRA without paying federal taxes.
- No age limit to open: You can open a Roth IRA at any age, as long as you have earned income (you can’t contribute more than your earned income).
Invest your self-directed Roth IRA in any way that you want!
#1 Invest Your Roth Retirement Account in Crypto
A time when it makes good financial sense to invest with a Roth IRA is if you expect substantial earnings that a Roth account allows you to keep completely tax-free. A Crypto Self Directed Roth retirement account can be the cornerstone of a strong alternative investment strategy. The key is that the IRA account must be self-directed so that it can make alternative investments.
Cryptocurrency has certainly seen its ups and downs, but much of that is on its pathway toward maturity. As the cryptocurrency market matures, governments worldwide have recognized its rising importance as an alternative investment. As governments will do, they have introduced legislation to tax proceeds from crypto-related activities. Today, common trades often trigger taxable events that lead to tax liabilities. Avoiding paying taxes is illegal, but a Roth retirement account is a fully legal way to avoid triggering taxable events while holding onto all your cryptocurrency.
The robust growth potential of cryptocurrency holdings in a portfolio is enough to lure in investors who believe cryptocurrencies will keep on growing as the infrastructure around them boosts accessibility and new crypto-related products and services are created. Since regular crypto investments are subject to capital gains taxes, self-directed Roth IRAs can be a fantastic way to diversify your retirement savings and build your cryptocurrency portfolio in a tax-advantaged way.
If you have a longer time horizon in Bitcoin and other cryptos, a Roth IRA could be an appealing choice for those looking to take advantage of the long-term promise digital assets offer in a tax-free Roth retirement account.
#2 Invest Your Roth Retirement Account in Real Estate
Real estate is the best understood and most preferred self-directed asset. The Self Directed Roth IRA real estate account is the easiest way for everyone to invest in real estate. It is also the most proven wealth-building asset class of all time.
There are many reasons to be thinking about real estate as a very sound alternative investment. Today, investing in real estate as a hedge against inflation has become a backstop to all of the other reasons for investing your Roth retirement account in real estate. When many investors think about investing in real estate, they first think about single-family homes, which can be a great beginning point. However, when it comes to alternative investments with high-income potential and significant long-term growth, there are many classes of real estate worth considering. A few that might be suitable for a Roth retirement account include:
- Raw Land
- Commercial property
- Apartments (including syndicates with other investors)
- Skyscrapers (including syndicates with other investors)
- Mobile homes
- Real estate purchase options
- Tax liens certificates
- Tax deeds
A Self Directed Roth IRA invested in Real Estate is a wise choice.
#3 Invest Your Roth Retirement Account In Index Funds
This investment choice for a self-directed Roth IRA might be best suited for younger investors that are currently in a lower tax bracket that still have many years to grow their earnings. Index funds are an easy, low-fee way to invest. It could be the smartest and easiest investment you ever make. Index funds mirror the performance of an existing collection of stocks, such as the Standard & Poor’s 500 index. If you invest in an index fund that tracks the S&P 500, you’ll be invested in all the companies within that index.
Index funds are considered a “passive” investment rather than an “active” investment. Because an index fund tracks an existing fund, there is not a lot of trading activity that needs to happen. Fewer trades mean less in trading fees will have to be paid by your Roth retirement account. Index funds offer both tax-free investing and low transaction costs that combine to maximize long-term growth. With an index fund, you’ll enjoy a broadly diversified portfolio that includes some of the world’s strongest companies,
If you’re looking to let your money grow steadily over time, particularly if you’re saving for retirement, index funds may be a great investment for your self-directed Roth IRA.
#4 Invest Your Roth Retirement Account in Mortgage Notes
Real estate notes are another form of passive investing that offers the security of real estate without having to actively manage the property. You are holding the mortgage on another person’s property. A mortgage note is a promissory note that property owners sign when taking out a mortgage. It is a promise to pay the mortgage under penalty of foreclosure should the borrower default.
For clarity, trust deeds and mortgages in a Roth retirement account (trust deeds, deeds of trust, and mortgage notes) are largely the same investment, depending on the state in which you invest. These notes may be either in first or subordinate positions and may be purchased from brokers or private parties. Usually, the documentation is recorded at county recorder offices, and the title to the property is insured, as you instruct. You may also invest in discounted notes as well as real estate purchase options.
Important note: The IRS does not allow your self-directed Roth IRA to buy notes from yourself, some family members, or IRA beneficiaries.
Your Roth IRA might want to buy mortgages that have substantial down payments and that are “seasoned” — notes that have a proven history of borrower payments that are on time and in the full amount.
#5 Invest Your Roth Retirement Account in Traditional Equities
When you have a self-directed Ro, it really does mean you have total control. A Roth IRA can invest in stocks, bonds, and mutual funds (along with derivatives such as options). It’s as easy as establishing a stock brokerage account in the name of your Roth retirement account. However, equity investing is considered one of the riskier investment strategies. Unless you have ample experience and a desire to stay current with the ever-fluctuating markets, you might want to outsource the management of your Roth IRA to an equities professional.
One reason to hold volatile stocks in a Roth IRA rather than a traditional IRA is you might be forced to sell traditional IRA-held stocks during a mandatory distribution for a loss when the markets tumble. The Roth IRA does not have a mandatory distribution.
Having your most aggressive or riskiest investments in your self-directed Roth IRA is designed to maximize tax-free growth. If you don’t need the money in retirement, you can leave the Roth IRA to your heirs, who will be able to take tax-free withdrawals, too.
If you want to build wealth, you must plan for it. According to The National Study of Millionaires, 3 out of 4 millionaires (75%) said that regular, consistent investing over a long period is the reason for their success. Regardless of where their income comes from, they actually save money and invest!