Roth IRA And Self Directed IRA – A Closer Look At The Differences

Roth IRA

If you live in the US, then you know that the IRA, or Individual Retirement Account, is one of the best ways to save for retirement, while enjoying income-tax savings.

You can customize this IRA to suit your needs.

The two primary IRAs are self-directed IRAs and self directed Roth IRAs. Let take a closer look at both.

Once you open your self directed IRA, you have full control over it. You can invest the money based on what you feel will bring you the best profits.

You can open a Roth IRA with the help of a broker or bank. Whatever you contribute toward a Roth IRA is on an after-tax basis. The advantage of a Roth IRA is its exemption from tax, even as the money grows.

Traditional IRAs give you much-needed tax relief because the contributions are tax deductible. However, you will end up paying taxes when the time comes to withdraw your money.

On the other hand, Roth IRAs are not tax deductible, but the money you withdraw from it is exempt from tax. So if you are due to retire in about ten years, the investment you made in self directed Roth IRA will continue to grow and you’ll enjoy huge tax benefits when you withdraw.

Let us look at an example to illustrate: assuming you made $50,000 in 2008 and you invested $5,000 in an IRA.

You now pay income tax on $45,000, since the IRA contribution is tax deductible.

Also, your IRA contribution of $5,000 now grows tax free until you withdraw it on retirement after you are 59 ½ years old.

When you withdraw it, your money will be taxed as income at the ordinary income tax rates.

In case you withdraw this money before your retire, you will be expected to pay tax as well as a 10% penalty on the accrued earnings.

In the Roth IRA, the tax implications are different. As per the above example, you’d be taxed on your earnings of $ 50,000 in spite of contributing $ 5,000 to a Roth IRA. But when you withdraw the money on retirement, you don’t pay tax on the money or the accrued earnings.

Remember there are restrictions related to Roth IRAs. In order to qualify, your income should not exceed $177,000, if you happen to be married and file joint tax returns. If you are married and live with your spouse and file separately, your income should be less than $120,000 a year to qualify. If you are single and file as the head of household, or married but didn’t live with your spouse during the year, your income should not exceed $120,000 a year to qualify.

What a Self-Directed IRA Lets You Do

With your self-directed IRA, you’re free to sell and buy stocks. You get to control your investments, saving money on management fees.It’s best to get your accountant or tax advisor’s opinion before you change anything, though. But if you were always looking for this kind of flexibility and don’t mind the responsibility, a self-directed IRA would be a good fit.And What About Self-Directed Roth IRAs?

Self directed Roth IRAs also offer significant benefits. For starters, the money you put into the account can be withdrawn at retirement tax free. The contributions you make to your Roth are after tax.If you happen to qualify, your contribution to a traditional IRA is tax deductible; but when you withdraw the money on retirement, you will pay federal taxes on the amount. With a self directed Roth IRA, you’re withdrawing after-tax money, so there’s no tax deduction when you withdraw your money on retirement.

Roth vs. Traditional IRA: Which One Is For You?

In terms of age limit, Roth IRAs have the advantage over traditional IRAs. If you look at income contribution limits, traditional IRAs have the advantage over Roth IRAs. If tax savings are your primary concern, then a traditional IRA is right for you, since you can deduct your contribution from taxable income, tax free. But in the distribution stage, Self directed Roth IRA wins out because you don’t have to pay taxes on your Roth withdrawal.

Familiarize yourself with the benefits, challenges and options related to self-directed IRAs before you decide which option is the best for you. Your IRA can be a traditional IRA or a self directed Roth IRA, and can give you the flexibility to select from a variety of investment options. This also lets you diversify your IRA.

To make an informed decision, the best thing to do is take a good look at the differences between a self directed Roth IRA and a traditional IRA, the Roth IRA rules and guidelines, contribution limits, tax implications in different situations, etc. Whichever you choose, examine the facts. It is your personal choice and largely depends on your income and age. Done with the right amount of caution, self-directed investing can pay off in a big way.


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