What is a Self Directed Roth IRA? 

There are two types of Self Directed IRAs: Traditional and Roth. A Self Directed Traditional IRA is a tax-deferred investing account. This means that you do not pay any taxes when you initially fund your account. Instead the taxes come due when the account holder reaches 72 years old and takes out a RMD (Required Minimum Distribution).   

In a Self Directed Roth IRA, the account holder pays taxes upfront. Then, when the money is distributed in retirement, it can be taken out tax-free. Basically, the account holder is paying the bill now so that they do not owe anything later. This makes the Self Directed Roth IRA a powerful investment tool as all profits that accrue in the account are tax free. This is a great advantage if an asset is expected to do perform above average. Self Directed Roth IRA account holders have an additional benefit in that they can maintain a Roth indefinitely. There is no RMD required during their lifetime. 

The self-directed element of the Roth IRA allows investors to expand beyond the standard investment assets. With it, account holders can place property and other alternative assets in their retirement fund. 

What are the advantages of a Self Directed Roth IRA 

Self Directed Roth IRAs create numerous opportunities:    

  • Diversified Portfolio – A Self Directed Roth IRA allows account owners to invest in a variety of alternatives that are inaccessible in standard IRAs. Possible investment options include real estate, cryptocurrencies, promissory notes, tax liens, and more. 
  • Total Control – Self Directed Roth IRA owners can manage assets in a way that fits with their personal financial goals. There is more involvement in the process and the account holder possesses total control over the investment decisions.    
  • Steady Returns – Investing in assets you are more familiar with can result in a more stable revenue stream, thereby avoiding the volatile stock market.    

How to set up a Self Directed Roth IRA 

Setting up a Self Directed Roth IRA is similar to setting up a Traditional Self Directed IRA. In the classic custodial model, the process is simple and inexpensive. 

  1. Open a Self Directed Roth IRA account – This starts with a short form that can be filled out online or over the phone. Here you will answer the basic questions needed to get going. 
  1. Transfer funds into the Self Directed Roth IRA – Next you will fill out another form from the self-directed Custodian– the Transfer Authorization – which will be sent to the Custodian currently holding the IRA. The funds will then be transferred and deposited into the new Roth account. If you will be rolling over funds from a 401(k) plan, you will have to contact the plan administrator and request the appropriate forms from them. After those forms are processed, the funds will then be sent to your Self Directed Roth IRA. 
  1. Direct the investing in the Self Directed Roth IRA – First you will work independently (or with your financial advisor) to identify the assets that make sense for your Self Directed Roth IRA. Once identified, you will submit an Investment Authorization form that identifies the asset and instructs the Custodian to make the purchase.  

In a Self Directed Roth IRA with checkbook control (see below), the setup process has a few extra steps. In addition to opening a new account, you will also establish a financial vehicle for the purpose of opening a checking account. This vehicle can be in the form of a Trust or an LLC. Once the Trust/LLC is established, you will go to the bank of your choice and open a new checking account for it. This effectively gives your Self Directed Roth IRA the power to make investments just by writing a check. 

The Self Directed Roth IRA LLC 

Adding an LLC to your Self Directed Roth IRA gives you more control over the investment process and also cuts back on a lot of the fees. The idea behind it is similar to a traditional investment. Just like you can place your retirement funds in a company like Coke or Apple, you can also place them in an LLC. In other words your new Roth IRA LLC will be using your retirement funds to do business. This can really mainstream your investing as you no longer have the middle step of having every transaction processed by a Custodian. (The Custodian will still hold the IRA, just without any transactional involvement.) This is great for time sensitive investments that have to be moved on quickly. It’s also a tremendous boon for assets that require a lot of maintenance as it saves both time and money in their management. 

Additional Rules for the Self Directed Roth IRA 

Income Requirements – Only earned income can be contributed to a Self Directed Roth IRA. (Earned income is money paid to you for work performed or money made from running your own business.) You can contribute to a Self Directed Roth IRA at any age, as long as the contribution is earned income and the amount contributed is not more than your earned income that year.   

Contribution Limits – For a Self Directed Roth IRA, your maximum annual contribution depends on your filing status and income level.   

Filing Status 2020 MAGI Maximum Annual Contribution  
Single, Head of Household or Married Filing Separately 
(if did not live with a spouse during the year)  
Less than $124,000  $6,000 ($7,000 if 50 years old or older)   
 $124,000 – $139,000  Reduced Contribution   
 $139,000 or more  Not Eligible to Make a Contribution 
Married Filing Jointly or Qualifying Widow(er)   Less than $196,000  $6,000 ($7,000 if 50 years old or older)   
 $196,000 – $206,000  Reduced Contribution 
 $206,000 or more   Not Eligible to Make a Contribution  
Married Filing Separately 
(if lived with a spouse at any time during the year)   
Less than $10,000 Reduced Contribution 
 $10,000 or more  Not Eligible to Make a Contribution 

Required Minimum Distributions – Unlike a Traditional IRA, there are no required minimum distributions for a Self Directed Roth IRA. You have the freedom to use the account in retirement or leave it as an inheritance to your heirs.   

If you choose to take out contributions from your Self Directed Roth IRA, you may do so at any time and for any reasons without taxes or penalties. However, if you are withdrawing earnings from your Roth, it may trigger taxes and penalties depending on your age and how long you have had the account. Those over 59 ½ years old who have owned the Self Directed Roth IRA for at least 5 years can take out earnings without taxes or penalties. Under 59 ½ there are a limited number of situations that that would similarly avoid a penalty:  

  • first-time home purchases  
  • qualified education expenses  
  • unreimbursed medical expenses  
  • permanent disabilities   

Talk to a Specialist   

Here at Madison, we understand your desire for clarity when it comes to making investment decisions. We can help answer any questions you may have and make your investment experience as seamless as possible.  

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