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What is a Self-Directed Roth IRA?

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  • Written By: Adam Hill
  • Edited By: Bronwyn Harris
  • Last Modified Date: 01 February 2020
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More and more people are realizing the importance of saving money for use during retirement. There are a few options for doing so, which in the United states, carry positive incentives from the government. One of these is the Individual Retirement Account (IRA). Traditional IRAs and Roth IRAs both provide tax incentives. One variation of the IRA is the self-directed Roth IRA, which allows its owners to use that money to determine where the money should be invested.

Roth IRAs differ from traditional IRAs in that money deposited in regular IRAs is subject to taxes when it is withdrawn at retirement. Deposits can be made with pre-tax dollars, however. Roth IRAs are the opposite way when it comes to taxes. Deposits can only be made with after-tax dollars, but withdrawals are tax-free at retirement. Roth IRAs have significant advantages over traditional IRAs, however.

Funds in a self-directed Roth IRA may be withdrawn tax-free at any time. Additionally, transactions that occur inside a self-directed Roth IRA, including interest payments, capital gains, and dividends, incur no tax liability. The owner of the Roth IRA can invest the money as he chooses, in order to maximize this tax-free income option.

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The setup of a self-directed Roth IRA is a fairly simple process. The first thing to do is to get in contact with a stockbroker from the investment firm of one’s choice. Once an account holder has explained to the broker that he wants to set up a self-directed Roth IRA, the broker will send him two forms. It also may be possible to download the forms from the brokerage website.

The first form is simply an application for a Roth IRA, which must be completed and sent back to the broker. The second form is useful to convert a traditional IRA to a self-directed Roth IRA. It goes to the existing IRA custodian and is needed to exchange or rename an IRA custodian.

Another intriguing aspect of the self-directed Roth IRA is that it allows the purchase of real estate using money from the IRA itself. Up to $10,000 US Dollars (USD) can be used to purchase a principal residence. A Roth IRA can also be used to purchase investment properties if structured correctly. The IRA can even be used to hold title to a property if there are sufficient assets in it. The specific steps for investing in this way are somewhat complex, but the tax advantages are very significant if the whole process is done correctly.

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