A self-directed Roth IRA is defined as one where the accountholder determines where the money is invested. That's a fairly common arrangement when it comes to Roth IRAs.
Benefits of Self-Directed Roth IRAs
One of the nice features of Roth IRA plans is the money placed into the account can be withdrawn at retirement tax-free. On the down side, contributions to a Roth are made on an after-tax basis, meaning accountholders cannot deduct contributions on their federal income tax return. That's different than the way a Traditional IRA might work.
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For those that qualify, it's possible to deduct a contribution to a Traditional IRA. When the money is removed from the account, federal income taxes are owed on all amounts withdrawn. With a Roth IRA, money goes into the account on an after-tax basis (contributions are not tax deductible), but the amounts withdrawn once retired are tax free.
Another benefit of a Roth is there is no age restriction for contributions. Readers that want to take a more in-depth look at the differences between Roth IRAs and Traditional IRAs should take a look at our article: IRA Rules.
Establishing a Self-Directed Roth IRA
Setting up a self-directed Roth IRA is a straightforward process. The first step involves contacting a stockbroker to help set up the self-directed account. That broker will then send two forms, or the forms can be downloaded right from the company's website.
The first form is an application for a Roth IRA, and this is the same form used when setting up a Traditional IRA with a bank, investment house, or mutual fund. That form needs to be completed and mailed back to the broker.
The second form goes to the existing Roth IRA custodian; if there is an account that's being converted. This form is the basis for an exchange, or renaming, of the Roth IRA custodians.
Trustee-to-Trustee Transfers
There may be a short delay for a trustee-to-trustee or custodian-to-custodian transfer to take place. It can take up to 45 days for the transfer to occur. By allowing the money to exchange hands between these financial institutions, the accountholder avoids all of the potential IRA withholding policies such as the 60-day rule and withholding tax. This process helps to avoid tax penalties too. A more detailed explanation of this topic can be found in our article: IRA Rollovers.
Roth IRA Account Guidelines
The IRS has established guidelines that all IRAs must abide by to be considered "legitimate" accounts. This includes self-directed Roth IRAs. Summarizing those requirements:
The trustee or custodian of a Roth IRA must be a bank, a federally insured credit union, a savings and loan association, or an entity approved by the IRS to act as trustee or custodian. This list also includes a stockbroker's account.
The trustee or custodian agrees not to accept more than the allowable annual contribution limits for a Roth IRA.
All contributions, except for Roth IRA rollovers or conversions, must be in cash.
The account must offer the accountholder a non-forfeitable right to the money at all times.
The money in the account cannot be used to purchase life insurance.
The assets in this account cannot be combined with other investment assets.
Finally, the account owner needs to abide by all of the minimum required distribution rules that apply to IRAs. (Roth IRAs do not have minimum required distributions.)
Contributions to a Roth
Anyone thinking about starting a self-directed Roth IRA needs to be aware of the contribution rules and limits that apply to these accounts. Taxpayers with a filing status of Married Filing Joint returns with modified adjusted gross income or AGI that are less than $206,000 in 2020 or $208,000 in 2021 can make a contribution to a Roth. The AGI limit is $139,000 in 2020 and $140,000 in 2021, for Single filers and those filing as Head of Household. Phase-out limits do apply, starting about $10,000 to $15,000 lower than the limits just discussed.
Individuals that are eligible to make a contribution to a Roth, and reach the age of 50 before the end of the calendar year, can also make a catch up contribution to a Roth IRA. The contribution limits for the years 2007 through 2021 appear in the table below:
Roth Contribution Limits (2007 to 2021)
Tax Year | Contribution Limit | Limit with Catch-Up |
2007 | $4,000 | $5,000 |
2008 to 2010 | $5,000 | $6,000 |
2011 to 2012 | $5,000 | $6,000 |
2013 | $5,500 | $6,500 |
2014 | $5,500 | $6,500 |
2015 | $5,500 | $6,500 |
2016 | $5,500 | $6,500 |
2017 | $5,500 | $6,500 |
2018 | $5,500 | $6,500 |
2019 | $6,000 | $7,000 |
2020 | $6,000 | $7,000 |
2021 | $6,000 | $7,000 |
2022 | Indexed with Inflation |
Rollovers, Conversions and Distributions
We've already published quite a bit of information concerning Roth IRAs, and it's not our policy to repeat information when we can avoid doing so. Anyone thinking about starting a self-directed Roth might want to look at some of our other articles including:
Roth IRA Rules
This article provides insights into a number of Roth IRA rules such as eligibility requirements, contributions, and distributions. This article also talks about conversions and distributions, also known as transfers.
Roth IRA Contribution Limits
This article's sole focus is on Roth IRA contribution limits. It gives a brief explanation of the phase-outs for contributions, and its relationship to tax filing status. Catch-up contributions are also discussed in this article.
Retirement Planning Tools
Finally, if anyone is thinking about setting up a self-directed Roth IRA, then we have some retirement planning tools that can help users figure out if their retirement plan is working. Our retirement planning guide helps walk users through all of their investment options, while our retirement calculators can help users figure out if they have enough retirement funds to meet their future income needs.
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