Pros & Cons of a Self Directed Roth IRA

Weigh carefully decision regarding retirement accounts.

Weigh carefully decision regarding retirement accounts.

An individual retirement account provides workers with a way to accumulate a nest egg and receive tax incentives to make the process more rewarding. IRAs come in two flavors: traditional and Roth. Money contributed to a Roth IRA has already been taxed, but it can grow and be withdrawn tax-free. A traditional IRA provides a tax-deduction on contributions, but you must pay taxes on all withdrawals. Either one can be set up as a self-directed account or as a managed account

Roth IRA Pros

The post-tax nature of Roth IRA contributions ensures that you don’t have to worry about paying taxes on the withdrawal of earnings as long as you’ve had the account for five years and are at least 59 1/2 years old. These requirements are waived if you become disabled or die. You can withdraw earnings up to $10,000 tax-free at any time if you use the money to buy your first home. There are also withdrawal allowances made when the money is used to pay for qualified higher education expenses. The various withdrawal restrictions apply only to earnings. You can withdraw contributions any time without penalty. If you withdraw earnings without meeting the requirements, you may be subject to a 10 percent penalty tax. Unlike traditional IRAs, Roth IRAs do not require you to make withdrawals at age 70 1/2 and there is no age cap on making contributions.

Roth IRA Cons

You get no tax deductions for Roth IRA contributions. There are income caps on Roth IRA contributors but none for traditional IRA participants. These limits can change each year. For 2013, the limits on modified adjusted gross income start at $59,000 for individuals and $178,000 for couples. You can use Internal Revenue Service Form 1040 to calculate your MAGI.

Self-Directed Roth IRA Pros

Self-direction is a benefit for those who wish to control their investments. You do not have to cede control to others and hope they make the right decisions. You can set up a self-directed Roth IRA through a brokerage account that allows you to purchase a wide variety of mutual funds and money markets. You can also trade stocks and bonds through the account. Some accounts allow trading of options, futures, commodities, real estate and precious metals. To guarantee you obtain the flexibility you desire, check the guidelines of several competing providers of self-directed Roth IRAs. This information is widely available on the Internet.

Self-Directed Roth IRA Cons

The flip side of control is responsibility. You must evaluate whether you have the time, knowledge and inclination to direct your Roth IRA investments. It is often difficult even for professionals to beat simple index funds, so it makes sense to consider a managed account if you feel you do not have the ability to outperform professional investment managers. If you are wiped out financially, you’ll have only yourself to blame, whereas you may have legal recourse if you lose all your money in a managed account. Managed accounts may come with high fees to pay for the professional judgement of fund managers. One unhappy fact of life is that fraud sometimes occurs in the financial industry and managed accounts are much easier to manipulate than self-directed ones.

 

Resources

  • Go Roth!: Your Guide to the Roth IRA and Other Roth Accounts; Kaye A. Thomas
  • The Roth Revolution: Pay Taxes Once and Never Again; James Lange
  • The Retirement Savings Time Bomb . . . and How to Defuse It: A Five-Step Action Plan for Protecting Your IRAs, 401(k)s, and Other Retirement Plans from Near Annihilation by the Taxman; Ed Slott

Photo Credits

  • Hemera Technologies/AbleStock.com/Getty Images