Setting Up a Self-Directed Roth IRA – Pro’s and Con’s

August 27, 2012 No Comments »
Setting Up a Self-Directed Roth IRA – Pro’s and Con’s

For many investors, mainstream options, like stocks, bonds, EFTs and mutual funds, monopolize their investment dollars. And, while these are popular options, there’s a less used investment that offers an interesting opportunity. It’s called a self-directed Roth IRA.

Not only does this investment shelter your earnings from taxes, like a traditional Roth IRA account, there’s more potential to earn a nice return. But, what is a self-directed Roth IRA, and how do you open this type of account?

What is a Self-Directed IRA? 

With a traditional Roth IRA, you benefit from tax free growth on your investment, instead of getting an upfront tax deduction. With this type of account, you can invest in stocks, bonds, certificates of deposit, mutual fund or a money market account. A self-directed IRA, however, is slightly different.

With a self-directed Roth IRA, you still enjoy the tax benefits. However, you get more flexibility in your investment options. You can invest in things other than securities registered with the federal or state government. For example, you might use funds from your self-directed Roth IRA to purchase rental property, put a down payment on an investment home, or invest in a business.

Where to Find a Self-Directed Roth IRA? 

The best way to open a self-directed Roth IRA is to call local financial services firms, to find out which ones offer this type of investment. Once you find a firm, you’ll fill out the necessary paperwork, which requires your name, date of birth, social security number, type of investment and beneficiary. After your account is established, you’ll need to fund it.

Once you establish the account, the IRS requires that all income and expenses flow through your self-directed Roth IRA account. You’ll need to work with your financial institution to follow the IRS rules closely, to avoid the account being stripped of tax-advantage features.

The Restrictions 

A self directed Roth IRA allows a lot of flexibility. However, there are some restrictions. For example, you can’t use self-directed Roth IRA funds to purchase a rental property, and rent it to yourself. Self dealing rules also prevent you from owning a business funded by your account. You also can’t have controlling interest in a business that you’ve funded. And, similarly, you can’t purchase a vacation home with funds – and use for personal benefit.

A Word of Caution… 

The Securities and Exchange Commission and the North American Securities Administrators Association issued an investor alert on self-directed IRA Fraud several months ago. Any person offering an investment should be checked out with the Security and Exchange Commission (SEC) and your state securities administrator.

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