Four Reasons to Convert to a Self-Directed Roth IRA | Think Realty | A Real Estate of Mind
Investing Strategies

Four Reasons to Convert to a Self-Directed Roth IRA

Hint: the benefits go beyond taxes

Some Investment Advisors tell their clients to not use a Roth IRA but a Traditional IRA instead. Their logic is with a Traditional IRA, the client gets a deduction for the amount of their contribution in the current year. Of course, in the future, the distributions from that IRA account will be taxable. Their theory is, when it is time for the distributions you will be in a lower tax bracket. I agree, in some cases, this could be true. However, is the investment advisor really saying to their client, “Stick with me and someday you will be in the lowest income tax bracket?”

The reality is that investors never stop making investments. Just when other people are retiring and watching their income drop to nothing, investors are entering their largest earning days and their earning power will keep snowballing. In other words, investors never achieve the goal on zero income. Instead, they can easily find themselves spending the last 30 or 40 years of their life not in the lowest but in the highest tax bracket. By using a Roth IRA, the investor does not just move themselves to a lower tax bracket in the future, they move themselves into a 0% tax bracket (on the earnings made in their Roth IRA). There is no doubt, if a person expects to keep earning money (from investments), a Roth IRA is the greatest opportunity Congress could have ever handed them.

Advantages of converting from a Traditional IRA to a Roth IRA or  Advantages of converting a Retirement Plan from a former employer to a Roth IRA

  1. Pay tax on the seed, not the tree. If you believe the investments your IRA will be making have growth potential, your choice is clear. You can pay the tax now before the value grows or wait until the investment appreciates to pay a tax bill based on a higher valuation. (It’s a no brainer).
  1. Which way are taxes headed in the future? If you perform a Roth IRA Conversion now, you will pay the current income tax rates for your conversion. If you keep your Traditional IRA, you will be taxed at the income tax rates as they will be in the future. Which way to you believe income tax rates will go? In the future, do you believe tax rates be lower than they are today or higher? Converting locks in today’s rate. Some economists believe income tax rate risk is greater than investment risk.
  1. Tax-free distributions as early as one day after a Roth Conversion. Many people believe that money in an IRA is locked up. Not true, there is no “lock-up.” Here is an example.
    Sam (age 48) sees a good investment opportunity. He wants to use his IRA to make the investment. Because the profits could be good, Sam decided to convert his $80,000 Traditional IRA to a Self-Directed Roth IRA account so he can avoid the bigger tax bill in the future. Sam’s Roth IRA makes the investment. Nine months later the IRA cashes out of the investment for $175,000.
    However, a family need comes up and Sam could use $50,000. But his money is tied up in the IRA.
    Sam calls our office, and says he wants to take a distribution of $50,000. He knows because he is not yet 59 ½, he’ll get clobbered with taxes. We send Sam the $50,000 he requested.
    How much income tax will Sam pay on the $50,000? Zero. Because of FIFO accounting, the distribution we send to Sam was from the $80,000 he originally converted to the Roth (not from the profits made by the IRA). (The amount of a Roth IRA conversion may be distributed to the account owner any time with no additional income tax due.) Yes, Sam will still pay the 10 percent early distribution penalty; however, there will be no income tax due on the distribution as there would have been with the Traditional IRA. (If Sam were over 59½, even the 10 percent penalty would go away.)
  1. Your Beneficiaries will thank you if you convert to a Roth IRA.
    Here is another example. Ben is proud of how he has built his Traditional IRA. He started with very little and by making regular contributions and good investments, today he has an IRA with 12 houses all generating a positive cashflow.
    Ben passes, leaving his IRA 50%-50% to his two adult children. Should the children decide to sell the houses and liquidate the IRA, they will have a substantial taxable event. Why? Because an IRA retains its tax treatment. As this was a Traditional IRA, the “distribution” from Dad’s IRA is a taxable event.
    Alice is proud of how she has built her Self-Directed Roth IRA. She started with very little and by making regular contributions and good investments, today her IRA holds 12 houses all generating a good cas flow.
    Alice passes, leaving her IRA 50%-50% to her two adult children. Should the children decide to sell the houses and liquidate the IRA, the adult children will have NO taxable event. Why? Because the IRA retains its tax treatment. As Alice had a Roth IRA, the “distribution” is not a tax able event.

The above are just four of the advantages to making your investment with a Roth IRA. There are others. Roth Conversions can save you hundreds of thousands in taxes.

Dennis Blitz is a recognized authority on Self Directed IRA and Solo 401(k)s. He is an author, national speaker, and President of IRA Club. Today IRA Club has thousands of members successfully investing their IRA and Solo 401(k) money in: Real Estate, Making Hard Money Loans, Private Placements, Agricultural Land, Life Settlements, Pre IPO-Stocks, and more.