Deciding to open a self-directed IRA with a custodian such as Quest Trust Company is a prudent financial choice. With the expanded range of investment choices that you have with a self-directed IRA (as compared to an IRA with a traditional custodian or a 401(k) at work), you’ll have the greatest opportunity to invest in the precise asset types you desire.
But even after you’ve decided to open a self-directed account, you still have another choice to make – whether to form that account as a traditional IRA or as a Roth IRA.
It’s a bit of an oversimplification, but essentially you’re faced with a choice. You can choose to save taxes now, or potentially save much more money later.
With respect to traditional IRAs, many retirement savers are initially drawn to them because they can provide a current year tax deduction for the contributions you make, depending on your income level and whether you’re covered by a retirement plan at work.
For example, if you’re a single taxpayer and you are covered by an employer retirement plan, then you’ll have a full or partial deduction based on your contribution if your modified adjusted gross income is $71,000 or less. A married taxpayer will have a full or partial deduction if the couple’s modified adjusted gross income is $118,000 or less.
Single taxpayers who are not covered by a plan at work can take a full deduction regardless of their income, while a married taxpayer who isn’t covered by a plan, but whose spouse is, as available tax deduction if the couple’s modified adjusted gross income is $193,000 or less.
While the current year tax deduction might seem irresistible, it is important to weigh it against the value you could derive from a self-directed IRA that’s set up as a Roth account. Roth IRAs allow you to take distributions from your account during retirement on a completely tax-free basis. With a traditional IRA, all distributions are taxable. It can be hard to give up a financial benefit this year for one that you might not realize for several decades, but the difference can be significant, and many retirement savers choose Roth accounts precisely for this reason.
In addition, it’s important to take a look at what you would do with the funds you save from a current year tax deduction to a traditional self-directed IRA. For example, if you invest your tax savings wisely, particularly if it’s in an investment that doesn’t throw off dividends or income or otherwise create a new ongoing tax burden, then that’s a good thing. Similarly, if you use that additional current cash flow to help pay for your child’s college expenses so that you don’t have to take out any funds to do so, then that might be a good financial decision.
But if you instead use the money for entertainment or something else that doesn’t provide you or your family with any lasting economic value, then you may wish to reconsider the true value of that tax deduction, and make your contribution to a Roth self-directed IRA instead.