The type or types of retirement accounts you use can impact many different aspects of your overall retirement planning. Different accounts have different contributions, different features, different limitations, and different types of tax advantages. In fact, the type of self-directed IRA you choose can even impact your timeframe for retirement.
The two types of self-directed IRAs are traditional accounts and Roth accounts, and they differ in a few key respects. First, a traditional self-directed IRA is subject to the IRS rules on required minimum distributions. This means that once you reach age 70½, you’ll need to begin making withdrawals from your account.
The amount of the required minimum withdrawal each year is calculated based on the balance in your account and your age. The annual minimum withdrawal amount can change significantly from year to year, for example, if your account experiences particularly large investment gains or losses. Roth IRAs, on the other hand, are not subject to this set of rules.
Having to follow the rules on required minimum distributions could impact a person’s investment timeframe in that it forces a person to take taxable withdrawals from their traditional self-directed IRA regardless of their actual income needs, regardless of whether they desire to continue working, and irrespective of their other retirement assets.
The type of self-directed IRA you choose can also impact the income you’re able to draw from your account each year.
With a traditional self-directed IRA, you’ll be subject to income tax on the distributions you take from your account. This means that when you’re planning your strategy for when and how much you’ll withdraw from your account in order to fund your living expenses during retirement, you’ll need to do some additional calculations to account for your tax liability.
For example, let’s say your annual budget for all your expenses is $50,000 per year. If your self-directed IRA is set up as a traditional account, then taking a $50,000 distribution is likely to yield perhaps only $40,000 or less. So in order to wind up with $50,000 you might need to take a distribution of perhaps $60,000 or $65,000 or more, depending on your individual tax situation. Once you take these factors into account, you may determine that your traditional self-directed IRA won’t last you as long as you assumed it would just by looking at your account balance, particularly when your tax situation can change from year to year.
Distributions from a Roth self-directed IRA during retirement are not subject to income tax, so the amount you have in your account is the amount you can use for planning your distributions in whatever way you see fit.
It’s true that when you make contributions to a Roth self-directed IRA you can’t deduct those contributions for your income tax return. But choosing a Roth account over a traditional account can give you greater retirement planning flexibility going forward.