How Do I Build up my Self-Directed Roth IRA Fast?

One of the most popular questions we receive from our clients is how can I boost my Self-Directed Roth IRA as fast as possible.  Clearly, any smart investor understands that the more money in your Roth IRA, the more tax-free wealth you will have when you are over the age of 59 ½.  This article will explore the various ways one can boost their Self-Directed Roth IRA as fast as possible.

What is a Self-Directed Roth IRA?

A Self-Directed Roth IRA is a type of IRA that allows one to invest in alternative assets, such as real estate, and generate tax-free returns.  A Self-Directed IRA acts much the same as a Roth IRA, except it allows one to invest in more than just stocks and bonds.

A Self-Directed Roth IRA is a newest type of IRA that was created in 1997. It differs from a traditional, pretax plan in several ways. First and foremost, a Roth is funded with after-tax dollars. In other words, you don’t get an upfront tax deduction when making a contribution. However, all qualified distributions from the plan are tax free! For a distribution to be qualified, you must satisfy two things: reach the age 59 ½ and any Roth must have been open for at least five years.  This is the major advantage of the Self-Directed Roth IRA over a traditional plan.  So long as you satisfy the distribution requirements, you never pay a dollar in taxes, on both your contributions and the income generated by your investments.

Self-Directed Roth IRA Benefits

As we just alluded to, the primary benefit of a Self-Directed Roth IRA comes down to tax savings.  It can be argued that the Roth IRA is the best legal tax shelter still entrenched in the Tax Code. Roth IRAs offer a number of potential advantages over traditional IRAs. While traditional IRAs allow for tax-deferred growth of retirement assets and an upfront tax break, with a Roth, you’ll never have to deal with taxes again. Keep in mind, withdrawals may be subject to a 10% federal tax penalty if distributions are taken prior to age 59 ½.

Other features include:

• Unlike Traditional IRAs, you are not required to begin taking distributions at age 73
• Roth IRA contributions can be taken as a tax-free distribution at anytime
• A Roth IRA can be used as an estate planning tool because the assets can be passed on tax-free to your heirs
• Tax diversification of retirement assets allows for more flexibility to manage taxable income in retirement.

Related: Real Estate Investing with a Roth IRA

Self-Directed Roth IRA Contributions

There are three ways one can fund a Roth IRA: (1) contributions, (2) rollovers, and (3) conversions.

Contributions

For 2023, the maximum Roth IRA contribution limit is $6,500 or $7,500 if at least age 50.  Note – only individuals with earned income below $153,000, if single, or $228,000 if married filed jointly can make direct Roth IRA contributions.  Earned income includes all the taxable income and wages you get from working for someone else, yourself or from a business you own.

There is a legal work-around to making a Roth IRA contribution is your income is in excess of the annual income limitations. Beginning in 2010, there is no longer an income limitation on Roth conversions.  Enter the Backdoor Roth IRA conversion strategy.  Now, one who earns more than the Roth IRA income limitations, can make an after-tax IRA contribution and then immediately convert to Roth.  There would be no tax on the conversion from after-tax to Roth, although, if the individual had other pretax IRA funds at the time of the conversion, a percentage of the conversion would be taxable.

Related: Backdoor Roth IRA vs Mega Backdoor Roth IRA

Rollovers

One can rollover Roth IRAs between different institutions, as well as Roth 401(k) funds into a Roth IRA tax-free. Rollovers come in handy if you leave your job and want to take your 401(k) funds with you. Moving IRA funds from one custodian to another is technically called a transfer, but the same principle applies. The most common reason for rolling over (or transferring) retirement funds is the ability to make the investments you want. Your current plan provider may not allow for alternative investments, such as real estate or cryptos, so you elect to move those funds to a provider that will.

Conversions

One can convert pretax retirement assets to a Roth IRA. Traditional IRA funds can be converted at any time. If you wish to convert 401(k) funds, you need to first roll them over into an IRA before converting. Keep in mind that you need a triggering event to access those funds. Generally, you can’t move current 401(k) funds out of your employer’s plan.

Income tax would be due on the cash or fair market value of an asset converted to Roth. Essentially, the amount you convert is added to your adjusted gross income (AGI) during the year of the conversion. Obviously, this will increase your tax burden for the year. Keep in mind, you don’t have to convert everything all at once. You can decide to convert as little or as much as you want, depending on when you want to eat those taxes.

The taxpayer’s age, ability to pay the tax with non-retirement funds, and long-term investment expectations are deciding factors of when to convert.

Self-Directed Roth IRA Investment Strategies

It is not hard to understand that the most common tax strategy for Self-Directed Roth IRA investors is centered around acquiring low-valued assets with high upside in a Roth account so that all future gains will be tax free. Since the annual Roth contribution limits are quite small, the most common way to boost your Roth IRA fast (other than via conversion) is by making high-return investments. Massive returns from the Roth IRA flow back to the plan without tax and can begin to compound and grow via future investments. 

Starting in 1997, smart investors, such as Peter Thiel, saw the opportunity to take advantage of the Roth IRA benefits by owning start-up shares with high upside in the plan. The beauty of this investment strategy is that is can be employed for any investment asset, such as publicly traded stocks, real estate, private company stock, cryptos, and much more.

The framework for the Self-Directed Roth IRA investment strategy is simple:

1. Establish the plan
2. Fund the Roth IRA via contribution, rollover, or conversion
3. Identify an investment with high-upside or strong cash flow
4. Be patient and trust the process

Of course, investing a Self-Directed Roth IRA does not come with guaranteed returns.  The question is whether the reward outweighs the risk.  If it does, then making the investment in a Roth could make a lot of tax sense.  Take the case of Peter Thiel.

The Peter Thiel Story

Peter Thiel, a Stanford law graduate, ran a small hedge fund in the late 1900s. In 1999, single taxpayers were only allowed to contribute to a Roth if they made less than $110,000. Like many startups, PayPal offered its top executives low initial salaries and large stock grants. Thiel’s income that year was $73,263. While SEC filings describing that time don’t mention Thiel’s Roth, they show that he bought his first piece of the company in January 1999. Thiel paid just $0.001 per share for 1.7 million shares.

After a year, the value of his Roth jumped from $1,664 to around $3.8 million! Then, in 2002, eBay purchased PayPal and a legend was born. Thiel sold the shares, which were still inside his Roth. By the end of 2002, tax records show that Thiel’s Roth IRA was worth about $28.5 million. Before long, with smart investment decisions, the plan is rumored to be worth over $5 BILLION!

The Peter Thiel Roth IRA strategy has been utilized tens of thousands of times in various investment settings, from publicly traded stocks to real estate, and even cryptos.  The key is to buy a undervalued asset in the Roth, and have it rise in value so that all gains will be tax free.  As they say, the hardest part is waiting, but patience is a virtue.

Conclusion

The Self-Directed Roth IRA is arguably the most powerful and legal tax shelter around. Although you can’t directly contribute a lot to the plan on an annual basis, there are ways to build your Roth IRA up fast. Rollovers/conversion from other retirement plans are one way. The other, takes smart investing and a little bit of luck. All it takes is one home run to amass a tax-free fortune swiftly.