Named for Delaware Senator William Roth and established by the Taxpayer Relief Act of 1997, a Roth IRA is an individual retirement arrangement (a type of qualified retirement plan) that bears many similarities to the Traditional IRA. The biggest distinction between the two is how they’re taxed. A Roth IRA allows the assets held under the ownership of the Roth IRA to grow without being taxed and allows the distributions to be Tax Free.
Suppose I had bought Income Producing Real Estate through my Roth IRA. So, I own the Roth IRA and the Roth IRA owns the House or Apartment Building that I bought… this means I don’t pay any Capital Gains taxes on the growth of my asset and I don’t pay any Income Tax on the money I take as a distribution or withdrawal from my Roth IRA. What more can anyone ask for?
Roth IRA buys: House for $1,000,000 in 2005.
Roth IRA collects Rental Income: The House produces Rental Income of $40,000 per Year.
Roth IRA Value at the Time of Sale: House sells for $2,100,000 in 2019.
Capital Gain: $1,100,000
Income of 14 Years: $560,000
TAX FREE Distribution: $1,660,000
* Qualified Distributions & UBIT apply
Traditional IRA contributions are generally made with pretax dollars; you usually get a tax deduction on your contribution and pay income tax when you withdraw the money from the account during retirement. Conversely, Roth IRAs are funded with after-tax dollars; the contributions are not tax deductible – although you may be able to take a tax credit (Savers Credit) of 10 to 50% of the contribution, depending on your income and life situation. But when you start withdrawing funds, qualified distributions are tax free. Similar to other individual retirement plan accounts, the money invested within the Roth IRA grows tax free. Other defining characteristics of a Roth:
Contributions can continue to be made once the taxpayer is past the age of 70½, as long as he or she has earned income.
The taxpayer can maintain the Roth IRA indefinitely; there is no required minimum distribution (RMD) during the account holder's lifetime.
Eligibility for a Roth account depends on income.
A Roth IRA must be established with an institution that has received IRS approval to offer IRAs. Self Directed ROTH IRAs must be opened with an institution that has received IRS approval and has the capability to administer the type of asset you wish to hold in your ROTH IRA. The Entrust Group or New Horizons are two Self Directed Retirement Plan Administrators that I like to use with my clients.
A Roth IRA can be established at any time. However, contributions for a tax year must be made by the IRA owner’s tax-filing deadline, which is generally April 15 of the following year. Tax-filing extensions do not apply.
There are two basic documents that must be provided to the IRA owner when an IRA is established:
-the IRA disclosure statement
-the IRA adoption agreement and plan document
These provide an explanation of the rules and regulations under which the Roth IRA must operate, and establish an agreement between the IRA owner and the IRA custodians/trustee.