Are Your Highest Growth Assets in the Right IRA?

For many investors, the conversation around Roth conversions centers around tax rates, and whether they’ll be in a lower tax bracket when they begin withdrawing their funds or if they’d preserve more wealth by paying taxes now.

But if you’re a self-directed investor who’s building wealth with alternative assets, there’s something else to consider: How much do you expect your assets to appreciate and how could that affect your decision?

How Does a Roth Conversion Work with Alternative Assets?

Converting alternative assets to a Roth IRA is a very similar process to converting traditional assets, but there are extra considerations with privately held or illiquid assets.

1. Determine the Asset’s Value. You must have your asset appraised to determine the fair market, current value of your asset. That amount is reported to the IRS and determines how much you pay in taxes.

2. Start the Transfer. Contact your custodian to begin the transfer process. With non-liquid assets, you will need to re-title the asset to your Roth account. It’s important to note that non-liquid assets can’t easily be split up, so you will likely have to convert the entire asset instead of partially.

3. Wait Five Years Before Withdrawing. Even if your Roth IRA has been open for more than five years, each conversion has its own five-year holding period. Depending on your age and other factors, withdrawing those converted funds too early could result in an early withdrawal penalty.

Roth conversions can also reduce future Required Minimum Distributions (RMDs) by lowering the amount of money held in tax-deferred retirement accounts. For investors who hold non-liquid alternative assets, such as real estate, smaller future RMDs may also make it easier to meet distribution requirements.

Understanding the Tax Implications of a Roth Conversion

Converting from a Traditional IRA to a Roth IRA can impact your taxes not just today, but also potentially decades in the future.

If you convert, you pay taxes on the converted amount today with non-retirement funds. Not only will that stretch your current finances, but could also push you into a higher tax bracket for the year.

While converting your investments to a Roth IRA today can help you continue to grow your wealth tax-free, many choose to keep their investments in a tax-deferred account because they expect to be in a lower tax-bracket in retirement. In that situation, you may end up paying more in taxes by converting your funds now than if you were to wait to make withdrawals.

What to Consider Before Making a Roth Conversion

One major consideration for a Roth conversion is the current value of your assets and how much you expect them to appreciate. The greater the appreciation potential, the more beneficial tax-free growth may be.

However, if the goal of the investment is wealth preservation rather than growth, some investors may consider keeping it in a tax-deferred account as they will be in a lower tax bracket when they withdraw funds in retirement. An asset’s value may increase for many reasons, including:

• Property renovation or development
• Zoning or entitlement approvals
• Business growth or sale
• Additional funding rounds for private companies

A Roth Conversion Example

Let’s look at two examples of Roth conversions.

Investor A is currently in the 22% marginal tax bracket, and they have a property in their Traditional IRA worth $200,000, among other investments. They expect it to appreciate significantly over time and decide to convert it to a Roth IRA and pay taxes on its current value.

Once they retire, they sell it for $400,000. Because they converted the property to a Roth IRA before it appreciated, they can make qualified withdrawals of the proceeds tax-free.

On the other hand, Investor B also has a property worth $350,000 inside their Traditional IRA, and they also keep it in that account. But their current marginal tax bracket is 32%.

Although they also expect their property to appreciate to $400,000, they anticipate being in a much lower tax bracket when they retire. By keeping it in their Traditional IRA, they expect to pay less taxes on withdrawals than if they had converted the property to a Roth IRA while they were still in a higher tax bracket.

Investing with a Self-Directed Roth IRA

A Roth conversion can be an important part of many investors’ retirement plans. It can help you preserve more of your investment’s future growth by paying taxes before it appreciates. It also allows the growth to remain tax-free, which is especially important if you expect to be in the same or a higher tax bracket in the future. Even non-liquid alternative assets like real estate can be converted into a Roth IRA.

However, conversions count as ordinary income, meaning that you must pay taxes with non-retirement funds, and converted amounts could place you into a higher tax bracket for the year.

If you’re eligible to contribute directly to a Roth IRA, you can invest in a self-directed Roth IRA from the beginning. Learn more about tax-free growth and tax-free withdrawals through self-directed Roth IRAs here. It is always a good idea to consult your specific situation with a tax professional.

Ready to get started with a rollover or transfer to a self-directed IRA? Talk to an IRA Counselor today.