The Pitfalls of Self-Directed Roth IRAs
If a typical Roth IRA doesn’t give you the investment opportunities you’re looking for, a self-directed Roth IRA might be of interest. However, you’d better know what you’re doing.


Tech mogul Peter Thiel made headlines in June after revealing he has $5 billion saved in a Roth IRA that he’ll never have to pay taxes on in retirement, and he did it in a rather unorthodox way. It’s unrealistic for an average person to amass that kind of wealth in IRAs, and more importantly, they should understand there’s a lot of risk in trying to follow his model.
Savers can contribute up to $6,000 a year to their Roth IRAs in 2021 (or $7,000 if they are age 50 or older), based on certain income limits. To contribute, single filers must have incomes below $140,000, and for those who are married filing jointly, their incomes must be below $208,000. There are ways to invest those funds to rapidly build a Roth IRA, but they are rare, and if it’s not done correctly, the account can be subject to huge tax penalties.
Building Your Roth IRA Nest Egg
Thiel and others who have successfully built their Roth IRAs to be worth millions (or billions) of dollars have done so by investing in start-ups before they go public. This is difficult — if not impossible — for most people simply because most Americans don’t have the connections and opportunities to invest in companies ahead of their public offerings. Even if you have access, 90% of start-ups fail, potentially leaving your Roth IRA vulnerable to increased risk.

Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Fortunately, there are specific types of Roth IRAs that make building wealth more easily accessible to investors. Self-directed Roth IRAs, for instance, give investors more freedom to invest in a greater variety of investments to grow their money. With a typical Roth IRA, savers are usually limited to mutual funds. But self-directed Roth IRAs can be used to invest in real estate and precious metals, as well as partnerships and tax liens.
With real estate investments within a self-directed Roth IRA, any rental income goes straight into the Roth IRA tax free. If you buy a home and later sell it through a self-directed Roth IRA, the profit goes back into your IRA until you begin distributions. If those distributions qualify under I.R.C. 590-B, they will be tax-free.
Prohibited Transaction Rules
While self-directed Roth IRAs can be profitable through real estate investments and private equity, incorrectly completed transactions may be subject to heavy tax penalties. One example is the sale or lease of property in a self-directed IRA. The owner of the IRA cannot initiate a transaction with a spouse, linear family member or a fiduciary. Even allowing a family member to live for free in one of your investment properties is not allowed.
If any prohibited transaction occurs, a 15% penalty tax on that transaction could apply. If that transaction isn’t corrected during the same tax year, you could receive a 100% penalty tax on the prohibited transaction. Furthermore, a prohibited transaction could cause your entire Roth IRA to lose its tax-free status. Ultimately, these violations are rare, but it’s important to be fully knowledgeable of the law when engaging in any of these transactions.
In addition, most investments in private companies or direct real estate require substantial capital. For most investors, this would consume most, if not all, of the value of those Roth IRA accounts, exposing the portfolio to unnecessary unsystematic risk. This could lead to a lower probability of meeting future financial objectives.
Disclaimer
Defined Financial Planning, LLC (“DFP”) is a registered investment adviser offering advisory services in the state(s) of California, Nevada, and in other jurisdictions where exempted. The following content is provided by DFP and is subject to change at any time without notice. The content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding your specific financial situation. Past performance may not be indicative of future results. All references to future rates of return are provided for illustration purposes only and are not guarantees of future performance. All investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful. California Insurance License #0L77279 and #4042728.
Disclaimer
Certified Financial Planner Board of Standards, Inc. (CFP Board) owns the CFP® certification mark, the CERTIFIED FINANCIAL PLANNER™ certification mark, and the CFP® certification mark (with plaque design) logo in the United States, which it authorizes use of by individuals who successfully complete CFP Board’s initial and ongoing certification requirements.
Disclaimer
The appearances in Kiplinger were obtained through a PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.
Get Kiplinger Today newsletter — free
Profit and prosper with the best of Kiplinger's advice on investing, taxes, retirement, personal finance and much more. Delivered daily. Enter your email in the box and click Sign Me Up.

As Principal and Director of Financial Planning, Sam Gaeta helps clients identify financial goals and make plan recommendations using the five domains of financial planning — Cash Flow, Investments, Insurance, Taxes and Estate Planning. He is responsible for prioritizing clients' financial objectives and effectively implementing their investment plans and actively monitors the ever-changing nature of clients' financial and investment plans.
-
6 Stunning Waterfront Homes for Sale Around the US
From private peninsulas to lakes, bayous and beyond, Kiplinger's "Listed" series brings you another selection of dream homes for sale on the waterfront.
By Charlotte Gorbold Published
-
Six Reasons to Disinherit Someone and How to Do It
Whether you're navigating a second marriage, dealing with an estranged relative or leaving your assets to charity, there are reasons to disinherit someone. Here's how.
By Donna LeValley Published
-
Should You Still Wait Until 70 to Claim Social Security?
Delaying Social Security until age 70 will increase your benefits. But with shortages ahead, and talk of cuts, is there a case for claiming sooner?
By Evan T. Beach, CFP®, AWMA® Published
-
Retirement Planning for Couples: How to Plan to Be So Happy Together
Planning for retirement as a couple is a team sport that takes open communication, thoughtful planning and a solid financial strategy.
By Andrew Rosen, CFP®, CEP Published
-
Market Turmoil: What History Tells Us About Current Volatility
This up-and-down uncertainty is nerve-racking, but a look back at previous downturns shows that the markets are resilient. Here's how to ride out the turmoil.
By Michael Aloi, CFP® Published
-
Could You Retire at 59½? Five Considerations
While some people think they should wait until they're 65 or older to retire, retiring at 59½ could be one of the best decisions for your quality of life.
By Joe F. Schmitz Jr., CFP®, ChFC® Published
-
Home Insurance: How to Cut Costs Without Losing Coverage
Natural disasters are causing home insurance premiums to soar, but don't risk dropping your coverage completely when there are ways to keep costs down.
By Jared Elson, Investment Adviser Published
-
Markets Roller Coaster: Resist the Urge to Make Big Changes
You could do more harm than good if you react emotionally to volatility. Instead, consider tax-loss harvesting, Roth conversions and how to plan for next time.
By Frank J. Legan Published
-
Why Homeowners Insurance Has Gotten So Very Expensive
The home insurance industry is seeing more frequent and bigger claims because of weather, wildfires and other natural disasters.
By Karl Susman, CPCU, LUTCF, CIC, CSFP, CFS, CPIA, AAI-M, PLCS Published
-
Going Through Probate? How to Find the Right Attorney
Just having the skills and experience to do the job isn't enough. The probate attorney you hire needs to have the right temperament for your particular case.
By John R. Silva, Esq. Published