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Roth IRA vs. Traditional IRA: Which One Works for You?

Roth IRA vs. Traditional IRA: Which One Works for You?

Estimated reading time: 4 minutes 

The most obvious difference between a Traditional IRA and a Roth IRA is how they are taxed upon distribution.

When you save for retirement using a Traditional IRA, your contributions are typically made out of pre-tax income. That gives you the immediate benefit of a lower tax bill. But that tax bill comes due when you begin taking distributions from the Traditional IRA. You will pay taxes on the distributions, based on your tax bracket in the year you take your distribution.

However, Roth IRAs have additional features that you may want to consider if you want to invest in real estate using an IRA.  

Three advantages that give Roth IRAs the edge for real estate investing:

1. No RMDs while the IRA holder is alive.

If you have a Traditional IRA, you have to start taking annual Required Minimum Distributions (RMD) the year in which you reach age 70 ½. There is no RMD requirement for Roth IRAs.  This means you don’t have to deplete your retirement assets even after attaining age 70 ½.

This difference is especially important when your IRA assets include real estate. A Traditional IRA account holder may face liquidity issues when she needs to take an RMD in cash. Failure to take an RMD means a 50 percent penalty on any amount not distributed.  RMDs involves calculating the value of the real estate assets to determine the correct amount to distribute.  This means additional costs such as an appraisal would not have to be incurred since RMDs are not required in a Roth.

Again, with a Roth IRA, you don’t have to take RMDs upon attaining age 70 ½. You don’t have to worry about liquidity or about valuation.

2. Roth distributions are tax-free.

The contributions you make to your Roth IRA do not reduce your taxable income.  This means that the contribution can be distributed at any time since they have been essentially taxed already.  Instead, you gain the benefit of tax-free withdrawals of the growth in the market value of the real estate assets held in your Roth IRA—which may be substantial.

Once you have owned your Roth IRA for at least five years and reach age 59 ½, or if you become disabled or die, no taxes are due on the distributions of earnings or growth from your account.

In a Traditional IRA, the increase in value would be taxed as you took RMDs.  This is another feature that makes Roth IRAs a good choice for real estate investors.

3. Your beneficiaries also enjoy tax-free distributions from your Roth IRA.

Here’s an example of how this works: Boris opened a Roth IRA in 2009 and used it to buy a rental property at a good price during the real estate downturn. In 2015, he passed away and the Roth IRA went to his beneficiary, Natasha. All of the assets Natasha inherits are tax-free since Boris has had the Roth for 5 years and has passed away.  As a beneficiary, here are options for Natasha on how to deplete the Roth IRA she inherited.  She could choose:

  • A complete lump-sum distribution tax-free
  • The five-year-rules option. This lets Natasha leave the assets in the Roth IRA until the fifth anniversary of Boris’s death in 2020. At that point, the assets are distributed in a lump sum tax-free
  • The life expectancy payment option: in this case, the assets do not have to be distributed in 2020, but instead Natasha must take an annual distribution, starting December 31st of the year following Boris’ death.  The annual distribution is calculated based on Natasha’s age.  Since the property is a rental property, if the income is enough to satisfy the annual distribution, she may never have to distribute the property during her lifetime. 

Two More Roth IRA Advantages Worth Considering

1. Flexibility.

You can withdraw the contributions made to a Roth IRA tax and penalty-free at any time. Even if you have not satisfied the criteria to distribute the earnings tax-free, you can withdraw some of the growth in value (after all the contributions have been distributed), penalty-free in certain circumstances. Examples include a $10,000-witthdrawal for the purchase of a first home or for post-secondary education expenses.

2. Contributions are allowed after age 70½.

If you want to keep on working past the “normal” retirement age, you can keep on contributing to a Roth IRA.

Transfer, Rollover, or Convert Your IRA Today

The first step to giving your retirement savings account a workout is opening a self-directed account. This gives you the flexibility to invest in assets like real estate. Once you’ve made that move, think about the advantages of a Roth IRA for real estate investing.

If you want to take your retirement savings workout to the next level, consider converting your Traditional IRA to a Roth IRA. Open a Self-Directed IRA under 10 minutes, here's how.


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Self-Directed IRAs:
The Basics Guide

Learn about your investment options, Self-Directed IRA rules, and much more!

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