Adam Bergman

Founder, Tax Lawyer, Author

I’ve been a tax lawyer for more than 25 years, and I believe the Roth IRA is the greatest legal tax shelter available to American investors. I feel so strongly about it that I wrote a book called In God We Trust, In Roth We Prosper. A Roth IRA lets you invest after-tax money, potentially grow it into millions, and withdraw it completely tax-free if you follow a few relatively simple IRS rules. A Self-Directed Roth IRA takes that one step further, letting you invest in real estate, private equity, private businesses, cryptocurrency, and other alternative assets while keeping the same tax benefits. Here’s what every beginner needs to know.

What Is a Roth IRA?

A Roth IRA is a retirement account created under Section 408A of the Internal Revenue Code. A traditional IRA generally gives you a deduction today and taxes your withdrawals in retirement. A Roth IRA works in reverse: you contribute money that’s already been taxed, your investments grow tax-free, and qualified withdrawals are free of federal income tax.

Say you contribute $7,500 and invest it in an asset that grows to $100,000. If you satisfy the Roth distribution rules, you can withdraw the full $100,000 without paying federal income tax on the $92,500 of gains, and the result is the same if it grows to $1 million. The government doesn’t share in your future investment success. For anyone who thinks tax rates could rise over the next 10, 20, or 30 years, that’s an incredibly attractive deal.

Roth IRA vs. Self-Directed Roth IRA: What’s the Difference?

A Roth IRA and a Self-Directed Roth IRA follow the same IRS tax rules. The difference is what you can invest in. A Roth IRA at Fidelity, Schwab, or Vanguard generally limits you to publicly traded stocks, bonds, mutual funds, and ETFs. Those are perfectly good investments, but those firms generally won’t let you buy private real estate or a stake in a private business.

A Self-Directed Roth IRA is held by a custodian that permits a much broader range of assets, including:

• Residential and commercial real estate
• Private equity and venture capital
• Private businesses and startups
• Hedge funds and private investment funds
• Private lending and promissory notes
• Cryptocurrency, including Bitcoin
• Certain precious metals
• Tax liens and other alternative assets

I like to explain it this way: a Roth IRA gives you the tax benefits, and a Self-Directed Roth IRA gives you the tax benefits plus investment freedom. Self-directed doesn’t mean alternatives only, either. Depending on the provider, you may be able to hold stocks and ETFs alongside your alternative investments.

Who Can Contribute to a Roth IRA?

Almost anyone with eligible earned income can contribute, subject to IRS income limits. You can be an employee, a business owner, an independent contractor, or a teenager with a part-time job. You generally need taxable compensation such as wages or self-employment income, since investment income alone doesn’t count. A spouse without earned income may also contribute under the spousal IRA rules if you file jointly. There’s no maximum age, so as long as you have eligible compensation, you can keep contributing at 73, 80, or beyond.

Self-Directed Roth IRA Contribution Limits for 2026

For 2026, the IRS allows you to contribute up to $7,500 to a Roth IRA, plus a $1,100 catch-up contribution if you’re 50 or older.

These limits apply to your combined traditional and Roth IRA contributions, and you can’t contribute more than your earned income for the year. You also have until April 15, 2027, to make your 2026 contribution, so just tell your custodian which tax year it’s for.

Direct contributions phase out based on your modified adjusted gross income (MAGI):

Within the range, your allowed contribution shrinks, and above it you can’t contribute directly. But I always remind investors that a high income doesn’t lock you out of a Roth IRA.

The Backdoor Roth IRA

The backdoor Roth IRA is one of my favorite strategies for higher-income Americans. The IRS limits who can contribute directly to a Roth, but there’s no income limit on converting traditional IRA money to a Roth. So you make a nondeductible, after-tax contribution to a traditional IRA and then convert it.

Say you’re 45 and earn $300,000 a year. You can’t contribute directly, but you can contribute $7,500 to a traditional IRA on a nondeductible basis and convert it. If you have no other pre-tax traditional, SEP, or SIMPLE IRA balances and the money hasn’t generated gains, the conversion may create little or no tax. The catch is the IRS pro rata rule. If you hold other pre-tax IRA money, part of the conversion may be taxable even though you’re converting after-tax dollars. I walk through whether it makes sense for you in Is a Backdoor Roth IRA Worth It?

How Roth IRA Conversions Work

A Roth conversion moves money from a traditional IRA or other eligible pre-tax account into a Roth IRA. You pay ordinary income tax on the taxable amount converted, and the money grows tax-free from then on. There’s no income limit and no annual dollar cap, so you could convert $25,000 or $1 million in a single year. The more you convert, of course, the more tax you owe.

I’ve used Roth conversions to move my own retirement savings into Roth accounts, but I didn’t convert everything at once. I converted amounts over several years based on my tax situation and available cash. With a $500,000 traditional IRA, you might convert $50,000 this year and $75,000 next year, managing your bracket while steadily building tax-free savings.

Market downturns can also create good conversion opportunities. If an asset drops in value and you expect it to recover, converting at the lower value reduces the tax while letting the rebound happen inside the Roth. Just remember the tax is real, a recovery isn’t guaranteed, and conversions generally can’t be undone.

The Roth IRA Five-Year Rules

This is one of the most misunderstood parts of the Roth IRA, because there are two separate five-year rules.

The five-year rule for tax-free earnings. To withdraw earnings tax-free, you generally must be at least 59½ and have satisfied a five-tax-year holding period. The clock starts January 1 of the tax year of your first Roth contribution or conversion. If you fund your first Roth IRA for tax year 2026, the requirement is met on January 1, 2031. Death, disability, and a qualifying first-home purchase can also satisfy the rules before 59½.

The five-year rule for conversions. Each conversion has its own five-year period, but it mainly matters for the 10% early withdrawal penalty if you’re under 59½. Once you’re 59½, you can generally withdraw converted amounts without tax or penalty even if the conversion was recent. For example, if you’re 62, opened your first Roth IRA in 2015, and convert $500,000 in 2026, the converted amount and later earnings can come out tax-free right away. You’d still owe tax on the conversion itself.

Rolling a Roth 401(k) into a Roth IRA has a wrinkle. The years in the 401(k) generally don’t count toward the Roth IRA’s clock. If you already have a Roth IRA, its existing clock applies, and if you don’t, a new clock usually starts with the rollover. That’s why I encourage people to open and fund a Roth IRA as early as possible, even with a small amount. I cover the details in The Roth IRA Five-Year Rule Explained.

Can You Withdraw From a Roth IRA Before 59½?

Yes. You can withdraw your regular contributions at any time, for any reason, without tax or penalty. If you’ve contributed $50,000 and the account is worth $90,000, you can generally take out the $50,000. The IRS treats Roth withdrawals as coming out in a set order: regular contributions first, then conversion and rollover amounts, then earnings. Early withdrawals of earnings may face income tax and a 10% penalty unless an exception applies, such as a qualifying first home, certain education or medical expenses, or disability.

I don’t recommend treating a Roth IRA as an emergency fund, since every dollar you take out stops compounding tax-free. And if your Self-Directed Roth IRA owns real estate or a private fund, you may not be able to get cash quickly even when a withdrawal would be tax-free.

No Required Minimum Distributions

Traditional IRA owners generally must start required minimum distributions at 73, or 75 for those born in 1960 or later, whether they need the money or not, and those withdrawals are taxable. Roth IRAs have no RMDs for the original owner during their lifetime. You can leave the account invested at 75, 80, or 100, letting it keep growing tax-free and potentially become a meaningful asset for your children.

How a Roth IRA Can Help With Medicare Premiums

Medicare uses your income to decide whether you pay higher premiums under the Income-Related Monthly Adjustment Amount, or IRMAA. Traditional IRA withdrawals and Roth conversions raise the income used in that calculation, but qualified Roth withdrawals don’t. If you’re retired and need an extra $100,000, taking it from a traditional IRA could push your Medicare premiums higher, while a qualified Roth withdrawal generally won’t. It’s one more reason the Roth becomes more valuable as you get older.

How Inherited Roth IRAs Work

This is one of my favorite Roth benefits from an estate-planning standpoint. Under the SECURE Act, most non-spouse beneficiaries, including adult children, must empty an inherited Roth IRA by the end of the tenth year after the owner’s death. But for beneficiaries under the standard ten-year rule, there are generally no annual RMDs during those ten years. Your child could leave the entire account invested for a decade and withdraw it all at the end, and if the Roth’s five-year requirement has been met, the whole amount is generally free of federal income tax.

Say your child inherits a $1 million Roth IRA that averages 8% a year for ten years. It could grow to about $2.16 million, all potentially tax-free. Returns are never guaranteed, and certain beneficiaries, such as a surviving spouse, minor children, disabled or chronically ill individuals, and those not more than ten years younger than the owner, have special rules. Trusts and estates can face different requirements too. For me personally, the chance to leave my children a tax-free inheritance at a time when tax rates could be higher is one of the Roth’s most attractive features.

What Can a Self-Directed Roth IRA Invest In?

The tax code doesn’t limit IRAs to publicly traded stocks and bonds. It mainly lists what’s prohibited, so a properly structured Self-Directed Roth IRA can invest in a wide range of alternatives. Your Roth could buy a rental property, collect the rent, and keep the rental income and appreciation tax-free, assuming the deal doesn’t trigger UBIT. It could invest in a private startup, and if that company takes off, the gains could stay entirely tax-free. The same idea applies to private equity, venture capital, private lending, and cryptocurrency. Imagine buying Bitcoin or shares of a promising private company in a Roth years before they appreciate.

Alternative assets can also be risky, illiquid, hard to value, and vulnerable to fraud. A custodian agreeing to hold an investment doesn’t mean it has reviewed or approved it, so understand both the investment and the account rules before you move forward.

Self-Directed Roth IRA Prohibited Transaction Rules

A Roth IRA can invest in almost anything except life insurance, collectibles such as art, and transactions that directly or indirectly benefit a “disqualified person.” Under Internal Revenue Code Section 4975, disqualified persons include you, your spouse, parents, grandparents, children, grandchildren, and certain related entities and fiduciaries. The IRS prohibited transaction rules spell out the details.

In practice, you can’t use your Roth IRA to buy a vacation home your family uses, buy property from yourself or certain relatives, or personally borrow from the account. If your Roth owns a rental, you generally can’t do the repairs yourself, so the IRA should pay unrelated third parties. The idea is simple: your Roth IRA invests for your retirement, not your current personal benefit. A prohibited transaction can cause the entire IRA to lose its tax-advantaged status, which is why working with an experienced Self-Directed IRA provider and tax adviser matters here.

Can a Self-Directed Roth IRA Owe Tax? Understanding UBIT

Yes. Certain investments can trigger unrelated business income tax, or UBIT, even inside a Roth. The two big triggers are:

• Active businesses held through pass-through entities. If your Roth invests in an LLC or partnership running an operating business, part of the income allocated to the IRA may be taxable.
• Debt-financed investments. If your Roth buys rental property with a nonrecourse loan, part of the rental income and part of the gain on sale may be taxed under the unrelated debt-financed income, or UDFI, rules.

These taxes are paid at trust rates, which reach the top 37% federal bracket at relatively modest income levels. An IRA with $1,000 or more of gross unrelated business income generally must file IRS Form 990-T, even if the final tax is low or zero. None of this means you should avoid alternatives. It means you need to understand how each investment is structured. A fund operating through a C corporation, for example, can produce a different UBIT result than a partnership, though corporate-level tax reduces returns. I explain how this works for leveraged real estate in UBIT and UDFI Explained. In my experience, understanding UBIT is one of the biggest differences between a traditional brokerage firm and a provider that specializes in alternative investments.

How to Open and Fund a Self-Directed Roth IRA

Opening an account is simple. You choose a Self-Directed IRA custodian that supports the investments you want, complete the Roth IRA application, and then fund the account in one of four ways:

• A regular annual contribution, subject to the limits above
• A direct transfer from an existing Roth IRA, which generally isn’t taxable
• A rollover of eligible Roth 401(k) funds
• A Roth conversion of traditional IRA or other pre-tax money, paying tax on the amount converted

Once it’s funded, you direct the custodian to make the investments you choose. Some investors use a Roth IRA LLC, often called checkbook control, for more flexibility, but an LLC doesn’t remove the prohibited transaction rules, tax reporting, or recordkeeping. For beginners, I generally recommend starting with a straightforward Self-Directed Roth IRA and adding complexity only when your strategy calls for it. At IRA Financial, we charge a flat $495 a year for a Self-Directed IRA with no asset value fees, so your cost doesn’t rise as your Roth grows.

Common Self-Directed Roth IRA Mistakes to Avoid

After more than 16 years helping Americans with self-directed retirement accounts, I see the same avoidable mistakes again and again:

• Assuming a Roth can’t hold alternatives. It absolutely can, as long as the investment is permitted and properly structured.
• Thinking high earners are shut out. Conversions and the backdoor Roth IRA keep the door open.
• Misreading the five-year rules and withdrawing earnings before they qualify as tax-free.
• Ignoring prohibited transactions and UBIT, especially with leveraged real estate and pass-through businesses.
• Running out of liquidity. A Roth that owns a rental needs cash for taxes, insurance, and repairs, and you generally can’t just pay those bills personally.
• Confusing tax benefits with investment quality. A bad investment doesn’t become a good one because it’s in a Roth.

Focus on assets you understand, do your due diligence, and build a diversified retirement portfolio.

Final Thoughts

As a tax lawyer, I’ve always seen retirement planning as more than accumulating investments. It’s about controlling how much of your wealth you ultimately keep. A traditional account gives you a tax break today and a tax bill later. A Roth IRA reverses that: you pay tax upfront in exchange for decades of potential tax-free growth, no lifetime RMDs, more flexibility in retirement, and the chance to leave your children a tax-free inheritance. A Self-Directed Roth IRA adds the freedom to pursue real estate, private equity, private businesses, and crypto while keeping those advantages.

I don’t believe everyone should convert their entire traditional balance to Roth immediately, since the conversion tax, your current and future brackets, and your time horizon all matter. But I do believe every American should understand the Roth IRA and seriously consider making it part of their plan. I built my own retirement savings around Roth accounts for exactly these reasons, and after more than 25 years as a tax lawyer, I still believe the Roth IRA is one of the greatest wealth-building tools Congress has ever created.

This content is for educational purposes only and does not constitute legal, tax, or investment advice. Consult a qualified professional before making any investment decisions.