Investors looking to diversify their retirement savings by opening a self-directed IRA face the same dilemma other IRA investors face: Which IRA type will provide more income in retirement?

What is a Roth IRA?

A Roth IRA is a retirement account that allows individuals to make after-tax contributions into an account and then withdraw the money tax-free. Only a few withdrawal restrictions or requirements exist for Roth IRAs. *

How does a Roth IRA differ from a traditional IRA?

In a traditional IRA, for 2011, anyone with an earned income can contribute up to $5,000 annually ($6,000 for individuals age 50 and older). Individuals may only contribute to a traditional IRA until the age of 70 ½ and must begin to withdraw funds at the same age. Contributions are made with pre-tax dollars and are taxed as ordinary income when they are withdrawn.

In a Roth IRA, in 2011 contributions can be made by single filers with a modified adjusted gross income up to $122,000, or couples up to $179,000 of income. Like the traditional IRA limits, individuals may contribute up to $5,000 annually ($6,000 for individuals age 50 and older). Roth IRAs have no age thresholds on contributions and distributions. Contributions are made with post-tax dollars and are tax-free when withdrawn from the account.

What is the difference between a Roth IRA, a Traditional IRA, and a self-directed IRA?

A self-directed IRA is simply an individual retirement account that can be invested in a broad range of alternative assets such as real estate, trust deeds/mortgages, limited liability companies (LLCs) and limited partnerships (LPs), non-exchange traded REITs, hedge funds and offshore funds. A self-directed IRA can be funded with pre-tax dollars (a Traditional IRA) or after-tax dollars (a Roth IRA).

What are the benefits of a Roth IRA?

For most investors, the primary benefit is the tax-free growth of assets in the account. Contributions are made at today’s tax rates with post-tax dollars. Withdrawals, provided they are deemed as qualified distributions, are tax-free. Paying taxes now rather than later may interest those who expect to be in a higher tax bracket at retirement, this may occur due to increased future tax rates or other reasons such as loss of various deductions such as mortgage interest and children.

Some additional benefits of a Roth IRA include:

No mandatory distribution requirements for the IRA owner.

Beneficiaries can inherit the Roth IRA tax-free.

Contributions can be withdrawn at any time without penalty.

Contributions may be made to a Roth IRA even if the account owner is also participating in a qualified retirement plan such as a 401(k). (Contributions may be made to a Traditional IRA, but they may not be tax deductible.)

Money converted from a traditional IRA to a Roth IRA can be withdrawn without penalty, as long as the "seasoning" period (currently five years) has passed on the converted funds.

As federal and state budget deficits grow, so do concerns that tax rates will rise, however, no one can predict what will happen to tax rates in the future. Converting to a Roth IRA locks in the taxes you pay today when you have control over your income. During retirement, your income will be determined by the performance of your investments, and each dollar withdrawn will be free of taxation.

Converting a Traditional IRA to a Roth IRA

To convert a Traditional IRA to a Roth IRA requires paying taxes on the Traditional IRA amount (either using all or some of your IRA funds) and then depositing the balance in a Roth IRA account. Your decision to convert to a Roth IRA depends on your income (now and in retirement) and preference to pay taxes now versus in retirement.

If you are considering converting to a Roth IRA, you should talk to your financial planner or tax advisor to determine if the move is right for your particular situation.

*The account must be open for at least five years for principal withdrawals and the owner’s age must be at least 59 ½ for withdrawals on the growth portion of your account.