At a recent MidAtlantic IRA National Strategy Call, Jack Kiley, CPA, walked through how these accounts are taxed and where self-directed investors have room to be strategic. Here are the ideas worth sitting with.
Start With Three Buckets
Every dollar you have lives in one of three buckets. The first is taxable: your paycheck, your savings account interest, your rental income, anything you own personally. The second is tax-deferred: Traditional IRAs, SEPs, SIMPLEs, and 401(k) plans, where you get a deduction now and pay tax when you withdraw later. The third, and the smallest, is tax-free: Roth accounts, where qualified withdrawals come out without tax.
Once you see your money this way, the real question stops being “Roth or Traditional?” and becomes “how do I move money between these buckets as efficiently as possible?” For alternative investors, there are more ways to do that than most people realize.
When Roth Makes Sense, & When It May Not
The conventional guidance holds up in a lot of cases. If you’re younger or in a lower tax bracket today, contributing to a Roth and locking in tax-free growth is often a strong move, especially for investments you expect to appreciate significantly.
But there’s a wrinkle that catches many entrepreneurs and real estate investors off guard. The standard assumption is that your income drops in retirement, which makes tax-free withdrawals later look attractive. For people who are self-employed or active in real estate, income often doesn’t drop. Many keep working as long as they want to, not as long as they have to. When that’s the case, the deduction you get today from a pre-tax contribution can be worth more to you now than tax-free treatment decades from now. It depends entirely on your own numbers, which is exactly why this is a conversation to have with your tax advisor.
Converting At A Discount
Here’s where alternative assets open a door that stocks and bonds don’t.
When you convert money from a Traditional account to a Roth, you pay tax on the fair market value of the asset at the moment you convert. With publicly traded holdings, fair market value is simply the market price. But alternative assets don’t always trade at face value.
Consider a private note held inside a Traditional IRA. If interest rates have risen since the note was written, or if the borrower has fallen behind, an appraisal may value that note well below its unpaid balance. Convert the note at that lower appraised value, and that is the amount you’re taxed on. If the note is later repaid in full, the difference flows into your Roth and is never taxed again. The same logic can apply to a property whose value has temporarily dropped, or to a partial ownership interest that carries a valuation discount for lack of control or marketability.
The result is what Jack calls a permanent timing difference: you pay tax on the lower value today, and the full recovery lands in the tax-free bucket. For investors who regularly see these situations, opportunities like this come up more often than you might think.
Why Roth is Becoming An Estate Planning Tool
There’s one more reason Roth deserves a fresh look, and it has to do with what happens after you’re gone.
Under rules that took effect after 2020, most non-spouse beneficiaries who inherit a Traditional IRA must drain the account within ten years. Depending on the size of the account and the heir’s own income, that can push them into high tax brackets and hand a meaningful share of the account to taxes.
Inherited Roth accounts don’t carry that tax bill. Distributions to beneficiaries remain tax-free. For families thinking about what they leave behind, gradually converting Traditional dollars to Roth in lower-income years can be a way to pass on more of what you built and less of a tax problem.
The Bottom Line
None of this is one-size-fits-all. Whether Roth or Traditional is right for you, and whether a conversion strategy makes sense, depends on your income, your tax bracket, the assets you hold, and your goals for retirement and beyond. The frameworks here are meant to help you ask better questions, not to hand you an answer.
MidAtlantic IRA, LLC serves as a self-directed IRA administrator and custodian. We’re here to educate and to help you understand what’s possible inside a self-directed account, and we’re always glad to talk through the mechanics with you and your advisors. For decisions about your own situation, please consult your tax and legal professionals.
Questions about your accounts, or curious what self-directed investing could look like for you? Reach out any time at hello@midatlanticira.com.