If you have a self-directed IRA or 401(k) and want to convert it into a Roth IRA, you may be concerned about your options and taxes. These retirement accounts are taxed in different ways, and you'll want to be aware of the financial implications before you make any decisions. In addition, strategies such as a discounted Roth conversion can be helpful for accredited investors with IRAs that have over $1 million in value.

When considering a Roth conversion, you'll want to understand the difference between a self-directed IRA or 401(k) and a Roth IRA and what is involved in the process. It's also useful to be aware of discounting from a tax planning perspective so you know what's available.

If you have a self-directed IRA or 401(k), the contributions you make each year will be deducted from your taxable income. This could reduce your tax liability for the year, and the funds can grow tax-free within the account. When you take withdrawals in retirement, the amount you remove will be subject to income tax.

With a Roth IRA, you put in after-tax dollars, meaning you won't get a tax reduction during the year that you make a contribution. However, the money in the account and the earnings can grow tax-free over time, and your withdrawals won't be taxed either.

For individuals who have a self-directed IRA or 401(k), it might make sense for you to convert the taxable assets you have inside your traditional IRA to the tax-free environment of a Roth IRA, a process known as a Roth conversion.

When you convert the funds from the self-directed IRA or 401(k), you'll have to pay taxes on the amount before the new account becomes a tax-free Roth IRA. It will be treated as taxable income, and if you're in a high tax bracket or are pushed into a higher income tax bracket because of the distribution, this amount could be higher than if you were in a lower tax bracket.

Fair Market Value (FMV) discounting is a technique for alternative assets held in self-directed IRAs and 401(k) plans. It involves adjusting the reported value of assets based on several factors, including minority interests, lack of marketability, and fractional interests.

Privately held assets such as real estate and partnership interests are subject to valuation adjustments, whereas publicly held products like stocks, bonds, and mutual funds are generally not. An independent third party can create a well-supported appraisal to justify the discounts. When these adjustments are made, the assets' result can be a lower reported value. This, in turn, could lead to a reduced tax liability at the time of the Roth conversion.

You'll also want to understand the reporting requirements listed by the IRS. IRA custodians are required to report the FMV of IRA accounts annually, providing the IRS and the account holder with a snapshot of the account's value. Properly documenting the FMV of assets is necessary to report taxable distributions and withdrawals accurately.

Discounted Roth conversions offer a strategy that can help with tax planning. By implementing FMV discounting techniques, you could unlock tax savings and preserve your wealth so you can enjoy it tax-free in retirement and even pass it on to your heirs.

If you haven't heard your financial advisor offer this strategy during a tax planning session, it may be time to seek a second opinion.