If you’re new to investing, the world of IRAs can seem pretty confusing. But don’t worry—we’re here to help. In this blog post, we’ll give you a crash course on everything you need to know about what is a self-directed IRA.
By the end, you’ll be an expert on this type of retirement account and know whether it’s right for you.
What is a Self-Directed IRA?
A self-directed IRA is a tax-advantaged account that gives investors more control over their investments than a traditional IRA.
With a traditional IRA, investors are limited to investing in stocks, bonds, and mutual funds.
But with a self-directed IRA, investors can choose from a wider range of investment options, including real estate, precious metals, private equity, and more.
Self-directed IRAs also offer greater flexibility when it comes to how your money is invested.
With a traditional IRA, your money must be invested through a financial institution like a bank or brokerage firm.
But with a self-directed IRA, you can choose to invest your money yourself or through a third-party manager.
Types of Self-Directed IRAs
There are two main types of self-directed IRAs: traditional and Roth.
Both have their own unique benefits and drawbacks, so it’s important to understand the difference between them before deciding which is right for you.
Traditional Self-Directed IRA
- With a traditional self-directed IRA, contributions are made with pre-tax dollars.
- This means that you can deduct your contributions from your taxes in the year in which they are made.
- The money then grows tax-deferred until you reach retirement age, at which point you will pay taxes on withdrawals.
- One benefit of this setup is that it can help lower your overall tax bill in the present day.
Roth Self-Directed IRA
- With a Roth self-directed IRA, contributions are made with after-tax dollars.
- This means that you cannot deduct your contributions from your taxes in the year in which they are made.
- However, the money then grows tax-free until you reach retirement age.
- When you make withdrawals in retirement, they will also be tax-free.
- One benefit of this setup is that it can provide tax-free income in retirement.
How Are Self-Directed IRAs Different From Regular IRAs?
The main difference between a self-directed IRA and a regular IRA is who controls the investments within the account.
With a regular IRA, the financial institution that holds the account—typically a bank, brokerage firm, or mutual fund company—makes the investment decisions on your behalf.
With a Self-Directed IRA, on the other hand, you are in control of your own investments.
Another key difference between these two types of retirement accounts is the types of investments that you can hold in each.
A regular IRA generally only allows you to invest in stocks, bonds, and mutual funds.
However, with a Self-Directed IRA, you can also invest in alternative assets such as real estate, precious metals, and private equity.
Lastly, there are differences in the fees associated with each type of account.
Typically, regular IRAs have higher fees than Self-Directed IRAs because there is more work involved in managing them.
However, this is not always the case—it depends on the financial institution that you use.
Which Type Of Asset Classes You
Can Own in a Self-Directed IRA
- Generally speaking, most types of investment assets can be held in a self-directed IRA. This includes:
- Traditional investments like stocks, bonds, mutual funds, annuities, unit investment trusts (UITs), exchange-traded funds (ETFs), etc.
- It also includes alternative investments like real estate, private equity, and cryptocurrency.
- The main restriction on what can be held in a self-directed IRA is that the account cannot be used for personal gain.
- This means that no one—not even the account holder—can directly benefit from the assets held in the account.
- For example, especially with real estate, you could not buy a rental property with your self-directed IRA and then live in that property rent-free or put it out for rentals.
- Doing so would be considered a prohibited transaction and would result in penalties from the IRS.
Can’t Own in a Self-Directed IRA
- There are also some types of assets that are explicitly prohibited by the IRS. These include:
- Life insurance policies
- Collectibles like artworks, rugs, antiques; metals and gems; stamps, coins, and alcohol
- Derivative trades that come with unlimited or immeasurable risk, such as writing naked calls or employing ratio spreads
- A self-directed account owner can purchase real estate; however, they cannot directly benefit from the property in terms of receiving rental income or living in the purchased home
- A few coins
- Prohibited transactions such as lending money from your IRA funds, selling/leasing/exchanging properties you own, transferring assets/supplying goods or services/extending IRA credit to disqualified persons
- S-Corporation stocks as these are not allowed to have more than 100 shareholders
- Unrelated business income tax (UBIT), fair market valuations (FMV), etc
Tax, Contribution, And Withdrawal Rules
There are some key rules to be aware of when it comes to taxes, contributions, and withdrawals.
- Annual contribution limits apply to your total IRA deposits for all accounts. This means that you can’t put more than the limit into your IRA in any given year.
- Withdrawal limitations also apply – if you withdraw funds before age 59 1/2 without qualifying for an exception, you will owe a 10% penalty + normal income taxes.
- Finally, starting at age 72, you have to take the required minimum distributions (RMDs). The amounts you must withdraw annually are based on your year-end account balance and your life expectancy.
Related: 7+ Gold IRA Tax Rules To Live By
Self-Directed IRAs Pros and Cons
Self-directed IRAs offer investors more control over their retirement savings, but they also come with some downsides.
Here are some of the pros and cons of self-directed IRAs to consider before opening one:
- More control over your investments
- Choose from a wider range of investment options
- Invest your money yourself or through a third-party manager
- Save on fees by investing directly yourself
- Need to pay higher fees if you use a third-party manager
- Need to pay set-up costs if you open a self-directed Roth IRA
- You’ll be responsible for making sure your investments are compliant with self-directed IRA rules
How to Open an SDIRA?
Opening a self-directed IRA is a simple process that can be done online in less than 15 minutes.
In this section, we will walk you through the steps on how to open a self-directed IRA so that you can take control of your retirement savings.
Step 1: Choose the Right Self-Directed IRA Custodian
There are many IRA financial institutions that offer self-directed IRAs and provide investment advice, so it’s important to do your research and compare your options before selecting a custodian.
Some things you’ll want to consider include account fees, minimum balance requirements, and the types of investments allowed.
Once you’ve selected a provider, you’ll need to open an account and fund it with either cash or assets from another retirement account.
Step 2: Determine Your Eligibility
Not everyone is eligible to open a self-directed IRA. In order to qualify, you must meet the following criteria:
You must be age 18 or older
- You must have earned income from employment or self-employment
- You cannot be claimed as a dependent on another person’s tax return
- If you meet all of the above criteria, you can proceed to step 3.
Step 3: Review the List of Eligible Investments
As we mentioned earlier, a self-directed IRA gives you the ability to invest in a wider range of alternative assets than a traditional IRA.
However, there are still some restrictions in place.
For example, you cannot use your self-directed IRA to invest in life insurance policies or collectibles such as art, antiques, coins, or stamps.
To learn more about eligible investments, consult your financial advisor or review IRS Publication 590-A.
Step 4: Start Investing!
Once you’ve reviewed the list of eligible investments and chosen one that aligns with your financial goals, it’s time to start investing!
Remember, with a self-directed IRA YOU are responsible for making investment decisions—so be sure to do your homework and only invest in what YOU feel comfortable with.
Step 5: Monitor Your Progress
The final step is perhaps the most important one—monitoring your progress!
As with any investment portfolio, it’s important to periodically review your holdings and make adjustments as needed.
By doing so, you can ensure that your portfolio remains on track and continues to support your long-term financial goals.
Why Are Self-Directed Gold IRAs Such A Popular Option?
There are several reasons why you might want to consider investing in a gold IRA.
First, gold provides diversification for your retirement portfolio.
By including gold in your IRA, you can reduce your exposure to stocks and other asset classes.
Second, gold has historically outperformed other asset classes in times of economic turmoil.
Finally, gold IRAs offer tax advantages.
With a traditional IRA, you pay taxes on your contributions when you withdraw them at retirement.
With a gold IRA, you can make tax-free contributions (up to the annual limit) and defer taxes on your gains until you retire.
You can also invest in other precious metals, such as palladium, silver, and even platinum, with a gold IRA.
Self-Directed Individual Retirement Account FAQs
No, you can’t set up a self-directed IRA yourself. You’ll need self-directed IRA custodians to do that on your behalf.
However, it’s important to remember that you are responsible for making investment decisions and ensuring that your investments are compliant with IRS rules.
For help and guidance, consult a financial advisor or review IRS Publication 590-A.
The maximum amount you can contribute to a self-directed IRA for 2022 (for Roth and traditional IRA) is $6,000 (or $7,000 if you’re age 50 or older).
However, this limit is subject to change so be sure to consult your financial advisor or review IRS Publication 590-A for the latest information.
If you’re looking for a more hands-on approach to investing, a self-directed IRA may be right for you.
With this type of account, you have the power to choose your own investments and take control of your retirement savings.
And if gold is one of your favored assets, there’s no better way to invest than with a gold IRA.