Everything You Need To Know About Self-Directed IRAs (SDIRAs)

If you want to invest in non-traditional assets with your retirement savings, you might find it challenging to do so with IRAs held at brokerages, banks, and other financial firms.

You will likely be limited to stocks, bonds, and mutual funds when you have your IRA (individual retirement account) with these institutions.

A self-directed IRA solves this issue by allowing you to take advantage of certain alternative assets.

With self-directed IRAs, you are in charge of your funds and can invest them how you see fit.

This post will reveal everything you need about self-directed IRAs and cover some pros and cons.

What Are Self-directed Iras

A self-directed IRA is a kind of retirement account allowing you to invest in a broader selection of asset classes.

A trustee or custodian still administers the IRA, but it is managed directly by the account holder, hence why it is called “self-directed.” You can either open up a self-directed traditional IRA, in which you make tax-deductible contributions, or a self-directed Roth IRA, in which you make tax-free contributions.

Like an IRA you'd get from a bank or brokerage, you must follow the eligibility requirements and contribution limits to participate. For example, in 2022, the maximum contribution limit is $6,000 (or $7,000 if you're 50 years old or older), and you can only withdraw funds once you reach 59 and a half years old.

Most people open a self-directed IRA to invest in alternative asset classes. Holders of simple IRAs are typically limited to stocks, bonds, mutual funds, ETFs, and CDs. With a self-directed IRA, you can invest in the following:

  • Precious metals (gold, silver, platinum)
  • Real estate (rental properties, crowdfunding)
  • Commodities
  • Tax lien certificates
  • Limited partnerships
  • Promissory notes
  • Cryptocurrency
  • Livestock

And much more. Self-directed IRAs afford you much more freedom in the investments available, but that also means you are responsible for doing your due diligence and picking intelligent investments.

How To Open a Self-directed IRA

Typically you can go to a brokerage firm to open up any, but many mainstream brokerages don't offer the option of opening a self-directed IRA.

The most common place you'll find self-directed IRAs is through providers specializing in them. Some banks and trust companies provide these services. Different providers will have other offerings regarding investments available, so be sure to shop around if you're interested in a specific asset class. As a side note: the IRS still doesn't allow certain types of investments inside self-directed IRAs (like insurance or collectibles).

The steps for opening a self-directed IRA are as follows:

  1. Find a provider to open the account for you.
  2. Do due diligence on the investments you'd like to make.
  3. Decide on your investments.
  4. Contact the investment sponsor or holder to invest.
  5. Direct your provider to carry out the transaction for you.

Remember that these accounts are “self-directed” and that your provider cannot give you financial advice. Also, for the most part, investments made in self-directed IRAs are less liquid than investments made in regular IRA accounts.

For these reasons, it would be best to do lots of research before making any investments.

If you're not up for the task alone, working with an experienced financial advisor or fiduciary can help minimize your risk throughout the investing process. Remember that your SDIRA provider will not do any due diligence for you.


Advantages and Risks of Self-directed Iras

Before setting up your self-directed IRA, it's wise to understand its pros and cons.

Self-directed IRAs have specific benefits and risks, as with any financial decision. Here is an overview of them.

Advantages of Self-directed Iras

Here are some of the most significant advantages associated with self-directed IRAs.

  • Diversification – The main advantage of owning a self-directed IRA is that it allows you to diversify your investments away from traditional asset classes like stocks and bonds. A self-directed IRA lets you invest in wealth-building vehicles like real estate and even allows you to purchase non-publicly traded companies' shares.
  • Specialization – You can leverage your intellectual capital through self-directed IRAs if you have unique expertise or experience in a particular field. By making investments that align with your passions, you provide a sharper edge over the rest of the market.
  • Higher Returns – By investing in unique asset classes, there is the potential for greater returns. With an SDIRA, you can invest in a broader range of assets than with a regular IRA, which also opens up the possibility of you selecting a big winner. You can earn some sizable returns if you're creative and use self-directed IRAs correctly.

Risks of Self-directed Iras

Here are some of the most significant risks when opening a self-directed IRA.

  • Prohibited transactions – There is a strict set of rules that you must follow when investing with self-directed IRAs, and if you break one, you could be liable for a lot of owed money and penalties. If not, you may find your earnings taxable and be on the hook for penalties. For each asset class you own, you should know all the rules that govern it and follow them to a tee.
  • Concentrated portfolios – Though self-directed IRAs let you invest in various asset classes, the flip side is that it's also easy to concentrate too heavily on these alternative investments. Often, if you're only seeking diversification, one of the best options is to go with an ETF or index fund.
  • Due diligence – The due diligence of each investment is entirely up to you, and the firm you set up the IRA with can not help you. When setting up an SDIRA, make sure to factor in the value of your time (or if you are hiring a financial advisor, factor in the additional fees you will be paying them.)
  • Fees – Self-directed IRAs have a different fee structure than regular IRAs, and the payments can differ depending on which custodian you are with and what investments you choose.
  • Fraud – Since SDIRA providers can not evaluate an investment for account holders, scams are more common. Many fraudsters lure people into their schemes by saying the custodian has approved and vetted their investment. Be wary about what you're investing in with your self-directed IRA.
  • Liquidity – If you run into an emergency and need funds, it will be hard to withdraw them from your self-directed IRA. Selling stocks, bonds, and mutual funds are simple and only requires a button click. Unfortunately, this is not the case for many investments available for self-directed IRAs. Self-directed IRAs allow you to invest in a broader range of asset classes, but that also means you will sometimes be giving up your liquidity.

FAQs About Self-directed Iras

Here are some frequently asked questions about these self-directed retirement accounts answered:

What Is The Difference Between a Self-directed Traditional IRA Account and a Self-directed Roth IRA Account?

Traditional and Roth IRA accounts differ when the account owners realize tax benefits. For example, in a traditional IRA, you can take a tax deduction on the contributions made to your account. When you withdraw in the future, the IRS taxes the money withdrawn as regular taxable income. With Roth IRA accounts, you won't be able to make a deduction on the contributions to the account, but your retirement funds will be tax-free.

Is There a Minimum Amount Required To Open a Self-directed IRA Account

There is no minimum contribution requirement for self-directed IRAs, but the recommended amount you put in depends on what investment options you are considering. For example, suppose you invest in real estate with your self-directed IRA account. In that case, you'll want to ensure you have enough money to cover the down payment plus any additional repairs, improvements, and expenses on the property.

What Assets Cant I Buy With a Self-directed IRA

There are certain assets that the IRS does not allow in IRAs. These include artwork, antiques, gems, stamps, certain coins, metals (aside from gold, silver, and platinum), life insurance, and alcoholic beverages.

If I Have a 401K From an Old Employer, Can I Roll Over the Money Into a Self-directed IRA?

If you are no longer an active employee, you can transfer the money from your previous employer's plan to a new self-directed IRA. The IRA rollover process is simple and requires transferring funds from your last custodian to your new SDIRA provider. Just be sure to ensure that all rollover activity complies with the IRS, so you don't suffer any unnecessary penalties.

Can I Partner With Others To Make Investments Using My Self-directed IRA

You may partner your self-directed IRA with another funding source. This action is known as partnering and is available for your non-IRA funds, your spouse's IRA, or even another person's IRA.

Everything To Know About Self-directed Iras

Self-directed IRAs can be an excellent option for people seeking investments in alternative asset classes and looking to diversify their returns.

However, plenty of risks are involved, and a certain level of dedication is needed to manage a self-directed IRA successfully. Opening a self-directed IRA might be a wise move if you have specific expertise in a field or specialize in an industry.

Before opening a self-directed IRA, weigh all the pros and cons and ask yourself if you need a self-directed IRA or if you can realize your goals using an IRA from a brokerage. If the answer is resoundingly positive, it may be time to consider self-directed IRAs a viable investment vehicle.

Want more information on the benefits of an SDIRA and how you can get started? Download your free copy of the Self-Directed IRA Basics guide today. 

This article was produced and syndicated by Wealth of Geeks.