Alternate definition: A self-directed IRA allows you more leeway to choose investments that might be considered “alternative” investmentsAcronym: SDIRA
How Does a Self-Directed IRA Work?
IRAs are held by custodians that usually provide a limited menu of assets to invest in. Custodians can include brokerages, trust companies, and banks. In many cases, custodians steer investors toward asset classes such as stocks, bonds, and CDs. It’s also possible to find some custodians that allow you to invest in real estate through Real Estate Investment Trusts (REITs). A self-directed IRA, on the other hand, allows more freedom to the investor. The custodian usually disclaims some of its fiduciary duties to the investor, and that makes it possible for you to choose assets that might be considered “alternative.” The self-directed IRA still works like any other IRA, but you can keep different types of investments in the IRA, including:
Real estate Cryptocurrencies Tax lien certificates Promissory notes Private securities
Prohibited Transactions
As with other IRAs, you receive the tax benefits associated with a tax-advantaged retirement account. However, you have to follow the same rules you would for regular IRAs, too. The IRS prohibits you from investing in properties that you live in or maintain. Other types of prohibited transactions include:
Borrowing money from your SDIRASelling property you own to your SDIRAUsing your SDIRA as collateral for a loan
Are There Any Penalties?
The penalties associated with a self-directed IRA are the same as what you’d see with any other IRA. In most cases, there’s a 10% penalty if you withdraw funds before you reach age 59 ½. However, if you have a Roth account, you can still withdraw contributions at any time without paying the penalty. Additionally, there might be restrictions on the types of assets you can hold in the self-directed account, and you might face penalties if you don’t adhere to them. For example, you can’t hold rare collectible coins or most gold bullion in your SDIRA. Your custodian can help you navigate this and other issues.
Is a Self-Directed IRA Worth It?
Whether a self-directed IRA is worth it depends on your goals with your retirement plan. Depending on the situation, a self-directed IRA can provide you with the potential to see greater growth in your wealth. However, you might also take on increased risk. One of the biggest issues related to self-directed IRAs is the possibility of fraud. You might not receive all the information you need to make decisions about alternative investments, and some unscrupulous custodians might hide some of the details about investments that might not be properly protected against certain losses. Realize that many custodians of self-directed IRAs don’t actually evaluate the investment quality of the assets involved, so it’s on the investor to properly vet what they include in their retirement accounts. Plus, some investments aren’t very liquid, so selling them can be difficult. When you’re ready to make withdrawals, you need a good exit plan to ensure that you can unload the assets.
Alternatives to a Self-Directed IRA
Among the more popular alternatives to self-directed IRAs are retirement accounts offered by investment brokerages, which include Roth and traditional IRAs and 401(k) plans. Many of the best online brokers offer IRA choices that include simple and liquid assets, such as stocks and bonds, that can be used to build a retirement portfolio. Robo-advisors will even do the work of choosing the investments for you, based on your risk tolerance and timeline.
Traditional IRA vs. Roth IRA
You can choose a traditional or a Roth when you have a self-directed IRA. For 2021 and 2022, there is a combined contribution limit of $6,000 to your IRAs, with an additional catch-up contribution of $1,000 if you’re at least 50 years old. Examples of brokerages that allow SDIRAs include:
Community National BankMidland TrustGoldStar TrustSunWest Trust Inc.
