What is a self-directed ira account? How does it differ from other types of IRAs? Does it offer unique benefits that you should not miss out on? If you are here today because you want to obtain the answers to such and more questions pertaining to self-directed IRAs, then you are in the right place. All you need to do is read on till the end of this post to find out more. Let’s hop right into it.
What is a Self-directed IRA ( SDIRA)?
A self-directed IRA is a unique type of Individual Retirement Account ( IRA) that can hold a wide variety of alternative assets that are otherwise not allowed in regular IRAs. Although SDIRAs are overseen by IRS-approved custodians or trustees, they are directly managed by the person who owns the account, hence the term “self-directed”.
There are two main categories of SDIRAs, which are described below:
1. Traditional IRA
With a traditional IRA, you are required by the law to invest your money on a pre-tax basis. This means that you can avoid paying any taxes on your contributions, hence giving your investments the opportunity to grow tax-deferred. When it is time to withdraw your money during your retirement years ( at age 59 ½ years or older), you will be required to pay taxes on your withdrawals at the ordinary income tax rates defined by the IRS.
2. Roth IRA
For this type of IRA, investors get to invest their post-tax dollars, meaning that they pay taxes before making any contributions to their accounts. This effectively means that they will grow their investments tax-free, and when they withdraw their money during retirement, they won’t be required by the law to pay any taxes on their withdrawals.
Which assets can you hold or invest through a self-directed IRA?
An investor can use a self-directed IRA to invest in assets that are not allowed or offered through regular IRAs and online brokerages. With a self-directed IRA, you can tap into a wide range of financial assets, thus maximizing your income-generation potential.
Those who open regular IRAs are limited to paper assets such as:
- Certificates of Deposit
- Mutual Funds
- Exchange-Traded Funds ( ETFs)
With a self-directed IRA, however, you can access and invest in a wide array of assets, which include:
- Precious metals such as gold, silver, platinum, and palladium.
- Real estate
- Crowdfunded assets e.g. loans
- Limited partnerships
- Private stock
- Land and mineral rights
- Horse races
- Tax lien certificates, etc.
The list of allowed investments can be longer depending on what your self-directed IRA custodian allows you to hold. That said, however, there is a list of items and assets that you are not allowed to hold or invest in through a self-directed IRA, including:
- Life insurance
- Collectibles e.g. art, gems, alcoholic beverages, stamps, collector coins, antiques, and rugs.
How exactly does a self-directed IRA work?
A self-directed IRA works in a manner similar to standard IRAs. For starters, the annual contribution limit for SDIRAs is also $6000 ( or $7000 for those who are 50 years or older). Note that the annual contribution limits change from year to year. Investors can choose to open their SDIRA as a traditional IRA or a Roth IRA, with the taxation rules applying in the same manner as the standard Traditional and Roth IRAs.
The only difference between SDIRAs and standard IRAs is the type of investments one is allowed to hold through either account. With an SDIRA, you can hold alternative assets, in addition to the traditional assets that are exclusively allowed for Standard IRAs.
One thing that you should note, however, is that you cannot purchase the alternative assets from your SDIRA custodian. Your SDIRA custodian may only hold the assets after you have purchased them from a dealer or broker. This makes the process of investing through SDIRAs complex for some investors. You can, however, navigate this field easily if you turn to an IRA company that specializes in assisting clients to open a new account and begin investing with no hitches or hassles.
You should, however, be very careful about any company, dealer, or broker you interact with during the account opening process, since it is possible for you to get scammed by a fake company posing as genuine service providers.
How do I open a self-directed IRA?
If you are looking for a way to open a self-directed IRA, in a bid to increase your scope of investments, then you can follow the process outlined below:
1. Find a reliable custodian
You should start by finding a reliable IRS-approved self-directed IRA custodian. Do not forget to check their customer reviews, and any complaints filed on any consumer trust sites such as Trustpilot, Better Business Bureau, and Business Consumer Alliance.
2. Choose the products you need to purchase
After figuring out which company you will turn to for the custodian services, you can proceed to determine the alternative investments you want to buy. When you have settled on the asset classes, you may need to find a reputable dealer to purchase the assets. Your custodian may offer suggestions for the best dealers to contact for various assets, but you should do your due diligence to ascertain that you are getting the best deal out there.
3. Fund your account
You can fund your SDIRA by sending money directly from your bank account savings, or you can do an IRA rollover. An IRA rollover may be the best option for any account holder who has an existing retirement plan.
4. Complete the transaction
Once you have found a suitable custodian and dealer, you can proceed to instruct your custodian to purchase the investments from the dealer.
5. Track the performance of your account
Once you have purchased the required assets, you can now track the performance of your investments. You should consider rebalancing your portfolio periodically, to ensure that you are not exposing yourself to inflationary forces and other negative forces.
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Frequently asked questions on “What is a Self-Directed IRA account”
1. How much money can I put in my self-directed IRA?
The contribution limits may vary year over year, depending on the type of self-directed IRA you currently own. The IRS releases the annual contribution rules for all retirement plans in this category, including Traditional, Roth, SEP, SIMPLE, and ESA plans.
2. Which type of fees should I expect to pay as an SDIRA owner?
For starters, you should choose a self-directed IRA custodian company that has a simple and transparent fee schedule. This will enable you to plan ahead so that you make the payments when or before they are due. Generally, however, you should expect to pay the following fees:
- Account set-up
- Annual recordkeeping
- Purchase and sale of asset fees
- Transaction fees
3. I thought only assets such as stocks and funds were allowed for use in retirement investment plans? How come I have not heard of such an IRA?
Most investors are usually shocked to discover that they have the option to invest in alternative assets through a self-directed IRA. Interestingly, this option has been around since 1975, and those who have known about it have been taking advantage of it. Most brokerage firms only offer investment options such as stocks and funds, and may as such not be inclined to promote alternative investments.
4. Are there any disadvantages associated with using a self-directed IRA?
All investments come with risks, and self-directed IRAs are no exceptions. The investments held in self-directed IRAs present a greater income generation opportunity, but they may also be riskier. You, therefore, have to weigh the pros and cons, and also define clearly why you are interested in opening the SDIRA. For a precious metal investor, for instance, the reason may be to diversify their portfolio to protect their wealth or to hedge their portfolio against inflation.
Thank you for making it to the end of this article on what a self-directed IRA account is. I hope that you have learned something new from it and that you will also share it with someone whom you know would be interested in learning about this unique retirement plan. If you have questions or opinions that you would love to share, do not hesitate to drop them in the comments section – I will respond to them ASAP!
I wish you well,
Eric, Investor and Team Member at Gold Retired!