What is a self-directed IRA account? Does it have any unique benefits over traditional IRAs? Which assets can you hold in the self-directed IRA? What are some of the rules and requirements that you need to be aware of when opening your self-directed IRA? Such are some of the questions that those who come across this peculiar term ask themselves. If you’re here because you’re looking for answers as well, then you’re in the right place. Read on to discover what it will take for you to open your self-directed IRA and what you can invest through it.
What is a self-directed IRA?
A Self-directed IRA, or SDIRA, as popularly abbreviated is a type of IRA that allows an investor to hold a wider variety of assets, including alternative assets which are otherwise not allowed in regular IRAs. Despite SDIRAs being administered by custodians or trustees, they’re usually directly managed by their account holder, hence the name self-directed.
These unique IRAs are structured as either:
- Traditional self-directed IRA in which an investor makes tax-deductible contributions to their account.
- Roth self-directed IRA – in which an investor takes tax-free distributions.
Generally, self-directed IRAs are best-suited for investors who are interested in diversifying their retirement investment portfolio.
SDIRAs in detail
The key difference between SDIRAs and common IRAs is the type of assets that one can hold in their account. Generally, regular IRAs only allows you to hold paper assets such as:
- Certificates of deposit (CDs)
- Mutual Funds
- Exchange-Traded Funds (ETFs)
SDIRAs, on the other hand, allows their owners to allocate their funds to a wider variety of assets including:
- Precious metals such as gold, silver, platinum, and palladium
- Tax lien certificates
- Real estate
- Private placements
- Limited partnerships
- Promissory notes
As you can see SDIRAs call for greater for the account owner to do their due diligence before getting started, owing to the unique properties of assets invested in them.
Which assets are prohibited for use in SDIRAs (& disqualified persons and transactions that are prohibited)?
As much as SDIRAs allows for investors to invest in a wide range of alternative assets, there are two asset classes that you cannot invest in which are:
- Life insurance
- Collectibles such as antiques, jewelry stamps, artwork, rare coins, alcoholic beverages, antiques, and baseball cards.
You will also come to learn that the IRS prohibits account holders from doing certain transactions with “disqualified persons”. These include:
- Your spouse
- Lineal descendants
- The spouses of your lineal descendants
The IRS generally expects that you will not conduct any transactions between your self-directed IRA and any of the disqualified persons. Some of the prohibited transactions include:
- The lending of money
- The selling of property
- Using the funds in the IRA as collateral for loans
- Purchasing property for use in your IRA.
Those who violate these transaction rules risk being stripped of their account’s IRA status.
How can you open a self-directed IRA?
Most of the IRA providers today only offer traditional or Roth IRA options, in which you can only invest in paper assets. If you’re trying to open an SDIRA, then you need to search for an IRA custodian who specializes in the provision of such accounts.
One thing you should also know is that different SDIRA service providers accept different types of investments. If you’re, as such, interested in a specific asset, say precious metal, you should confirm that your SDIRA service provider of choice supports precious metal investments.
Also note that your SDIRA custodian is not allowed to offer any financial advice, which is a service that other investment firms, banks, and regular brokerages offer. This implies that as you open your SDIRA, you should be ready to come up with an investment strategy. In the event that you realize that you need help with picking or managing your investments, then you should seek the services of a financial advisor so that you can get help with creating a reliable plan.
Choosing your self-directed IRA provider.
Your choice of SDIRA service provider can make a big difference in how smooth your investment years become. As you start searching for the right SDIRA service provider, you will learn that their fees structures and fees differ quite significantly. The best SDIRA custodian is the one that offers you the services that you need at affordable prices. You need to establish which company is the best fit in terms of value for money. cheap may end up being expensive, and expensive does not necessarily mean that the high quality of services is guaranteed.
When making your choice, start by highlighting your must-haves, based on some of the following considerations:
- Do they allow checkbook control?
- Does the custodian support specific asset classes such as gold and cryptocurrencies?
- Would you like to also hold traditional assets in your IRA?
- The fees charged – e.g. set-up fees, transaction fees, maintenance fees, other admin fees.
You should also come up with a list of questions to ask your SDIRA custodian, to get a clear picture of what you are getting yourself into.
The taxes, contributions, and distributions
Like traditional IRAs, self-directed IRAs are subject to certain rules that pertain to the making of contributions, withdrawing funds, as well as required minimum distributions, also known as RMDs. Most of the rules also apply to traditional IRAs, including:
- One must adhere to annual contribution limits that are usually set by the IRA.
- All qualified withdrawals upon retirement are usually taxed in the same manner as ordinary income.
- Those who withdraw funds before hitting 59.5 years (and do not qualify for withdrawal exceptions) usually get hit with a 10% early withdrawal penalty, alongside the normal income taxes.
- Retirees who live up to the age of 72 years are necessitated to take RMDs. The amount one must withdraw annually is based on their year-end account balance, as well as their life expectancy.
- Those who wish to make post-tax contributions should open self-directed Roth IRAs.
If you are ready to open your SDIRA today, here are some reliable service providers worth considering:
That will be all for today’s article in which we have addressed what a self-directed IRA account is all about, and what you can expect from one. I hope that you now have the answers to the questions that you had in mind and that you now know what to do as you open your account. Let me know if you have more questions or concerns with regards to how you can open your SDIRA today and start investing in alternative assets.
I wish you well,
Eric, Investor and Team Member at Gold Retired.