Individual retirement accounts (IRAs) are the most popular retirement vehicle for individuals without employer-matching retirement plans. Using the tax advantages of a Traditional or Roth IRA, investors can save money in taxes when they place money in the stock market.

However, self-directing your account allows you to move into a wider range of asset classes, including real estate, precious metals, and more.

Learn how self-directed IRAs differ from regular IRAs and the benefits of self-directing your retirement account.

How Do IRAs Work?

Individual retirement accounts (IRAs) provide a pathway to wealth outside of employer-sponsored plans, such as 401(k)s or traditional savings accounts. When you open an IRA, you fund the account yourself, and the funds are invested into a portfolio of assets, including stocks, bonds, and mutual funds.

IRAs and investment decisions are typically made by the brokerage firm or financial institution holding the account, though account holders have some autonomy regarding investment decisions.

IRAs can be funded with pre-tax (traditional IRA) or after-tax (Roth IRA) dollars, and contributions and earnings remain in the account where they can grow tax-free until retirement.

What is a Self-Directed IRA?

Like a standard IRA, a self-directed IRA is an investment account that makes it easy to save for retirement without or in addition to an employer-sponsored plan. Thanks to special IRS provisions, self-directed IRAs allow investors to invest in a wide range of assets outside of traditional stocks and bonds, albeit with a more strict set of rules and prohibited transactions.

Similarities and Differences of a Self-Directed IRA

Standard IRA vs SDIRA: Differences

Self-directed IRAs share many structural similarities, including tax advantages, qualified withdrawals, RMDs, and more. However, these two types of accounts differ substantially in terms of asset allocation and management.

Assets

Standard IRA investments are limited to common assets, such as stocks, bonds, CDs, mutual funds, and ETFs. These can serve as a good base for your retirement portfolio but don’t offer the same high-yield potential that alternative assets, like real estate, do.

SDIRAs can hold alternative assets such as real estate, including managing rental properties, wholesaling, and tax lien investing. SDIRAs also allow you to purchase cryptocurrency, private equity, and commodities, as well as engage in money lending.

Many of these assets have higher earning potential, helping you grow and compound your wealth with interest. Think of SDIRAs not only as an advantaged tax strategy over standard IRAs but also as an advantaged investment strategy. For example, real estate flipping with an SDIRA offers more tax advantages than your savings or checking account.

Custodians

When referred to standard IRAs, a custodian is the financial institution, such as a bank or investment, that holds and manages your account and decides how and when to invest your funds. Though you have some control, such as choosing the types of assets in which your funds are invested, control is limited.

Self-directed IRAs require certified custodians approved by the IRS. The custodian relationship is passive, meaning it will not provide investment advice or otherwise determine how you invest your funds. Their sole job is holding the assets, completing administration tasks, and ensuring compliance with IRS rules.

Prohibited Transactions

Both standard and self-directed IRAs are subject to prohibited transaction rules.  Standard IRAs are prohibited from holding alternative assets and issuing loans to yourself.

Nevertheless, both types of retirement accounts share some of the same prohibited transactions, including:

• Holding prohibited assets, such as collectibles (stamps, art, gems, etc), alcohol, and insurance assets.
• Engaging in a transaction with a disqualified person. A disqualified person includes you, the account holder, your descendants and descendants (children, parents), your fiduciary, businesses in which you or a disqualified person has ownership, etc.

Disqualified person rules are particularly important for SDIRA holders, as allowed assets put you at a higher risk for engaging with disqualified persons or otherwise participating in prohibited transitions. For instance, if you purchase real estate with your IRA, you and your descendants cannot live in or work within that property. Similarly, you can’t use IRA funds to invest in your child’s business or to purchase a property from your fiduciary.

LLC Eligibility

A standard IRA is only designed for an individual. But if you have an SDIRA, you can transfer funds or open an LLC held by your SDIRA. This provides what is known as checkbook control. With LLC checkbook control, you can execute transitions directly from the LLC account without going through the custodian.

Standard IRA vs SDIRA: Similarities

Tax Structure

When you open an IRA or SDIRA, you can choose a traditional or Roth tax structure.

Under a traditional tax structure, the account is funded with pre-tax dollars, and qualified withdrawals are subject to income tax. Under a Roth structure, the account is funded with after-tax dollars, and withdrawals are not taxed.

These accounts are also subject to different withdrawal rules, which are explained below.

Withdrawals

IRA and SDIRA withdrawals (and any applicable rules and penalties) are determined by the account’s tax structure and the account holder’s age.

In general, withdrawals before the age of 59 ½ are penalized. However, there are some circumstances, such as purchasing a primary residence, that may allow you to withdraw funds without penalty. You can withdraw from Roth contributions at any time as long as the account has been open for five or more years.

Traditional IRA and SDIRA holders are also subject to required minimum distributions (RMD) rules. These rules state that once you reach age 73, you must begin to take annual distributions based on your age and the value of your IRA.

Contribution Limits

IRAs and SDIRAs share the same basic contribution limits. Starting in 2024, you can now contribute up to $7,000 annually to either type of account, with an additional catch-up contribution of $1,000 if you are 50 or older.

The IRS sets a phase-out range for Roth IRAs based on income and tax filing status (see Income Limits below).

Income Limits

In general, you can contribute to an IRA as long as you (or your spouse) have an earned income during the contribution year. Traditional IRAs are not subject to income limits, but Roth IRAs are:

If your income falls within the IRS Roth IRA phase-out range, your annual contribution may be decreased. If your income exceeds the phase-out range maximum, you cannot contribute to a Roth IRA. The 2024 Roth IRA phase-out ranges by tax-filing status are:

• Singles and head of household: $146,000 to $161,000
• Married couples filing jointly: $230,000 to $240,000.
• Married filing separately: $0 to $10,000.

Reasons to Open a Self-Directed IRA

Now that you understand the basic differences between a self-directed IRA and a regular IRA, it’s keen to explore some benefits of switching to a self-directed IRA.

SDIRAs offer all the basic benefits of a standard IRA but with the following additional benefits:

• Ability to invest in a wide range of assets not available under a standard IRA. This includes real estate, private equity, and cryptocurrencies.
• Enhanced freedom and control over your investment decisions. An SDIRA custodian plays a passive role in SDIRA management, allowing you to make decisions about when and how you invest and grow your retirement funds.
• Option to open an SDIRA LLC. Ideal for private equity and real estate investment, SDIRA LLCs give you even more control over your funds by further reducing the role a custodian plays in your investments. With LLC checkbook control, you can bypass the custodian and move money to and from the account as needed. This allows for quick response to investment opportunities and easier management of certain assets, like commercial property.

Finding the Right Self-Directed IRA Custodian

Even though an SDIRA custodian plays a passive role, choosing the right one is paramount to your success and overall satisfaction. The right partnership can help you grow your retirement how you see fit, but a poorly chosen custodian can lead to administrative headaches, tax issues, and unnecessarily cumbersome fees.

• Asset specialization.  Choose a custodian who has experience with the assets that drive your portfolio. When a custodian has experience working with a specific asset, like real estate, they are better equipped to ensure your portfolio adheres to federal regulation and industry best practices.
• Fees. All custodians have fees, but that doesn’t mean their fee structures are equal. Avoid custodians who charge for every little transaction or task, such as wire fees, research fees, and document handling fees. These can add up over time, eroding your wealth potential.
• Reputation. Not all custodians are created equal, and without proper research, you can fall victim to a custodian with poor experience or unethical practices. Work with custodians that have a history of excellence.
• Customer service. Your relationship with a custodian can span decades. Make sure the custodian you choose values you and your business. The right custodian will be eager and willing to work alongside you.

Fortunately, opening a self-directed IRA with a standard IRA or 401(k) is incredibly easy and your custodian will walk you through it. We’ve provided guides on choosing between a transfer and rollover to help you understand the difference and which one suits you best. As always, partner with a custodian that you can trust and that understands your investment goals.

FAQs

Can I invest in real estate through a Self-Directed IRA?

Yes, an SDIRA can hold real estate. Real estate investment opportunities are one of the leading reasons individuals choose to open and leverage SDIRAs.

What are the potential risks associated with Self-Directed IRAs?

One of the biggest risks of an SDIRA is a lack of due diligence. Unlike standard IRA custodians, an SDIRA custodian does not offer investment advice and will not vet a potential investment. As such, the onus of research is on the account holder.

Can I use a Self-Directed IRA for business investments?

Yes, you can use an SDIRA for business investments, including investments in limited liability partnerships, limited liability companies, joint ventures, and private placements.