Self-directed IRAs (SDIRAs) are flexible financial vehicles that allow you to save for retirement on your own terms. 

Whether it’s investing money from your previous 401(k) into real estate or buying physical gold coins to stash in your IRA, SDIRAs are America’s best-kept secret when it comes to retirement planning. 

That’s why we’re spilling the beans on this extraordinary investment and retirement opportunity. This guide will explain how SDIRAs work, including account basics and tips to help you start building real wealth for retirement. 

 

How Does a Self-Directed IRA Work?

Self-directed IRAs (SDIRA) are retirement plans administered by a licensed custodian, which enable you to invest in alternative assets. 

Depending on your investment strategy, self-directed IRAs can be structured like a standard IRA, either as a Traditional or Roth account. 

Traditional SDIRAs are funded with pre-tax dollars, and qualifying distributions are taxed on their way out of the account during your retirement. Roth SDIRAs are funded with after-tax dollars, and distributions aren’t taxed during retirement [Learn more: Traditional IRA vs Roth IRA.]

While SDIRAs offer the same tax advantages as many mainstream retirement plans, they also provide some pretty extraordinary perks that no other plan can offer. 

Alternative Investments

A leading reason investors choose SDIRAs over other individual retirement accounts is investment options. Standard IRAs restrict investors to basic assets, such as stocks, bonds, and mutual funds, that can be traded over an open exchange. 

SDIRAs open a world of opportunity by allowing investors to hold a wide range of assets in their portfolio, including:

  • Real estate
  • Precious metals
  • Tax liens
  • Mortgages
  • Promissory notes
  • Private Equity
  • Forex
  • Commodities and futures
  • Cryptocurrencies

It’s important to note that SDIRAs can hold real assets, such as solid gold and not just gold stock. This is an important distinction when trying to create a real estate or gold IRA. 


When you invest in tax liens, earnings come from the interest applied to the lien


Custodians

Unlike standard retirement plans, Self-directed IRAs require working with a licensed custodian to open an account. Self-Directed IRA Custodians are specially approved entities (by the IRS) that hold your investments and oversee the administrative tasks associated with your IRA. This can include tax reporting, executing trades, and ensuring regulatory compliance. 

However, investors are still responsible for selecting investment decisions and performing due diligence. For this reason, most SDIRA custodians are considered passive; their primary task is compliance. 

Checkbook Control

If the idea of running each investment decision by a custodian seems like a hindrance, there are solutions around this. 

By opening an LLC in the name of your IRA, you can establish what is referred to as “checkbook control.” In doing so, you can write checks or otherwise execute trades directly from the IRA account without having to consult your custodian. 

Checkbook LLCs also provide additional protection against liability, similar to a business LLC. 

Prohibited Transactions

SDIRAs may have seemingly unlimited investment freedom, but they do come with a fair amount of regulation attached. 

Known as Prohibited Transactions, SDIRA owners are forbidden by the IRS from:

  • Borrowing money from your IRA
  • Using your IRA as loan collateral.
  • Engaging in self-serving investments. For example, you can’t sell a property from your IRA to yourself.  
  • Completing an investment transaction with a disqualified person. This includes your spouse, ancestors, lineal descendants, account fiduciary, or service provider such as your custodian or accountant. 
  • Investing in prohibited assets, such as collectibles (arts, stamps, etc.), insurance, and alcohol. 

Self-Directed IRA Pros and Cons

Self-directed IRAs are highly complex retirement accounts that offer a lot of rewards for investors savvy enough to take advantage of their tax benefits. 

Pros:

  • Allow for alternative assets, such as precious metals, real estate, and foreign currency. This helps you diversify your portfolio easily. 
  • Enhanced control over investment decisions. Custodians do not make decisions about investments, and investors aren’t limited to a single set of assets offered by any one financial institution. 
  • Funds in an account grow tax-free, and, depending on the type of account you have, contributions are pre-tax (Traditional IRA) or distributions are tax-free (Roth IRA). 

Cons

  • SDIRA assets may lack liquidity. For instance, stocks and mutual funds can be sold quickly, while real estate or promissory notes don’t have that same level of liquidity. 
  • Internal fees can fluctuate by custodian and by asset type. For instance, if you finance a real estate purchase, you’ll likely be subject to Unrelated Debt-Financed Income (UBFI) taxes. 
  • Requires due diligence, the absence of which can result in penalties. Investors are required to thoroughly vet investment opportunities and ensure their account adheres to IRS rules. 

Self-Directed IRA Contribution Limits

The IRS sets contribution limits for all IRAs, including self-directed IRAs. This can change yearly, so always check the latest IRS guidance.  

The 2024 IRA contribution limit is $7,000 annually, up from $6,500 in 2023. If you are 50 or older, you can make an additional $1,000 catch-up contribution. The catch-up contribution limit was the same for 2023. 

Additional Roth contribution limits

If you have a Roth IRA, there are additional contribution limits to consider. Limits are based on your tax-filing status and income level. If you have or are considering a Roth IRA, take note of the following contribution phase-out ranges below. If you fall between the limits, your contribution will be decreased. 

If your income exceeds the threshold, you cannot contribute to a Roth IRA.  Any contributions that exceed your limit will be considered excess and can be penalized.

Tax-filing status 2023 phase-out range 2024 phase-out range
Single and heads of household $138,000 – $153,000 $146,000 – $161,000
Married filing jointly $218,000 – $228,000 $230,000 – $240,000
Married filing separate $0 – $10,000 $0 – $10,000

Is a Self-Directed IRA Right for Me?

An SDIRA is right for you if you want to save for retirement but desire more flexibility and control than a standard IRA or qualifying retirement account. Because SDIRAs provide more investment options, you can leverage your retirement funds for high-yield investments, such as real estate. 

In addition, an SDIRA allows you to take advantage of those investment opportunities as you see fit, without relying on a financial institution to offer a specific type of investment or, as is the case with checkbook control, the custodian to complete a transaction on your behalf.  This can be a significant advantage if you intend to invest in assets in a fast-paced industry that requires timely action.  

FAQs: How Does an SDIRA Work?

What Is a self-directed IRA?

A self-directed IRA is a type of individual retirement account that allows you to invest in alternative assets, such as real estate, precious metals, and commodities. 

What types of assets are available in an SDIRA?

In addition to stocks, bonds, mutual funds, and other common assets, SDIRAs allow you to invest in:

  • Commodities and futures
  • Cryptocurrencies
  • Foreign currency
  • Mortgage notes
  • Precious metals, such as gold, silver, platinum and palladium
  • Private equity, or investments not available in public trade
  • Promissory notes
  • Tax liens

Can you withdraw money from a self-directed IRA?

Yes, you can withdraw money from a self-directed IRA, but when and if you can do so without penalty depends on the type of IRA account you have. 

If you have a traditional IRA

  • You can take withdrawals without penalty after the age of 59 ½. 
  • You can withdraw without penalty under certain circumstances, such as to cover qualified education expenses, purchase your first home, or become disabled. 
  • Withdrawals made before age 59 ½, or those that don’t qualify as an exception, are penalized at 10%. 
  • You must take the required minimum distributions (RMDs) starting at age 72 now (unless reached age 72 in 2023, then it’s 73).

If you have a Roth IRA

  • You can take withdrawals without penalty after the age of 59 ½. 
  • You can take withdrawals from contributions at any time, without penalty, as long as the account is open for 5 years. 
  • You can withdraw without penalty under certain circumstances, such as to cover qualified education expenses, purchase your first home, or become disabled.  
  • RMDs are not required.