A self-directed IRA is one of the most powerful investment tools for increasing control over your retirement savings. Unlike Traditional IRAs, which limit you to common assets, like stocks, bonds and mutual funds, a self-directed IRA makes it easy to take advantage of alternative assets, diversify your portfolio, and better hedge against market volatility.

Is a self-directed IRA the best tool for your retirement ambitions? Understanding what makes this type of account different, its pros and cons, and who it’s best suited for can help you decide.

What Is a Self-Directed IRA?

A self-directed IRA (SDIRA) is a tax-advantaged retirement account that is structurally similar to standard IRAs but offers access to alternative investment opportunities not available in a standard IRA account.

SDIRAs follow the same contribution and taxation rules as Traditional and Roth IRAs. For instance, each has a maximum amount of money account holders can contribute each year, and the accounts are tax-advantaged. In fact, when you open an SDIRA account, you can choose between a Traditional SDIRA and a Roth SDIRA, maintaining the tax benefits of those accounts.

The key distinction is that an SDIRA allows you to hold various alternative investment assets, such as real estate and cryptocurrency. Standard IRAs confine you to a few conventional assets, like stocks, bonds, and mutual funds.

As such, an SDIRA gives you more control over how you plan to invest in retirement. You can take advantage of potentially higher-performing investments, such as private equity or real estate while establishing a far more diverse portfolio that better reflects your retirement goals, interests, and appetite for risk.

What Types of Investments Are Available in a Self-Directed IRA?

The primary advantage of self-directing your IRA is the ability to invest in alternative assets at a tax advantage. These assets include:

• Real estate, including residential and commercial property, rental/vacation properties, and raw land.
• Promissory notes, including secured and unsecured loans.
• Private equity, such as start-ups, LLCs, etc.
• Precious metals, such as gold, silver, platinum and palladium.
• Tax liens, typically purchased from the government.
• Cryptocurrencies, such as Bitcoin, Ethereum, Cardano and Ripple.
• Royalties and mineral rights, such as gas and oil royalties.

SDIRAs provide much latitude regarding asset selection, but a few restrictions exist. For instance, the IRS forbids IRA holders, self-directed or otherwise, from holding collectibles, art, insurance, and alcohol in their accounts.

Pros of a Self-Directed IRA

In addition to alternative assets, opening a self-directed IRA has many advantages, such as establishing an SDIRA LLC. These benefits include:

Greater Investment Flexibility

Since you’re not limited to traditional assets, you can build your SDIRA in a way that truly supports your retirement goals and timelines. For example, if you already invest in real estate using discretionary funds, you can apply that same strategy to your retirement account.

Potential for Higher Returns

Assets like real estate and cryptocurrency frequently beat out the stock market. Most importantly, these earnings can be reinvested at a tax-advantaged rate, making it even easier to grow your account.

Tax Advantages

Like standard retirement plans, all contributions and earnings grow tax-free while they’re in your account. If you have a Traditional SDIRA, you pay taxes on withdrawals. If you have a Roth IRA, contributions are taxed upfront, so withdrawals on those contributions are tax-free.

Portfolio Diversification

A mix of stocks, bonds, mutual funds, and ETFs can serve as a great foundation for your IRA, but they don’t always yield the desired growth and are market-dependent and sensitive to volatility. Many of the assets you can hold in an SDIRA can balance and diversify your portfolio, making it easier to weather any economic storms.

Control Over Investment Decisions

When you have a standard IRA, you have some control over how you invest your funds, but you’re often limited to whatever assets are offered by the financial institute that holds your account. SDIRAs put control entirely in your hands.

Further, you can choose to set up an LLC and open your SDIRA in the LLC’s name. In that case, you gain checkbook control, allowing you to directly invest in things like real estate without relying on your custodian to process transactions.

Cons of a Self-Directed IRA

Despite the many benefits, SDIRAs do come with higher risk and more complex rules. Before you open one, weigh the following drawbacks:

Complex Rules and Regulations

SDIRAs have an additional layer of rules and regulations that can change based on the asset type. For instance, if you invest in real estate using your SDIRA, you can’t utilize that property as a primary residence or vacation house. Your custodian can often help you stay within legal bounds, but as an SDIRA holder, much of the due diligence will fall to you.

Risk of IRS Penalties

Standard and self-directed IRAs have rules of engagement. If you don’t follow those rules, you can face penalties. In some cases, the risk translates to a tax penalty on the account, such as a 10% penalty on unqualified distributions. In other cases, you can lose the IRA designation if you don’t remedy the situation.

Limited Liquidity

Common assets like stocks and mutual funds are easy to sell on the open market, but that’s not always the case for the alternative assets that make SDIRAs so appealing. For instance, if you hold real estate, you will need to sell the property to gain access to the equity.

Higher Fees and Administrative Costs

All retirement accounts come with some fees, but SDIRA accounts often have more. That’s particularly true if you don’t have checkbook control, as you’ll likely pay fees or administrative costs for each transaction.

However, some custodians have more favorable fee schedules than others. As such, it’s vital that you ask for and compare fee schedules before you choose a custodian.

Increased Due Diligence and Responsibility

One of the very benefits of an SDIRA doubles as a drawback. SDIRAs are one of the few retirement accounts that really put you in the driver’s seat. That control can help you make the best decision for your retirement goals, but if you’re not well-versed in a specific type of investment or fail to do due diligence, you can risk your financial well-being.

Is a Self-Directed IRA Right for You?

A self-directed IRA can be a powerful investment tool in helping you retire early and build generational wealth. Here are some things to consider to determine if an SDIRA is right for you.

Investment experience

You don’t need decades of investment experience under your belt to open an SDIRA, but you should feel comfortable and confident in your understanding of the investment space. The same is true of the investment opportunity or industry drawing you to an SDIRA.

For instance, if you’re looking to leverage cryptocurrencies, you should have a working understanding of that industry. Want to use an SDIRA to flip houses? You should have some knowledge of your local real estate market.

Risk tolerance

Some non-traditional assets can present a higher level of risk than that associated with common assets. Still, that risk can often translate to higher earnings over the life of your portfolio. If you value the increased opportunity for growth and can tolerate risks, an SDIRA can be a good tool.

If you’re risk-averse, you may want to further examine the relationship between your goals, standard IRAs, and self-directed IRAs.

Time and due diligence

For many investors, a standard IRA lends itself to a “set it” and at least partially “forget it” experience, but that’s not often the case with an SDIRA.  You must complete due diligence and do your research at each step of the investment process, including while you hold the assets.  If you’re looking for a hands-on approach, then an SDIRA is a good fit.

A self-directed IRA opens up a whole new level of investment freedom, which can help you reach your retirement goals early. However, it can come with new levels of complexity and regulation. If you’re ready to self direct your retirement plan, contact Horizon Trust to explore different options and get started.

FAQs

What is the difference between a Self-Directed IRA and a Traditional IRA?

A Traditional IRA is a tax-advantaged retirement account that allows you to make pre-tax contributions and grow your funds and earnings tax-free while in the account. Withdrawals are taxed in retirement.

A self-directed IRA is a type of IRA that lets you invest in alternative assets, like real estate, private equity and cryptocurrency.  Self-directed IRAs can be structured as Traditional IRAs, meaning contributions are made pre-tax and withdrawals are taxed in retirement. Or, it could be structured as a Roth IRA, which allows for after-tax contributions with tax-free withdrawals in retirement.

Are there any restrictions on what I can invest in with a Self-Directed IRA?

Yes, current IRS rules specify that self-directed IRAs cannot hold collectibles, such as art, stamps, rugs, alcohol, or certain coins that don’t meet purity standards. The IRS also bans holding life insurance or any asset considered self-dealing for the account holder.

Likewise, the account holder cannot invest in a property they intend to use for personal reasons, such as a primary residence, office space, or vacation home.

How much does it cost to maintain a Self-Directed IRA?

The cost to maintain a self-directed IRA will largely depend on the assets in the IRA and the custodian you choose. Before you open an SDIRA, always review and compare custodian fee structures before selecting the best custodian for your needs.