Self-Directed IRA Pros and Cons
With the global economy constantly changing, the traditional forms of investment need a new strategy to help citizens achieve reasonable retirement goals. As the financial world ebbs and flows into a new age, savings have changed; to adapt, we must change with it by exploring new retirement options to prepare a secure nest egg for our future.
Though traditional investments are still an option, a new retirement account to consider would be a self-directed IRA. If you want to take personal control of your retirement investments, an SDIRA can be just the thing you are looking for long-term growth.
If you are considering taking charge of your future, there are few pros and cons you should be aware of before you start investing. As always, before making any financial decisions, perform your due diligence to find the best retirement plan for you. As you explore SDIRAs as a possible venture, consider these 10 important points on self-directed investing.
1. Pro – Beyond Traditional Investments: Alternative Assets
When you invest in a traditional IRA, your asset options are limited to stocks, bonds and treasury. While these investments have their benefits, in recent years, the global economy has turned, making their value less predictable. With self-directed IRAs, account holders have a pool of assets to draw from.
Alternative asset options can range from real estate investment, precious metals, private loans, trust deeds, and beyond. With a variety of options, investors can build a balanced portfolio with both passive and fast-growing assets for exponential long-term account growth. Having alternative assets can give you a more secure retirement account and allow you to grow your fund in many ways.
2. Con – Lack of Liquidity
Depending on your investment choices, you may not be able to move your funds as you see fit. Some alternative assets have no liquidity, making it difficult to pull your funds should you have a change of heart. For example, private loans and real estate investment are long-term growth assets. These funds take time to fulfill and are usually accompanied by a contract. If you wish to change your investment, it would take time to change these options. However, not all alternative assets have this issue. With a balanced portfolio, you can combat this problem by balancing out slow-growing investments with more liquid options.
3. Pro – Tax-Deferred or Tax-Free Growth
One of the perks of investing in a self-directed IRA involves tax-break benefits. Your retirement account can grow, tax-free or tax-deferred, depending on the IRA you choose. With traditional IRAs, your contributions will grow tax-deferred. Initially, you will get a tax-break and the funds in your account will grow more quickly. Tax-deferred contributions are only taxed after you withdraw funds when you reach retirement age. At that point, the funds are taxed as income.
A Roth IRA is a tax-free option; you don’t get the initial tax break, but your funds aren’t subject to taxation upon withdrawal when you hit retirement age. As you make contributions to your account, your funds will grow, tax-free, providing you with a secure nest egg as you hit 59 ½.
4. Con – Hidden Fees and Paperwork
Putting together an investment plan can sometimes result in unwanted fees, depending on how you invest. Two common issues SDIRA investors run into are Unrelated Business Taxable Income (UBTI) and Unrelated Debt-Financed Income (UDFI.) In addition, the custodian and other financial companies you hire may charge hefty fees you cannot avoid. It’s important to perform your due diligence to sidestep any unnecessary fees.
While financial assistance may not seem important at first, it’s crucial when drawing up contracts for your investments. When writing up a payment plan for a trust deed or private loan, your intentions should be clear and unbreakable. Any changes made to your account or assets must be submitted to your custodian; your instruction must be 100% clear. Without clear intent, the security of your assets and account may be compromised.
5. Pro – You Control Your Own Investment
With a self-directed account, you are in control of your future. You decide what to invest in, where your funds are allocated, and how far you want to spread your investments. As account holder, you will give your IRA custodian specific instructions, and any changes made will be handled by you. If you want near-complete control, you may consider an IRA LLC account. This step will grant you checkbook control of your IRA, allowing you to purchase investments at your leisure with your SDIRA funds. As account holder, you decide how you want your portfolio to grow and truly oversee your nest egg.
6. Con – Self-Complications and Sabotage
Of course, with so much freedom, there are issues account holders may run into. Self-directed IRAs are highly regulated by the IRS to avoid fraudulent accounts and other unsavory investors. If you are unsure of the process and you don’t perform your due diligence, you are at risk of tax-penalties and account disqualification. While opening your SDIRA, be aware of the IRS guidelines about prohibited transactions, disqualified persons, and alternative assets that are off-limits.
Prohibited transactions include self-dealing and not reporting your account changes to your custodian. Also, you cannot benefit from your retirement account assets any time before you reach retirement age. This means you cannot use real estate owned by your IRA or have more than 50% stake in a company you’ve invested in. In addition, anyone who may benefit from your SDIRA account falls under these rules and regulations as a “disqualified person.” These individuals include spouses, children, direct lineage, and financiers.
Lastly, the IRS has a clear list of alternative assets that are off-limits for any account. These investments include life insurance, most collectibles, and tangible or sentimental items. Before any investment, it’s important to research thoroughly before deciding.
7. Pro – Asset Protection
Like traditional IRAs, self-directed retirement accounts are protected from federal and state bankruptcy. These accounts are separate from the owner and cannot be considered if you run into hard times. This added benefit can secure your nest egg should you encounter any financial woes. As your account grows, be sure to continually add funds. In addition to protection against financial hardship, your account can pass down to the next generation as per your instruction. Should something befall you, SDIRA accounts can pass to your spouse, children, or grandchildren according to your personal preference. Be sure to keep your custodian updated on your most current plans in the case of any mishaps.
8. Con – Private Ownership
While your SDIRA account is protected against bankruptcy and can pass down to the next generation, it’s not completely secure. Depending on the assets you choose, you may end up losing more than you bargained for. Many investment options are privately owned; additionally, some can be considered high-risk investments. For instance, if you choose to invest in a particular cryptocurrency or a new startup company, you run the risk of losing your investment should the coin die, or the company fails. Be sure your investment options are helping you build a fund by selecting several assets without spreading your funds too thin. Be aware of where you are putting your funds and perform your due diligence.
9. Pro – Higher Return Rates
In comparison to traditional funds, SDIRAs grow more quickly and can set account holders up with a significant nest egg. While some investments may be slow-growing, the long-term investment goal tends to build much faster with a self-directed account. Again, you must be sure that your set up a solid portfolio to reap the benefits of the alternative asset options. Keep your eye on the market, and you can see substantial, upfront growth.
10. Con – Third-Party Connections
While having a self-directed account puts you in charge of your retirement, the IRS mandated that any SDIRA must have a certified custodian track your investments. They are the intermediary between you and the IRS. IRA custodians track your account, serve as a guardian, but they are passive; they are not obligated to give you financial advice on your investments. Also, depending on the company you choose, you may be subjected to hefty fees. It’s up to you, as the account holder, to perform your due diligence and report any changes to your custodian. Not doing so can result in the disqualification of your account.
Investing in Your Future
As you take steps toward your retirement goals, be sure to explore all your options. Self-directed IRAs can give you control over your nest egg, so long as you avoid the pitfalls and secure your future. With the global economy changing every day, new options are becoming available and you can reap the benefits. Build for your golden years and contact us to start investing today.