Self-directed IRAs offer investors a level of control and flexibility not available through standard retirement plans. In turn, these self-directed accounts frequently provide investors additional compound interest on their investments, helping them reach their retirement goals faster.
Understanding the rules for self-directed IRA investing can help you grow your retirement portfolio while keeping your account in compliance and avoiding unnecessary penalties. Here’s everything you need to know about self-directed IRA rules.
What Is a Self-Directed IRA?
A self-directed IRA (SDIRA) is similar to a standard IRA but with expanded investment opportunities. SDIRAs allow you to invest in alternative assets like real estate, cryptocurrency, and private equity. In contrast, standard IRAs limit investment opportunities to common assets, such as stocks, bonds, and mutual funds.
The broad range of assets available through an SDIRA makes it easier for account holders to make investment decisions based on their knowledge and expertise in specific industries, such as real estate or commodities. In addition, many of the assets that can be held in an SDIRA portfolio offer the potential for higher earnings.
Self-directed IRAs are administered by custodians that specialize in these accounts and hold custody over funds to invest at the account holder’s discretion.
Rules for Self-Directed IRA
SDIRAs share many of the same rules associated with standard IRAs. However, there are additional rules that govern what investments SDIRAs can invest in and who can benefit directly from these investments.
Understanding these rules can ensure that your account complies with IRS requirements and mitigate the risk of penalties that can negatively affect your earnings. Here are a few self-directed IRA rules to keep in mind.
Contribution Limits
The IRS limits the amount of money you can contribute to an IRA each year, and these rules apply to both standard and self-directed accounts and can change annually.
Traditional and Roth SDIRAs currently have an annual contribution limit of $7,000, with an additional $1,000 catchup contribution for individuals age 50 or older.
Income Limits
Roth SDIRAs have an additional layer of limits. Depending on your income and tax filing status, you may be able to contribute the full amount or find that your contribution limit is decreased or you may not be able to contribute at all.
For instance, if you are married, filing jointly, and have a modified adjusted gross income (AGI) of less than $228,000, you can contribute to the full annual limit. If your income exceeds that, your contribution amount will be reduced. If your AGi is $240,000 or more, your contribution limit drops to $0.
See the table below to determine your Roth SDIRA contribution limit.
| Filing status | MAGI | Contribution limit |
| Single/Heads of household | Less than $146,000 | $7,000 ($8,000 if 50 or older) |
| $146,000 or more but less than $161,000 | Reduced contribution | |
| $161,000 or more | $0 | |
| Married filing jointly | Less than $228,000 | $7,000 ($8,000 if 50 or older) |
| $228,000 or more but less than $240,000 | Reduced contribution | |
| $240,000 or more | $0 | |
| Married filing separately | Less than $10,000 | $7,000 ($8,000 if 50 or older) |
| $10,000 or more | $0 |
Prohibited Transactions
SDIRAs are known for expanded investment opportunities, but restrictions still exist. Current IRS rules prevent the account holder and disqualified persons (explained below) from engaging in any of the following transactions:
- Borrowing or personally lending to yourself from the SDIRA.
- Using the account as collateral.
- Using SDIRA-held real estate (residential homes, vacation properties, commercial space, etc.) for personal use.
- Selling property to the account.
- Investing in prohibited assets, which include S-Corps, life insurance, alcohol, or collectibles (art, gems, stamps, etc.)
Engaging in any of the aforementioned transactions will result in penalties.
Disqualified Persons
A disqualified person is someone who is banned from engaging in certain IRA transactions. Disqualified persons include:
- The account holder.
- Account holder’s spouse as well as any lineal ascedants and descendants.
- Plan’s fiduciary and any individual that provides account services.
- Any entity in which the account holder or another disqualified person has 50% or more interest.
Withdrawals and RMDs
You can withdraw funds from your SDIRA at any time, but if you do so before 59 ½, the withdrawal is typically subject to a 10% penalty. There are some exceptions, including the following:
- Qualified birth or adoption expenses.
- Qualified educational expenses.
- Qualified first-time home purchase.
- Unreimbursed medical expenses.
- The account holder becomes permanently disabled or is diagnosed with a terminal illness.
- After an economic loss associated with a federally declared natural disaster.
- The account holder is the victim of domestic abuse by their spouse or domestic partner.
- For Roth SDIRAs that are open for 5 years or longer, withdrawals from contributions.
See the full list of IRS exceptions.
If you have a Traditional SDIRA you must take the required minimum distributions, or RMDs, each year when you reach age 73. Your annual RMD is based on the account balance at the end of the previous year and an IRS-determined life expectancy factor. You can use the RMD worksheet provided by the IRS to determine how much you need to withdraw each year.
Additional Rules and Tax Considerations
SDIRAs have additional rules and tax considerations that govern account management and tax implications in certain situations or for specific types of accounts and investments.
Working with a Custodian
To open an SDIRA, you must work with a qualified, IRS-approved custodian, like Horizon Trust. Though traditional banks can offer SDIRA products, SDIRA custodians are frequently non-bank entities. The IRS website has a full list of approved custodians.
UBIT
Unrelated business income tax (UBIT) is a tax applied to certain transactions, including some income generated by an IRA. For SDIRAs, UBIT frequently comes into play when you finance an asset purchase.
For instance, if you purchase a residential property using a combination of IRA funds and a non-recourse loan, a portion of the earnings from the property will be subject to UBIT until the loan is paid off.
Roth vs. Traditional
SDIRAs can be structured as Traditional or Roth accounts.
- Traditional SDIRA are funded with pre-tax dollars. Contributions and earnings grow tax-free while in the account, and withdrawals are taxed based on your income tax bracket. Traditional SDIRA holders must take RMDs starting at the age of 73 (previously 72).
- Roth SDIRAs are funded with after-tax dollars, and contributions and earnings grow tax-free. Because contributions were taxed on the way into the account, withdrawals are also tax-free. Unlike Traditional SDIRAs, Roth accounts do not have RMDs.
Self-Directed IRA LLCs
An SDIRA LLC is a legal structure that increases accountholder control. If you have an SDIRA LLC, you gain “checkbook control” and can complete transactions, like asset purchases, without going through your custodian. These can be beneficial in many circumstances, especially timely ones, like real estate purchases.
To leverage this approach, establish an LLC and indicate the IRA is a member of the LLC and yourself as the manager of the LLC. Once that’s completed, you’ll benefit from increased flexibility and faster transaction execution.
Is a Self-Directed IRA Worth It?
Yes, an SDIRA can be a worthwhile investment product, especially if you want enhanced control over your retirement portfolio. Because SDIRAs allow you to invest in an array of alternative assets, this type of account is also worth considering if you’re knowledgeable in a specific area, such as real estate investment, private equity investments, or cryptocurrency.
Another reason SDIRAs may be worthwhile is that many assets that are allowed in an SDIRA portfolio (but not standard IRAs) are associated with a higher earning potential when compared to common assets like stocks and bonds. Assets like real estate have the opportunity to build generational wealth, especially when built in a way to avoid additional capital gains taxes with a Roth account.
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FAQs
Can I take a loan from my self-directed IRA?
No, you cannot take a loan from an SDIRA. Doing so is considered a prohibited transaction. However, some circumstances, such as the birth of a child or the purchase of your first home, allow for penalty-free withdrawals.
Can I manage my own self-directed IRA, or do I need a custodian?
While you can manage your own SDIRA investments, you must hire a custodian to administer the account.
What are the risks associated with self-directed IRAs?
One of the most prominent risks associated with an SDIRA is that the account is not managed. Instead, you are in control of investment decisions, including doing due diligence before purchasing or selling an asset. As such, inexperienced investors are at a heightened risk for losses due to poor investment decisions.
