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What is a Self-Directed IRA?

A self-directed IRA (SDIRA) is a great way to take control over your retirement investments. But beware: More control does come with increased risk.

Written by Ashlyn Brooks / July 13, 2022

Quick Bites

  • Self-directed IRAs offer more investment options for your retirement plan.
  • You are in control so make sure you have knowledge in the areas you wish to invest in.
  • Self-directed IRAs come with increased risks but the potential for higher returns.

Typically your standard retirement accounts will limit your investment options to bank-approved securities such as bonds, stocks, and mutual funds. With a self-directed IRA is a retirement account that lets you focus on alternative investment strategies outside of your standard investment accounts, including in real estate and precious metals. A SDIRA is a great way to diversify your investment portfolio and open doors to potentially more lucrative returns.

Inside this article

  1. What is a SDIRA?
  2. How to open a SDIRA
  3. SDIRA vs traditional IRA
  4. The rules are the same
  5. Investing in a SDIRA
  6. FAQ

What is a self-directed IRA (SDIRA)?

A self-directed IRA (SDIRA) is a retirement account that lets you have a little more freedom on where you invest your money. Different areas investors usually focus on in their SDIRA’s include:

  • Startup companies

  • Foreign currencies

  • Real estate

  • Precious metals (gold, silver, etc.)

  • Cryptocurrency (Bitcoin and/or Ethereum)

The investment strategies in SDIRAs typically come with the potential for greater returns on investment than you would see in a traditional IRA account. With that potential, of course, comes more risk.

How to open a SDIRA

There are several steps you will need to follow to set up your SDIRA. But don’t worry, it is easier than you think.[1]

Find an SDIRA custodian

A custodian is just another word for broker or bank. The goal here is to find a custodian that has a positive track record of being able to support the non-traditional investments you are trying to get into. Keep an eye out for their fee breakdown. Some custodians will charge set-up and annual fees that might not make them the right choice for you.

Set up and fund your account

Once you have found the right custodian for you, they will walk you through setting up your SDIRA. Once your account is active you will pay any necessary fees and then fund your SDIRA. You can fund your account in several ways:

  • Rollover money from another investment account

  • Direct deposit

  • Transfer assets from another custodian

Direct your investments

Once your account is funded and any fees are paid you are now in the driver's seat of where you direct your investments. You can do this by simply telling your SDIRA custodian what to invest in and they will make the purchases on your behalf.

SDIRA vs traditional IRA

“From a tax standpoint, there is no difference between a self-directed IRA and more conventional IRAs,” says Eric Satz, chief executive office at Alto, which offers SDIRAs. “The main difference between the two is what you can invest in. An SDIRA puts you in the driver’s seat, allowing you to invest your tax-advantaged retirement funds in assets that you’re interested in — like crypto, real estate, and startups. In other words, assets with the potential for outsized returns.”

SDIRA

With an SDIRA your investment strategy will focus on non-traditional areas off the stock market such as:

These non-traditional investments give you the opportunity to research and navigate potentially more lucrative fields. Understanding these alternative areas of investments opens the door for a greater increase in wealth. Which could allow for more financial security in retirement.

Traditional IRA

Traditional IRAs are typically restricted in what you are allowed to invest your money in. When dealing with a traditional IRA, your plan’s administrator will usually make your investment decisions for you based on what generates the most consistent return. These areas of investment are typically in:

  • Conventional stocks

  • Bonds

  • Mutual funds

  • ETFs

SDIRA and Traditional IRAs share the same rules

While an SDIRA and traditional IRA offer different investment styles, you will be held to the same IRS code in your self-directed account. With your SDIRA you will still be held to the following:[2]

  • Minimum required distributions must begin when you turn 72 years of age

  • Distributions taken out before the age of 59 ½ will be subject to a 10% tax penalty

  • Distributions that are taken in retirement are taxed as income

  • The contribution limit for an SDIRA in 2022 is $6,000

    What Are the Roth IRA Withdrawal Rules?

    What Are the Roth IRA Withdrawal Rules?

    Before you tap this tax-advantaged retirement account, make sure you know when a withdrawal can trigger taxes and penalties.

    Find out more

Investing in a SDIRA

Just like with any other investment opportunity, SDIRAs come with their own list of pros and cons.

“One hidden gem about SDIRAs, especially if you’re a crypto investor, could be the tax benefits,” says Satz. “Typically, when you buy and sell cryptos you are required to report each transaction on your yearly taxes. When investing in crypto through your SDIRA you bypass those tax-reporting requirements. So as long as you wait until you’re eligible to take distributions, you will never pay capital gains taxes on those investments, potentially saving you hundreds or even thousands.”

Advantages

Some of the advantages of a self-directed IRA include:

  • Potential for higher returns on investment

  • Increased diversification of investments

  • Increased control over your retirement investment strategy

  • Tax savings when waiting to withdrawal until you reach retirement age

Risks

Although an SDIRA comes with more freedom over your investment options, that extra freedom doesn’t come without risks. Some common risks associated with SDIRAs are:

  • Less liquidity

  • More fees

  • Limited protection against risky investments

  • Greater risk for IRS rule violations

FAQ

What is a self-directed IRA and how does it work?

A self-directed IRA is a type of traditional or Roth IRA, which means it allows you to save for retirement on a tax-advantaged basis. The difference between self-directed and other IRAs is the types of assets you own in the account.

Is a self-directed IRA a good idea?

There's increased potential for fraud in an SDIRA. Not only can the investments themselves be opaque, but the Securities and Exchange Commission warns that criminals prey on those with self-directed IRAs and encourage people to set one up in order to sell them a fraudulent investment.

Can I withdraw money from a self-directed IRA?

Remember, your self-directed IRA is a retirement account, and there are penalties for withdrawing money early from it. To withdraw funds without penalty, you must be at least 59 ½ years old. Additionally, you must begin taking required minimum distributions once you reach age 72.

Article Sources
  1. “Self Directed IRAs” IRAR Trust Company. https://www.iraresources.com/self-directed-ira
  2. “IRA FAQs” IRS. Jan. 3, 2022. https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-iras

About the Author

Ashlyn Brooks

Ashlyn Brooks

Ashlyn is a personal finance writer with experience in budgeting, saving, loans, mortgages, credit cards, accounting, and financial services to name a few.

Full bio

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