Investing in a Self Directed IRA can be a great way to grow your money and generate income. Self-directed IRAs let you invest in real estate, private equity, and other investment vehicles not typically available through the typical retirement account. With Self Directed IRAs, you’re able to take charge of your financial future by investing as much or as few as you wish into assets that are important for your personal goals.
Self-Directed IRA (SDIRA): What You Need to Know
A self-directed individual retirement account is a type of individual retirement account (IRA) that may hold a variety of alternative assets that are usually prohibited from standard IRAs. Although a custodian or trustee manages the account, it is directly managed by the account holder, which is why it’s known as “self-directed.”
Self-directed IRAs are available as a traditional IRA (in which you make tax-deductible contributions) or a Roth IRA (in which you may take tax-free withdrawals). Self-directed IRAs are best suited for knowledgeable investors who already understand alternative investments and wish to diversify away from taxable accounts.
What is a Self-directed IRA?
A self-directed IRA is an IRA that allows you to save for retirement using a tax-advantaged method and has the same IRA contribution limits as other IRAs. The distinction between self-directed and other IRAs lies only in the assets held in the account.
On the other hand, traditional IRAs are generally limited to stocks, bonds, mutual funds, and various common investments. Self-directed IRAs provide a lot more options. You may also invest in real estate or a privately held business. You’re ready to go if you can locate a custodian who will sign the contract. (With an IRA, you’ll need a custodian or trustee to keep the account for you.)
How Does a Self-Directed IRA Work?
A self-directed IRA is very identical to a traditional IRA in terms of structure and function. The yearly contribution limit for both is $6,000 for 2021 or $7,000 for those 50 and over. You may open an ordinary IRA or a Roth IRA with the same pre-tax and post-tax contribution restrictions.
Traditional IRAs limit your investment choices to authorized vehicles like equities, bonds, exchange-traded funds (ETFs), and mutual funds, depending on the custodian—usually a bank or a brokerage firm.
Self-directed IRAs may now own gold bars, silver ingots, or even Bitcoin, depending on the custodian. Certain investors seek IRA tax benefits for assets in non-traditional asset classes for diversification or possibly higher returns.
You cannot purchase non-traditional assets from a self-directed IRA custodian, who simply keeps the assets after you acquire them from a different broker. This raises the level of complexity for establishing a self-directed IRA, and it may be vulnerable to fraud if you buy other assets from untrustworthy dealers.
Advantages of a Self-directed IRA
Self-directed IRAs provide several distinct advantages that can assist you in increasing your retirement savings. The following are some of the most important features of a self-directed IRA:
- Increased flexibility in the investments you can hold in the account.
- The earnings from your investments will be subject to tax breaks.
- The ability to invest in areas that are aligned with your interests, knowledge, or experience.
- The ability to diversify assets by keeping some money in a self-directed IRA and other funds in traditional investment accounts or other retirement accounts.
- You may choose from a variety of fixed-income investments that might appreciate in value.
Disadvantages of Self-directed IRAs
Even if you do your homework thoroughly before investing in a self-directed IRA, the stakes might be high. The following are some of the drawbacks of self-directed IRAs:
- You can’t invest in collectibles, life insurance, or real estate you own.
- The investment has a higher degree of risk.
- It can be expensive to maintain your account.
- The tax reporting and record-keeping requirements are onerous.
- The IRS does not allow some types of transactions.
- If you don’t follow certain IRS guidelines, you’ll have to pay penalties or taxes.
What Assets Can You Own in a Self-Directed IRA?
In a self-directed IRA, you may invest in the following non-traditional assets:
- Real estate.
- Undeveloped or raw land.
- Promissory notes.
- Tax lien certificates.
- Gold, silver, and other precious metals.
- Water rights.
- Mineral rights, oil, and gas.
- LLC membership interest.
You can’t invest in anything that isn’t pure, such as life insurance or collectibles like paintings or antiques. If you do this, your expenditures will be regarded as a withdrawal. If you do so before you are at least 59 1/2, you’ll be responsible for any applicable taxes or early withdrawal penalties.
Top 5 Things to Know Before Opening a Self-Directed IRA
Choose Your IRA Custodian Wisely
While most financial institutions can open an IRA, only a few have the skills to store alternative assets in one. Excellent custodians can help you navigate the intricacies of self-directed IRA ownership while also educating you about potential hazards such as prohibited transactions and fraud red flags.
Only a few banks have the expertise to hold alternative assets in an IRA, although it is possible to start one at almost any institution. Only good custodians can walk you through the intricacies of self-directed IRA ownership and educate you about potential hazards, such as unlawful transactions and fraud red flags.
Decide Between a Traditional IRA or a Roth IRA
The IRS does not recognize the phrase “self-directed IRA.” This may come as a wonder, but a “self-directed IRA” is actually either a Roth IRA or a Traditional IRA in which you are self-directing — or controlling — the investments within it. A Traditional IRA and Roth IRA are the only two options available to you when opening your self-directed IRA. Visit the IRA overview page for further information on how to choose between a Traditional or a Roth IRA.
Be Sure to Avoid Prohibited Transactions
There are some transactions that the IRS considers unlawful when it comes to self-directed IRA investing. You’ll want to avoid them if possible to avoid any unintended tax consequences. Buying a house with your IRA funds or lending money to yourself or family members from your IRA are both examples of prohibited activities.
Before making an investment, be sure to familiarize yourself with IRS rules on disqualified persons and prohibited transactions. The Opportunity Analyzer on Pacific Premier Trust’s website can assist you in determining whether a business deal you’re thinking about is illegal. You may also contact one of Pacific Premier Trust’s IRA Specialists by calling.
Mull Your (Almost) Endless Investment Possibilities
While you should avoid engaging in unlawful transactions, self-directed IRAs provide a wealth of investment alternatives that are outside the realm of stocks and bonds. The IRS is rather particular about what you can’t invest in (e.g., life insurance and collectibles).
According to the IRS, from raw land to private placements to Bitcoin may be held in your self-directed IRA. Before you establish your self-directed IRA, consider what you want to invest in and whether you’re comfortable with the asset class. However, just because something is feasible to invest in doesn’t imply you should.
Choose Your Investment Carefully
No matter who you work with, it’s your job to choose investments and do any due diligence. The purpose of an IRA custodian is to make sure the asset is qualified to be held in an IRA, but self-directed IRA custodians do not give any investment, tax, or legal advice. Before making a financial commitment, we advise all of our clients to perform thorough research.
How to Open a Self-Directed IRA
- Find a Custodian
Self-directed IRA custodians can be banks, trust companies, or other organizations approved by the IRS. Check prospective custodians’ feedback and look for any complaints filed with federal authorities to ensure you’re working with a reputable entity.
- Choose What Products to Buy
You can pick and choose which alternative assets you want to purchase once you’ve decided where you want to establish a self-directed IRA. You may need to locate a trustworthy dealer if your custodian does not already have established relationships, especially if your preferred investment option is unique.
Some custodians specialize in a certain type of assets, such as gold or Bitcoin, while others are more broad, so it may be beneficial to choose a custodian before determining your preferred alternative assets.
- Complete the Transaction
You may instruct your custodian to purchase your assets from your dealer once you’ve located a custodian and trader for them.
- When the Time Comes, Plan Your Withdrawals
The same IRS rules apply to self-directed IRAs as they do to regular IRAs: You’ll have to pay taxes on any cash that hasn’t been taxed previously, with the exception of Roth account earnings. If you make a withdrawal before you are 59½, you’ll be charged a 10% penalty by the IRS. Self-directed traditional IRAs are subject to required minimum distribution (RMD) rules, which state that you must begin withdrawing funds from your account once you reach age 72.
The distinction is this: Because they contain non-traditional assets, self-directed IRAs are less liquid, making withdrawals more difficult. You’ll generally need to reverse the method you took to acquire your assets and find a broker to sell them for you. Make careful preparations for RMDs, in particular. Even if you instruct the custodian to deliver precious metals to you, you will still be responsible for taxes on the withdrawal that must be paid in dollars, based on the value of the distribution.
If you’re finding a way to save money and invest in assets other than stocks, bonds, mutual funds, or ETFs, then a self-directed IRA might be the best option. But before you go down this path, there are some important questions and considerations to make. The self-directed IRA advantages and disadvantages listed above should help steer your decision-making process as well as provide insight into the risks of choosing this route for retirement funding.