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What is a Self-Directed IRA and Should You Use One?



Retirement planning is essential for one and all. The wealthier you get, the bigger should be your retirement plans. Retirement is an age to take a break from work. You wouldn't be able to shrug off your current standard of living, would you? Saving more and more for those years, therefore, is crucial. The higher goes your income strata, the higher should be the volume of savings. Affluent individuals who look forward to maintaining a long-term wealth, often consider different retirement savings vehicles to ensure the strategic growth of their assets.


What are IRAs?


IRAs are of several types. A self-directed IRA is different from the traditional ones in a unique way. It allows you to save for your retirement IRA with an added tax advantage. The investment norms and limits are similar to that of the traditional IRA.


Talking about IRAs, they are primarily of 3 types – the traditional IRA, Roth IRA, and Rollover IRA. Whereas, in the case of Roth IRA, all your savings grow tax-free (as you are investing with that money that has already been taxed), in the case of a traditional IRA, the money (with which you invest) is that money that can be deducted during tax filing. The money is adjusted with your tax returns.


The potential earnings, in the case of a traditional IRA, grow tax-deferred. This holds a unique advantage. Individuals who find themselves in a lower tax bracket post-retirement will have to pay less money in terms of tax! ‘Rollovers’ include money generated from one concrete retirement plan, say 403(b) or 401(k) into a traditional IRA.


In short, a traditional or Roth IRA account allows for pre- or post-tax investment contributions. The question that evolves at this juncture is: then what is a self-directed IRA?


What is a Self-directed IRA


A self-directed IRA is similar to the ones we discussed above - the traditional or the Roth IRA. Tax-free savings for the retirement era is the crux of all IRA stories. The contribution limits, age restrictions, etc. are also similar to that of the traditional ones. The only distinction between self-directed and other IRAs lies in the type of assets held in the account.


Regular IRAs typically hold commonly held investments like stocks, bonds, mutual funds, etc. Self-directed IRAs provide a multitude of additional options. You could, for instance, invest in some of the non-traditional channels like real estate or even a privately held company.


The increased investment flexibility, on a positive note, results in portfolio diversification and also some significantly higher tax-free or tax-deferred returns than what is yielded by the average IRA.


To cut a long story short, self-directed IRAs, if properly managed, can possibly make room for the accumulation of millions of dollars for your retirement years through the strategic use of alternative investments.


The SDIRA (Self-directed IRA) is one type of IRA which differs from a traditional or Roth IRAs in one respect primarily: the type of assets that can be held in the respective accounts. As for regular IRAs, one can invest only in stocks, bonds, and mutual funds. For a self-directed one you can add a real estate or a non-traded business, that is, a privately owned company as well.

Investment inclusions in self-directed IRAs


Things like a life insurance policy and also tangible collectible investments are not permitted in self-directed IRAs. However, as we already discussed earlier, there are a plethora of assets in which you are permitted to invest. A few of them have been listed below:

  • Cryptocurrencies

  • Stock in a private company

  • Property investment

  • Livestock

  • Energy from renewable sources

  • Metals of great value


A self-directed IRA is often the most likely path to financial success. It’s always advisable to invest in something you're an expert in. There must be some genre or industry that you're an expert in. invest in that particular field. Self-directed IRAs can be used in this direction to directly apply your knowledge to strengthen your financial future.

At first, you’d have to collaborate with an IRA custodian who specializes in the asset class in which you wish to invest. Choose a trustee to manage investments and the account that you are investing in. This is essential because investing in self-directed IRA can be risky. It does have its share of risks, some of which have been enlisted here.


How to set up a self-directed IRA?


The first step is finding a custodian. It could be a bank, a trust company, or other IRS approved entities. The next step involves choosing the products that you want to buy, that is the alternative investments that you’d opt for. For an instance, some custodians are specialized in certain assets like Bitcoin or gold. Others, are more generic.


Potential risks associated with self-directed IRAs

  • A self-directed IRA’s setting up costs are much higher compared to that of a traditional IRA, although higher fees could be waived off with the higher returns.

  • Finding an IRA custodian is often a difficult task.

  • When you are choosing to take minimum distributions in retirement, you must be prepared for a potentially higher tax liability as well!

Can you convert a traditional IRA to a self-directed IRA?


Yes, of course! In fact, IRA transfers are a common thing and the conversions (from a traditional to self-directed or traditional to Roth) are pretty simple. With a proper process in place, the assets get transferred even without being taxed or reported to the IRS! The receiving and distributing financial intermediaries do the job.


You can make it penalty-free and tax-free too if you choose not to take any funds during the transfer. Once done, the pay the checks to the new custodian!


Finally, is a self-directed IRA the right choice?


Well, they aren’t appropriate for everyone. For investors who prefer a more hands-on approach to their investment strategies, a self-directed IRA should be an ideal option. Individuals also need to have in-depth knowledge of specific alternative investment industries.


Here's how much money you can put into IRA. It follows the regular IRA template. $6000 (or $7000 if one is above 50) happens to be the contribution limits for both 2021 and 2022. In a word, the self-directed IRA does not differ from the Traditional or the Roth variant in any way other than the custodian rules!


Self-directed IRAs have the potential to generate higher earnings with the presence of alternative investment options. Remember, the higher the returns, the higher the risks and complications.


Talking about investments on a broader spectrum, one might say that a SDIRA could be a risky investment. This is because this account is more volatile given the diverse investment opportunities that it offers.

Feel free to contact Samuel Rad, fiduciary financial advisor, for understanding the technicalities thoroughly before opening an account is, therefore, of utmost importance.