How to Open a Self-Directed IRA

When it comes to retirement and responsible savings, you might be feeling trapped between a desire to save responsibly, some trauma from coming of age in the great recession, and distracted by all the shiny objects out there seemingly turning out Bitcoin billionaire influencers on TikTok and Instagram like they’re on some kind of assembly line.

According to a study done in 2018, 66% of Millennials had nothing saved for retirement. And while studies are still emerging on financial behavior during and after the pandemic, there could be some real fear that Millennials are not dialed into the importance of retirement savings.

One might speculate that the world is changing in a way where gig economies and freelancing are more common and the idea of a traditional IRA or 401(k) could appear as old-fashioned, not relevant, or simply not possible in today’s world. Whatever the reason is, as everything else in the world changes, so do financial systems and solutions. That’s why we want to explore a different way of saving for retirement that could appeal to Millennials who are used to having more control and selection in how their life is curated.

We’re talking about the self-directed IRA, a way to be responsible about retirement savings while being able to participate in some non-traditional securities so you don’t have too much FOMO about the shiny objects being paraded around on Instagram.

What is a self-directed IRA?

A self-directed IRA (SDIRA) is a tax-advantaged retirement account that grants the freedom to the account holder to be more hands-on with their accounts and invest in securities that traditional IRAs and 401(k)s do not. It’s called self-directed for reasons you may have gathered by now: you get to direct what assets you invest in, and you can even direct in with the distinct difference that you can invest in assets such as real estate that you wouldn’t have access to otherwise. An SDIRA offers the included benefit of functioning as a traditional IRA where you make tax-deductible contributions or a Roth IRA where you’re eligible to receive tax-free disbursements, allowing you to still benefit from the tax advantages that retirement accounts offer.

Reasons to open a self-directed IRA

If you like what you’re reading so far, we’ll soon explain how to establish a self-directed IRA but first, it’s important to understand the core reasons why you would open one in the first place. After all, locking in on the decision to steward your financial future is a big one and you want to choose a strategy that you feel fully aligned with.

Here are some of the top reasons to open an SDIRA:

  • You understand investing and due diligence and want to combine that knowledge with the advantages of an IRA to have more control over your investments.
  • You’re ready to diversify your portfolio into different global assets.
  • You feel like you have what it takes to be your own investment advisor—after all, there’s no one else who has your interests at heart as you do.
  • You cringe at the thought of the restriction of asset allocation choice that is common with mutual funds.
  • You want to invest in real estate, commodities, private placements, and limited partnerships—and you have the investment chops to take on the risks with a relatively high degree of strategy and competence.

What are the pros of a self-directed IRA?

You might have gathered some of the advantages of opening an SDIRA in the previous sections, but here are some of the more specific advantages to consider as you discover what is a self-directed IRA.

  • There are big risks that come with SDIRAs; however, there is the potential for greater return on investment.
  • You’ll retain your tax benefits.
  • Freedom of choice in investments.
  • For most SDIRAs, you can make investments at your leisure.
  • Bonus: your investments have the potential to impact communities positively. For example, if you invest in a real estate development that is providing affordable housing to a community in need, your money is improving not just your future, but the lives of others.

What are the drawbacks of a self-directed IRA?

At this point, you might be thinking, “Great! How can I open a self-directed IRA?” Everything we’ve talked about so far correctly belongs in the “pros” column, but an SDIRA is not an appropriate strategy for every investor. There are serious considerations to weigh before opening a self-directed IRA to make sure that you can enjoy the likelihood of success.

  • Exit plans and liquidity. Selling a stock, bond or other traditional security is typically a quick and easy thing to do, so if you find yourself in a situation where you need that money you can access it fairly soon if needed. Depending on your investments in your SDIRA, you might find a different situation. For example, if you own a building as a real estate asset you’ll have to find the right buyer. In some markets that’s no problem. However, it’s prudent to assume that finding the right buyer who can complete a transaction will take some time to locate. So unfortunately if you need the money tied to that asset in a pinch, that will be a problem.
  • Fees. There are more complicated fee structures attached to SDIRAs. Depending on where you establish your account, you’ll likely pay an establishment fee, first-year annual fee, renewal fee, and investment bill-paying fees. It’s worth the time to understand the fee structures and how they could affect your potential ROI in a variety of investing and market scenarios.
  • Due diligence is on you. With greater choice and control in your assets comes greater responsibility as well. With a traditional IRA or 401(k), there is a team of financial experts who are coordinating investment strategies to create a return on your investment. They know what they’re doing, taking any burden of knowledge off of the account holder. That’s why self-directed IRAs are considered a good strategy for more sophisticated investors who can perform due diligence and assess any risk as adequately as possible.
  • Prohibited transactions. Breaking any rules or violating compliance in any way could potentially put you in some hot water—another reason SDIRAs are considered more ideal for savvy investors. You must understand the rules for the assets in your account to avoid fees and penalties.
  • Fraud. To open an SDIRA, you’ll have an account custodian. They are unable to offer financial advice, but they can make certain investments available, but they don’t necessarily evaluate “the quality or legitimacy of any investment in the self-directed IRA or its promoters.” 

The main takeaway? If you’re willing to take on the risk, be sure to know what you’re getting into, how to perform due diligence, keep up on fraud, and understand that you are responsible for following the rules.

How to open a self-directed IRA

Even though so far it might sound like an SDIRA is some renegade account that can just be created anywhere while doing its own thing, the IRS requires that all retirement accounts and assets are held by a qualified custodian such as a credit union, bank, or other financial institution. This custodian is tasked with administering the SDIRA, holding the investments, and ensuring the SDIRA is compliant with IRS rules.

Investors will want to do their research before choosing the financial institution in which they want to invest, as not all of them are going to offer to invest in all assets. For example, if you have your heart set on investing in real estate and gold bullion, don’t assume that just because a bank will open an SDIRA for you that they offer access to those assets. Always ask before establishing your account, and enquire about assets beyond what you currently have your eye on; you never know what might call to you in the future.

Remember to also enquire about fee structures so you can fully understand how fees will affect your overall return on investment.

Potential investors will want to gain knowledge before opening their SDIRA including a list of custodians. However, we’ve listed some custodians that could be a potential establishment where you can open and operate your SDIRA.

Once you’ve decided which custodian you’ll partner with to open your SDIRA, you’ll need to roll over any funds from existing retirement accounts. If you don’t currently have retirement accounts, you’ll need to be ready to deposit funds; your custodian should notify you of how much before you set up your account. Then you’ll start investing!

Final thoughts

Hopefully, you’re clear on what you need to know about how to create your own self-directed IRA. Though this strategy isn’t for everyone, it fits the spirit of the Millennial generation: one that knows how to cultivate their knowledge based on the vast resources available to them.

On top of opening an SDIRA, Ark7 offers an innovative way to invest in fractional real estate by purchasing shares of properties using your new SDIRA on Ark7. If you’d like to learn more and browse our selection of investments, get started here.

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