Self-Directed IRA vs. Regular IRA

Chances are, you’ve heard of an IRA account before and you may even have one set up through your employer. But, contrary to popular belief, IRA is not just an umbrella term used to describe retirement accounts. There are different types of IRAs with different uses, purposes, and benefits. In this post, we’ll go over the differences between two different types of IRA investments: the self-directed IRA and a regular IRA.

What is a regular IRA?

An individual retirement account, or IRA, is a tax-deferred saving account with the goal of providing an income source for retirement. A broker or investment advisor typically oversees these accounts, which are limited to traditional investments, such as:

  • Stocks.
  • Bonds.
  • Mutual funds.

Self-Directed IRA vs. Regular IRA

Both types of IRA accounts are created with the intent of saving money for retirement. The difference comes in when it comes to managing the account. Self-directed IRA account investors are free to make most, if not some, of their investment decisions, including into alternative investments. 

Alternative investments that you can invest in with a self-directed IRA include:

  • Real estate.
  • Cryptocurrency.
  • Gold and other precious metals.
  • Water rights.
  • Undeveloped or raw land.
  • Livestock.
  • Hedge funds.
  • Commodities.
  • Futures. 
  • Private equity/debt.
  • Foreign currency.
  • And much more.

With such broad investment offerings, people who choose self-directed IRA accounts can diversify their investment portfolio, which in turn allows them to earn dividends faster with less risk.

There are a few things you can’t use a self-directed IRA to invest in, including collectibles such as:

  • Rare coins.
  • Art.
  • Antiques.
  • Alcohol.
  • Jewelry.
  • Baseball cards.
  • Memorabilia.
  • Stamps.

These limitations impact what kind of precious metal investments you can hold in your self-directed IRA. For example, while you can invest in the gold market with your self-directed IRA, you can’t purchase collectible gold coins.

You also can’t use the funds in your self-directed IRA to do the following:

  • Lend money.
  • Sell property.
  • Use it as collateral for a loan.
  • Buy property for personal use.

Self-directed IRA accounts provide the owner with tax advantages. They also have contribution limits. For 2022, the maximum contribution is $6,000 for people under age 50 and $7,000 for those 50 and older.

The rules for regular IRA accounts and self-directed IRA accounts—which are both governed by the Internal Revenue Service (IRS)—are the same:

  • When you turn 72, you are required to start taking RMDs, or required minimum distributions from your account. If you turned 70.5 in 2019 or earlier, you have to take them from that point on.
  • Any distributions you take before you turn 59.5 will be taxed and you could face an additional 10% penalty.
  • Distributions you take while retired will be taxed as regular income.
  • There are no income limits required to qualify for either kind of IRA.
  • You could be eligible for a tax break on your contributions, depending on your circumstances. This is something you should discuss every year with your tax preparer. 

Self-directed IRA accounts and real estate investments

As we mentioned above, real estate is a very popular investment choice among self-directed IRA investors. For example, you can use the money in your IRA to purchase foreclosed properties that will be held in your account custodian’s name. The restrictions come into play in terms of prohibiting you from actually living at the property.

How to set up a self-directed IRA

Although you do have more control over a self-directed IRA account, you don’t manage it completely alone. Typically, people use a third-party service or platform to help them manage their IRA investments.

If you want to open a self-directed IRA account, take the following steps:

  • Find a platform or a smaller, local trustee that can help you manage the account.
  • Choose the investments you want to make.
  • Make your investments or ask the account custodian to carry out your transaction.

Different types of IRA investments will work best for different people. If you’re considering which one to invest in, take time to do ample research into the requirements, contribution limits, benefits, tax breaks, etc., so you can make the most informed decision and propel yourself toward a comfortable retirement.

Final thoughts

Both the self-directed and regular IRAs are tools to save for retirement. However, there are several differences in how they work. Regular IRAs are managed by brokers and are limited to traditional assets; self-directed IRAs are invested by the account owner and typically offer portfolio diversification into alternative assets. They both have contribution limits and regulations as determined by the IRS.

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