If you’re looking for a way to save for retirement with tax advantages and the ability to diversify your investment portfolio, look no further than a self-directed retirement account.
In this post, we’ll go over what you should know about self-directed IRA accounts so you can make the most informed decision based on whether this investment type suits your needs and goals.
What is a self-directed IRA account?
Self-directed IRA accounts, also known as SDIRAs, are self-directed retirement accounts. These accounts offer tax benefits and allow investors to hold several alternative investments that would otherwise be prohibited from traditional IRAs.
Account holders directly manage their SDIRAs, unlike an employer-sponsored retirement account, which an employer or third-party oversees. SDIRAs still have custodians or trustees to handle administrative tasks, but most of the heavy lifting is done by the account holder themself.
Self-directed retirement accounts are a popular choice among self-employed people or those who otherwise do not have an employer-sponsored retirement account option. They are best suited for experienced investors who understand alternative investments and looking to diversify their investments further in a savings account with tax advantages.
You can use the funds in your SDIRA for:
- Real estate.
- Livestock.
- Cryptocurrency.
- Water rights.
- Undeveloped land.
- Raw land.
- Gold and silver.
- Mineral rights.
- Oil and gas.
How to open a self-directed IRA
There are two ways to open an SDIRA:
Brokerage firms
Brokerage firms are a popular option for people investing in SDIRAs. But, you’ll have to do your research to find a brokerage firm that offers self-directed IRAs.
Custodians
This is the more popular option. Custodians are companies that specialize in SDIRAs. Some banks and trusts offer this specialty, and it’s also essential to shop around to find the one that best matches your goals and needs. Here are some important considerations to keep in mind when choosing a custodian:
- Complexity. You’ll likely need more help managing it than your custodian is capable of. This is why it’s recommended to seek the help and guidance of a financial advisor. This will help ensure your investments are managed diligently.
- Investment limitations. There are certain classifications of investments that the IRS has forbidden SDIRA account holders from investing in, including:
- Collectibles, like coins, art, and certain precious metals.
- Life insurance.
- S-Corporations.
- Real estate you reside in.
Once you have found a qualified custodian, financial advisor, and account type you want to work with, you will open your self-directed IRA account and start contributing money.
Benefits of self-directed IRAs
There are several reasons someone would choose to invest in a self-directed IRA account, including:
- You have greater flexibility over the investments held in your account.
- Built-in tax advantages on your earnings.
- Greater chance to diversify your funds by keeping some money in your SDIRA and other funds in traditional retirement or investment accounts.
- You have the freedom to choose investments that have a higher potential to appreciate.
- You can invest in things you are passionate or knowledgeable about or have experience in.
Drawbacks of self-directed IRAs
As with any investment, there are some potential drawbacks associated with investing in self-directed IRA accounts you should be aware of, including:
- Certain classes of investments you cannot invest in with your SDIRA include:
- Life insurance.
- Collectibles.
- Real estate you reside in.
- These investments are usually considered higher-risk.
- Account maintenance fees can be high.
- If you don’t follow specific guidelines, you will have to pay penalties and taxes to the IRS.
- Complicated record keeping and tax reporting requirements.
What’s the difference between SDIRAs and traditional or Roth IRAs?
When you set up your SDIRA, you will have the option of a traditional or Roth IRA account. So, what’s the difference? While both accounts offer tax advantages, there are two main differences:
- Traditional SDIRAs allow you to deduct the taxes on contributions you make to the account. Once distributions are taken later, the withdrawals are taxed as ordinary income.
- Roth SDIRA contributions are not eligible for tax breaks. But, when funds are withdrawn later, the distribution is not taxed.
Final thoughts
Self-directed IRAs are what their name implies: they are IRAs that are managed by the account holder directly. They are popular for self-employed individuals to diversify their portfolios, and they can be used for investing in alternative assets including real estate, cryptocurrency, and mineral rights. There are several categories of investments that are not allowed, though, and they have greater complexity that traditional IRAs.
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