A Self-Directed IRA is not a term you will find anywhere in the Internal Revenue Code (IRC), meaning the IRS does not define what a Self-Directed IRA is. It refers to an IRA account that permits you to invest in traditional assets, such as stocks, but also alternative assets, such as real estate, metals, and cryptocurrencies. It’s important to understand the different types of Self-Directed IRAs so you can choose the best one for your situation.
Self-Directed IRAs provide essential benefits, like flexibility and tax advantages. In the last several years, the number of self-directed retirement accounts has grown significantly. Today, there are approximately 50 million IRAs totaling about $9.3 trillion. Self-directed accounts offer investors the flexibility and control to manage their own investments, rather than relying on traditional market fluctuations.
With your Self-Directed IRA, you decide when to buy, and sell and what investments you wish to make. As a result, you better diversify your retirement portfolio and gain the ability to invest in asset classes you feel confident about.
What is a Self-Directed IRA?
A Self-Directed IRA refers to an IRA account that permits you to invest in traditional investments, as well as alternative asset investments, including real estate and private equity.
What are the main types of Self-Directed IRA accounts?
A custodian controlled Self-Directed IRA is ideal for investors who wish to be more hands-off and let the custodian do all the work. A Checkbook IRA, also known as a Self-Directed IRA LLC, is better for those who want total control of the investment process and the limited liability protection of the structure
Why Choose a Self-Directed IRA?
This type of IRA allows investors to use their IRA funds to make diverse investments. Many IRA investors believe they can only use an IRA for traditional investments, such as bank CDs, the stock market, or mutual funds. Fewer investors know that the IRS permits investments like real estate to be held inside individual retirement accounts.
The two main advantages of using a Self-Directed IRA to make investments are that you can invest in what you know and trust, and all the income and gains are tax-deferred or tax-free in the case of a Self-Directed Roth IRA. Consulting a financial advisor can provide valuable insights on financial, legal, or tax matters, enhancing your overall investment strategy.
Types of Self-Directed IRA and Roth IRA Accounts
You can establish a Self-Directed IRA with:
- Pretax (traditional) IRA
- Roth IRA
- SEP IRA
- SIMPLE IRA
In addition to these, traditional and Roth IRAs offer unique benefits and flexibility for retirement planning.
A Self-Directed IRA is essentially a vehicle that allows you to use your IRA funds to make investments banks or traditional financial institutions do not provide. A Coverdell Education Savings Account is another tax-advantaged option that allows tax-free distributions for qualified educational expenses, making it a valuable tool for both K-12 and higher education. Another option is the Self-Directed Health Savings Account, which helps pay for medical bills, while saving for retirement.
What Are Self-Directed IRAs?
There are essentially two different types of Self-Directed IRAs that we will focus on: the Custodian Controlled SDIRA, and the Checkbook IRA, also known as a Self-Directed IRA LLC. Understanding the Self-Directed IRA rules is essential to avoid penalties and maintain the tax-advantaged status of your account.
Custodian Controlled Self-Directed IRA
First, you have the custodian-controlled Self-Directed IRA. This type of IRA gives investors more options than a self-directed plan a financial institution offers. A special IRA custodian will serve as the custodian of the plan. Most custodians make money by opening and maintaining IRA accounts keeping them in IRS compliance. They do not offer financial investment products or platforms.
With a custodian-controlled Self-Directed IRA, IRA funds are typically held with the IRA custodian. The custodian will then invest the funds into traditional or alternative assets at your direction. For example, if you wish to purchase a piece of real estate, the custodian will be a part of the entire process.
This “standard” Self-Directed IRA structure is popular with retirement investors who don’t plan to invest in an alternative asset that involves a high frequency of transactions, such as private fund investments.
Checkbook IRA
The second type of Self-Directed IRA offers “checkbook control.” Also known as the Self-Directed IRA LLC, a special purpose limited liability company (LLC) is established, which the IRA owns and the IRA holder (you) manages. Because you are the manager of the LLC, you have the authority to make investment decisions on behalf of your IRA. You don’t need the consent of a custodian to make a transaction.
With a Checkbook IRA. all your IRA funds will be held at a local bank in the name of the IRA LLC. Therefore, if you want to make any kind of transaction, you simply write a check straight from the bank account. You can also wire the funds and similar way to move funds to the final destination. This means you no longer have to deal with custodian delays and hefty transaction fees. Further, because of the aspects of the LLC, you are afforded more privacy for your transaction.
Self-Directed IRA Investment Options
Traditional Investments
Traditional investments are a cornerstone of many retirement planning strategies, offering stability and growth potential. These investments include:
- Stocks: Individual stocks or stock mutual funds can be held in a self-directed IRA, providing opportunities for capital appreciation and dividend income.
- Bonds: Government and corporate bonds can offer a steady income stream, making them a reliable choice for conservative investors.
- Mutual Funds: A variety of mutual funds are available, offering diversification and professional management, which can help mitigate risk.
- Exchange-Traded Funds (ETFs): ETFs offer flexibility and diversification, tracking various market indexes and sectors, making them a versatile addition to any portfolio.
- Real Estate Investment Trusts (REITs): REITs allow individuals to invest in real estate without directly owning physical properties, providing exposure to the real estate market with the liquidity of stocks.
These traditional investments can provide a solid foundation for a Self-Directed IRA portfolio, balancing risk and return while offering the potential for steady growth.
Alternative Investments
Alternative investments offer a way to diversify your portfolio portfolio beyond traditional assets. These investments include:
- Real Estate: Direct property ownership, such as rental properties or fix-and-flip projects, can be held in a Self-Directed IRA, offering potential rental income and long-term appreciation.
- Private Equity: Investing in private companies or startups can provide the potential for high returns, though it comes with higher risk.
- Precious Metals: Gold, silver, and other precious metals can be held as a hedge against inflation or market volatility, providing a tangible asset that retains value.
- Cryptocurrencies: Bitcoin and other cryptocurrencies offer the potential for high returns and diversification in a rapidly evolving market.
- Crowdfunding: Platforms like Kickstarter allow individuals to invest in projects or businesses, providing a unique opportunity to support innovative ventures and potentially reap financial rewards.
Alternative investments can provide a unique opportunity for growth and diversification in a Self-Directed IRA, allowing account owners to explore a broader range of asset classes.
Creating a Diversified Portfolio
Diversification is crucial when creating a Self-Directed IRA portfolio. By spreading investments across different asset classes, individuals can reduce risk and increase potential returns. A diversified portfolio can include a mix of traditional and alternative investments, such as:
A financial advisor can help individuals create a diversified portfolio tailored to their investment goals and risk tolerance. By including a mix of traditional and alternative investments, individuals can create a diversified self-directed IRA portfolio that aligns with their retirement goals and risk tolerance. This strategic approach to retirement planning can help ensure a more secure and prosperous future.
Self-Directed IRA Services
There are two important Self-Directed IRA services that every retirement investor must be aware of:
- Choosing the right IRA custodian
- Navigating the IRS-prohibited transaction rules
Navigating these rules is crucial to avoid penalties and maintain the tax-advantaged status of your account.
1. Choosing the Right Self-Directed IRA Custodian
A Self-Directed IRA custodian (passive custodian) allows you to engage in non-traditional investments but generally does not offer investment advice or serve as a fiduciary.
Not all Self-Directed IRA custodians are the same. For one, not all allow for checkbook control. Also, custodians have different fee schedules. Some, such as IRA Financial, charge a flat annual fee with no asset valuation fees. However, others charge a fee based on the value of the IRA.
One of the more important services is the efficiency with which the IRA custodian can open and fund the account. This is by way of a transfer or rollover. Roth IRAs offer unique benefits, such as tax-free growth and withdrawals, making them an attractive option for many investors.
2. IRS Prohibited Transaction Rules
The Internal Revenue Code (IRC) acts as a guide to prevent IRA holders from triggering prohibited transactions. However, the IRC does not describe what investments a self-directed IRA can make. It does, however, describe what the IRA cannot invest in. If the IRA does not purchase life insurance or collectibles, or engage in a prohibited transaction outlined in IRC Section 4975, then you can invest.
When it comes to navigating the prohibited transaction rules, it is important to work with an IRA custodian who can help you understand whether the transaction you want to make will be a violation of the rules.
The good news is that establishing a Self-Directed IRA is now easier than ever. The key is choosing the right custodian that will perform all the required services efficiently and cost-effectively. While traditional IRAs offer accessibility and ease of setup, Self-Directed IRAs provide broader investment capabilities for experienced investors.
Frequently Asked Questions
What is a Self-Directed IRA?
A Self-Directed IRA (SDIRA) allows you to invest in alternative assets like real estate, private equity, and cryptocurrencies, in addition to traditional investments like stocks and bonds. Unlike traditional IRAs, SDIRAs give you full control over investment choices, offering greater diversification.
Why Choose a Self-Directed IRA?
SDIRAs allow you to invest in what you know, such as real estate or private businesses, rather than being limited to stocks and mutual funds. Depending on the type of SDIRA, all earnings grow either tax-deferred (traditional SDIRA) or tax free (Roth SDIRA).
What are the different types of Self-Directed IRAs?
Custodian-Controlled Self-Directed IRA – A specialized custodian holds your assets and processes investment transactions at your direction.
Checkbook IRA (IRA LLC) – Provides direct access to funds via an LLC, allowing you to make investments without custodian involvement.
What types of investments can you make?
An investor may choose traditional investments, including stocks, bonds, mutual funds, and ETFs, or alternative asset investments, such as real estate, metals like gold and silver, cryptos, private placements, and so much more.
What are the important considerations when choosing a Self-Directed IRA custodian?
1. Not all IRA custodians support alternative investments – choose one that aligns with your investment and retirement goals.
2. Compare fees and services – some charge flat fees, while others base costs on account value.
Bottom Line
A Self-Directed IRA offers more investment flexibility and control but requires careful management to stay compliant with IRS rules. Choosing the right custodian and investment strategy can help maximize tax advantages and retirement growth. Be sure you understand the different types of Self-Directed IRAs before settling on a custodian and account structure. You’ll be glad that you did!
Do you still have questions about which type of Self-Directed IRA or services to choose? Contact us at any time! You can also fill out the form to speak with an IRA specialist who is always on-site to answer any of your questions.
