What to Know if You’re Considering a Self-Directed IRA

By Nicole Young on May 22, 2023

It’s the strategy drilled into the minds of every investor — diversification. But when it comes to your IRA, you’re mostly limited to stocks, bonds, mutual funds and other common investments. For those who want to diversify their retirement portfolio with alternative assets, a self-directed IRA (SDIRA) is an option worth considering. With the rise in do-it-yourself traders, it may seem like it’d be easy to manage your own retirement account, but there are some important questions to ask before deciding whether an SDIRA is right for you.

How is an SDIRA similar to a traditional or Roth IRA?

An SDIRA is still structured as either a traditional or Roth IRA, so it follows the same basic rules for taxes and distributions. If your SDIRA is traditional, you’ll make tax-deductible contributions but pay taxes on your distributions, and you’ll follow the same rules for required minimum distributions (as of 2023, RMDs are required once you turn 73). If you take a withdrawal before age 59½ you’ll be required to pay normal income taxes on the full amount, as well as face an early-withdrawal penalty. If your self-directed account has a Roth IRA structure, your contributions are not tax-deductible, but your earnings grow tax-free and you do not have to take RMDs. The annual contribution limits are the same — $6,500, or $7,500 for those 50 and over, for 2023.

How do I open an SDIRA?

You will first need to find an IRS-approved custodian, such as a bank, brokerage firm or trust company, to hold your account. That custodian is not responsible for evaluating your investments and cannot provide you financial advice: It’s your responsibility to find — or work with a separate financial advisor to find — your own investments.

What are the differences and advantages of an SDIRA?

It comes down to the types of assets you can hold in your account. An SDIRA gives you the opportunity to pursue higher returns through investments that aren’t permissible in a traditional or Roth IRA. These include (but are not limited to):

Privately held or start-up companies
Real estate assets, including land, tax liens and deeds on foreclosed properties
Precious metals, such as gold or silver, that must meet IRS purity standards
Cryptocurrency
Foreign currency

Life insurance and collectibles (including artwork) are not eligible for SDIRAs.

What are the disadvantages?

Those with the time and know-how to do their homework will certainly see the advantage in choosing their own investments, while for others it may prove a major drawback to having an SDIRA. Because the investor has the sole responsibility for understanding and vetting the investments in their account, the SEC warns of the increased risk of fraud.[1] Alternative assets can also be subject to increased market volatility, and often they have lower liquidity that makes it complicated to take withdrawals and RMDs. For example, real estate holdings in a standard IRA may comprise shares of an REIT that can easily be sold, while it would prove challenging ― if not impossible — to liquidate a physical piece of land in your SDIRA in fractional amounts.

What are the rules of an SDIRA?

SDIRAs have a more complex set of IRS rules that do not apply to other IRAs, and even an unwitting violation can result in extra taxes and penalties. For example, if you want to buy real estate property through your IRA, you’ll likely have to pay cash in full, you or your family cannot use the property, and you cannot do any upkeep on the property yourself (i.e., if you own an investment house and you replace a broken fixture yourself, pay any ownership expenses directly out of pocket, rent the place out to your sister or even let your kids spend the night there when they’re in town, you’re in violation and risk voiding your account’s tax-deferred status).

What are the next steps if I’m interested in an SDIRA?

Having an SDIRA doesn’t need to mean going it entirely alone. Please reach out to us to determine if it’s the right vehicle for some of your retirement savings, and if so, for help finding a reputable custodian that has specific experience in holding SDIRA accounts. We can also help you align an SDIRA with your other investment accounts so that your overall asset allocation and asset location (i.e., which investment categories you own in which account types ― taxable or tax-deferred) align with your financial goals.

[1] U.S. Securities and Exchange Commission, “Investor Alert: Self-Directed IRAs and the Risk of Fraud, ”https://www.sec.gov/investor/alerts/sdira, February 7, 2023. Accessed April 23, 2023.

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