What is a Self-Directed IRA and is it a Good Idea?

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What Is a Self-Directed IRA?

A Self Directed IRA is a type Individual Retirement Account (IRA)  that allows you to invest in a really wide variety of alternative investments.  Traditional IRAs require that you invest in traditional asset classes — mainly stocks, bonds, funds, treasuries, annuities, and certificates of deposit. Self Directed IRAs and Self Directed Roth IRAs allow you to invest  in practically anything — while still getting tax benefits.

Self directed ira

Sounds pretty interesting, right? Keep reading to discover if a Self Directed IRA is right for you and your retirement savings.

The guidelines for opening and investing with a Self Directed IRA are, in some ways, similar to those for a traditional IRA. For example, the contribution limits are the same as with any IRA: The annual contribution limit for 2021 is $6,000 if you are under 50 and $7,000 if you are over 50.

However, there are significant additional regulations:

Prohibited Transactions: This can get a bit complicated. However, the short version is that there are numerous rules to prevent the IRA owner from using the account to enrich themselves or their family members (the IRS calls these family members “disqualified persons” and includes spouse, children, parents and more…). The only way to profit from the Self Directed IRA is to take a taxable withdrawal from the account.

Examples of prohibited transactions include:

  • Buying or selling property from a family member or other disqualified person
  • Making IRA assets available for use by yourself or a disqualified person
  • Compensating yourself or a disqualified person

Neither you nor disqualified persons can even perform or be compensated for work to improve a property, for example, in a Self Directed IRA. The full IRS description of prohibited transactions can be found here.

Reporting Requirements: The IRS requires that Self Directed IRA holders report on the value of your assets annually or when taking a distribution, making a conversion or demonstrating that an asset no longer has value.

Opening a Self Directed IRA is pretty straightforward.

1) Find a firm you want to work with.

You basically have two options for a Self Directed IRA firm. You can go through a brokerage (though most name brand brokerage firms do not offer this service) or with a custodian. Custodians are usually found at companies that specialize in Self Directed IRAs. This is good because following Self Directed IRAs can be complex.

2) Decide if you want your account to be checkbook controlled or custodian controlled. Custodian controlled means that the custodian will be involved and you will endure additional paperwork for all transactions. Checkbook controlled means that you have more control, but it requires that you open a Limited Liability Corporation (LLC). Most firms will help you with either option.

3) Open an account and start contributing money and making investments.

Finding the right firm can be difficult. Not all custodians handle all kinds of investments, so you’ll want to ask around to find the right fit for you.

Here is a list to help you get started finding an appropriate custodian:

  • Equity Trust
  • Pacific Premier Trust (formerly PENSCO)
  • IRA Financial
  • uDirect
  • The Entrust Group
  • Alto IRA
  • Rocket Dollar

Like a traditional IRA, a self directed IRA allows you to invest with tax-deferred money (you don’t pay taxes now on the money you invest in the account).  And, a self-directed Roth IRA allows your money to grow tax-free. (You pay taxes on the money you invest, but it grows tax free and all future withdrawals are tax-exempt.)

You need to know what you are doing with alternative investments. There is a significant risk to investing in unproven asset classes.

However, depending on your expertise and the type of investments you make, a non traditional investment in a Self Directed IRA can be financially rewarding. You can get in on the ground floor on a privately held company, speculate in real estate and more…

Just remember that high reward comes at the price of a high probability of risk.

A Self Directed IRA requires that you have an account custodian and, in most cases, you must go through that custodian every time you want to make a transaction.

Furthermore, opening a Self Directed IRA requires a lot of paperwork. And, each transaction you make requires a lot of paperwork.

NOTE: It is possible to create a  limited liability company (LLC) for your self-directed account which can cut down on the paperwork.

There are significant rules and regulations for holding a Self Directed IRA. And, if you violate those strict rules (even inadvertently), you are subject to taxes and penalties.

The custodian for your Self Directed IRA will charge you fees to hold your investments.

It is up to you to understand and make all investment decisions for your Self Directed IRA. The custodian is not allowed to provide any advice.

Many investments that are typically made with a Self Directed IRA — real estate for example — require a lot of capital and are not usually very liquid (not easy to buy and sell).

This is okay if you have lots of money and long time horizons, but less than ideal if you are lacking those resources. The lack of liquidity can also be a problem if you are over 72 and need to take Required Minimum Distributions.

You get to decide what to invest in and the sky is practically the limit (except for collectibles and life insurance).

Wild, Wacky, and Perhaps Wonderful Self Directed IRA Investments: Want to invest your tax-advantaged funds in an ostrich farm? No problem. Want to buy an apartment building? You got it. Want to invest in a franchise? You can do it! Here are a few examples of investments you can make with a Self Directed IRA:

  • Real Estate
  • Gold and silver
  • Commodities
  • Private companies
  • Mortgage notes
  • Water rights
  • Hedge funds
  • Oil, gas, lumber
  • Racehorses
  • Livestock
  • Cryptocurrency
  • Promissory notes
  • Franchise opportunities or other businesses (Though, this can be very tricky as there are additional regulations. You may not profit in the short term as opposed to when you retire.)
  • Movie productions
  • And more…

Special Notes on Real Estate: Real estate is the most common type of investment made with a Self Directed IRA.  Real estate in many different forms is eligible:

  • Raw land
  • Improved or unimproved property
  • Full or fractional ownership
  • Rental property — residential or commercial
  • A buy and flip property

However, it is important to note that there are some very strict rules. They include:

  • No Self Dealing: You can not buy or sell property to or from a related party.
  • No DIY Improvements: You can not do any work on the property yourself, you must hire an unrelated third party for all repairs and maintenance on a property.
  • No personal use. You may not live on the property.
  • No mixing funds. All of the investment property’s expenses, taxes and insurance must be paid from the Self Directed IRA.

For most people, a regular IRA is probably a sufficient saving vehicle.

However, if you have specialized knowledge in something that qualifies as a Self Directed IRA investment, adequate investment capital, an interest in non traditional investing, the patience for paperwork and a long time horizon, then a Self Directed IRA could be an interesting endeavor.

Just be sure to follow all rules.

You can model a Self Directed IRA in the NewRetirement Planner. See how your long term net worth changes with a high risk high reward account — be sure to evaluate the upside and downside of the investment and evaluate the tax consequences — especially when you need to make withdrawals from the account.

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Author: Kathleen Coxwell

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Carolyn Rosenblatt

Carolyn Rosenblatt

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We wanted to expand our reach so we incorporated My Annuity Store, Inc. and launched the online annuity platform, myannuitystore.com, on January 7, 2020. Our mission is to provide all Americans access to independent and unbiased annuity and retirement planning information.

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