Self-directed IRAs can be configured like a traditional IRA or a Roth IRA. The same potential tax benefits of tax-deferred growth or tax-free growth apply. And the same rules and restrictions associated with standard IRAs apply to self-directed IRAs. Like normal IRAs, a self-directed IRA requires the appointment of a custodian who will manage the IRA and keep your invested assets for custody.
However, looking for a custodian who can manage self-directed IRAs can be an overwhelming process. Kirk Chisholm, wealth manager and director of Innovative Advisory Group, an investment advisory firm that specializes in self-managed IRAs, says he met an experienced real estate investor who had been buying properties with his IRA. A self-directed IRA is a traditional or Roth type of IRA, meaning that it allows you to save for retirement with tax advantages and has the same IRA contribution limits. Second, in addition to finding a custodian to manage the SDIRA, you must be specific and find one that supports investment in the particular assets that interest you.
This adds an additional level of complexity to creating a self-directed IRA and may offer the possibility of fraud if you were to purchase alternative assets from unreliable agents. With normal IRAs, the depositary (usually a bank or brokerage firm) limits their investment options to approved securities, such as stocks, bonds, exchange-traded funds (ETFs) and mutual funds. The owner of a self-directed IRA can invest in private placements, limited liability companies, tax lien certificates, and precious metals. The possibility of obtaining better returns than with traditional assets is an important advantage of self-directed IRAs.
Regular IRAs usually house only stocks, bonds, mutual funds, and other relatively common investments. Of course, “traditional” simply means that it was the original IRA (unlike the Roth IRA, which came later). The broker must also obtain the account holder's permission to make trades, unless the IRA is in the hands of a money manager who has discretionary power over the account. First, many custodians who manage regular IRAs will avoid SDIRAs, which will limit the number of potential custodians.
While self-directed IRAs may make sense for some savvy investors, they come with greater risks and disadvantages than standard IRAs. They are not responsible for researching the quality or legitimacy of the IRA investment options they offer. A self-directed IRA may be a little more difficult to set up than a standard IRA, but many investors find that freedom is worth working harder for. A self-directed IRA with checkbook control allows you to invest in a world of investment opportunities, such as real estate, tax liens, precious metals and cryptocurrencies without the consent of the depositary.
Advocates of self-managed IRAs claim that their ability to invest outside the mainstream improves their diversification, but a self-directed IRA can just as easily lack diversity as any other retirement account.