What Is a Self-Directed IRA?

The term “self-directed individual retirement account (SDIRA)” defines a type of individual retirement account (IRA). However, it allows you to hold various alternative assets that are off-limits or prohibited in traditional IRAs.

Some non-conventional investments that people can have in SDIRAs include cryptocurrencies, precious metals, real estate, and more.

In other words, these alternative investments in a self-directed IRA are diversified, and you’re not limited to banks or other institutions. However, it is important to keep in mind that SDIRAs are more complicated to manage and usually require higher fees.

Moreover, you should understand other aspects related to SDIRAs before taking this path in your retirement planning. Find the most important below!

Understanding the Self-Directed IRA (SDIRA): What Is It?

As mentioned, a self-directed IRA is a variation of traditional individual retirement accounts, also known as IRAs.

SDIRAs are available as traditional IRAs or Roth IRAs with different tax advantages. If you choose a traditional IRA, you must make the tax-deductible contributions yourself. However, if you opt for a Roth IRA, you can take tax-free distributions.

Another important feature of SDIRAs is account management. While it usually falls into the hands of a custodian or trustee, it is managed by a self-directed account holder.

In other words, a self-directed IRA custodian manages the account. These administrators, who are also called trustees, usually hold the assets after purchasing them from another broker.

Also, self-directed IRA custodians cannot give financial or investment advice for self-directed IRAs. That’s why many think creating these accounts is more complex and can be fraudulent. However, there is still much to know before reaching a conclusion.

Understanding the Self-Directed IRA (SDIRA)

Main differences between SDIRA and other IRAs

A self-directed IRA is similar to a traditional IRA in several ways. In 2021 and 2022, the annual contribution cap will remain at $6,000, or $7,000 for those aged 50 and older. Moreover, you’ll have to meet the same pre-tax and post-tax contribution requirements whether you decide to invest in a self-directed IRA as a regular IRA or a Roth IRA.

However, there are some key differences between all types that you should be aware of before making a decision on your requirement planning.

Do Self-directed IRAs House Mutual Funds?: Types of Investments

The main difference between a self-directed IRA and other IRAs is the types of investments a person can own.

Regular IRAs are limited to common or traditional securities such as bonds, stocks, certificates of deposit (CDs), and mutual or exchange-traded funds (ETFs). In contrast, self-directed IRAs allow people to invest in a broader catalog of assets. Check out the most common investments below!

Self-Directed IRA Alternative Investments

If you opt for a self-directed IRA, these are some of the assets you can own as long as they meet IRS standards:

  • Cryptocurrencies or digital assets, such as Bitcoin or Ethereum

  • Precious metals, including gold, silver, platinum, and palladium (all must meet IRS purity standards)

  • Startups, as long as it is through crowdfunding platforms, such as StartEngine, Wefunder, or SeedInvest

  • Real estate properties – you should keep in mind that investing in real estate through self-directed IRAs also implies following some rules

  • Tax liens on foreclosed real estate

    Foreign currency as long as the investment is made through a forex IRA

Paying Taxes

Before making your retirement investment, you should also consider the differences between the traditional and Roth SDIRA.

SDIRAs can be set as traditional IRAs or Roth IRAs. However, both types are different in terms of tax treatments, contribution guidelines, eligibility requirements, and distribution rules.

Traditional IRAs offer an upfront tax credit, but when you start taking distributions in retirement, you must pay taxes on your contributions and gains.

In other words, you do not enjoy tax advantages when you make a contribution to a Roth SDIRA, but your earnings and contributions grow without taxes. These accounts also have tax-free qualifying distributions.

Income Limits

Although traditional IRAs do not have income limits, you must make less than a certain amount in order to open a Roth. The same is true if you plan to contribute.

Early Withdrawals

If you choose a Roth IRA when creating your self-directed IRA, you can withdraw your contributions at any time and for any reason without paying a tax or penalty.

While you can’t touch your earnings, withdrawals are tax and penalty-free after you turn 59 and six months as long as the account is five months old.

However, if you have traditional IRAs, you must start paying taxes as soon as you turn 59 and six months in order to withdraw your IRA funds.

Required Minimum Distributions (RMDs)

If you have a traditional IRA, you should be taking the required minimum distributions (RMDs) when you turn 72. However, if you choose a Roth IRA, you never have to worry about RMDs!

Keep in mind that these rules apply to whichever IRA version you choose when you open your SDIRA.

Advantages of a self-directed IRA

Health Savings Account

SDIRs offer many benefits to people hoping to invest in a retirement plan. These are some of them:

High Alucrative Returns

A self-directed IRA offers more investment options than traditional ones. In other words, it allows you to invest in alternative assets that promise higher lucrative returns, such as business properties or LLC memberships, as these are prohibited transactions in traditional individual retirement accounts. Additionally, you can invest your retirement funds in high-risk, high-reward securities like Bitcoin. If you invest in the stock market, your returns can be lower.

Asset Diversification

Retirees who want to protect their IRA assets against losses from inflation or recessions can rely on alternative investments like gold or other precious metals. While it’s true that many of these assets are volatile, just like mutual funds or stock bonds, they can diversify your portfolio and help you keep your money from losing value.

Savings in Tax-Advantaged Account

Investing in an SDIRA that allows tax-free or tax-deferred growth is the best option if you hope to positively influence your post-retirement wealth.

How to Open a Self-directed IRA

Opening an SDIRA because you expect to invest in precious metals and other types of non-conventional assets can be more complicated than opening a traditional IRA or a Roth IRA. These are the steps you must follow:

  1. Select the right custodian:

Remember that SDIRAs must be held by a custodian or entities approved by the IRS. The most common are usually banks or trust companies.

Do some research before choosing yours to avoid fraud or future problems. It is important to look for custodians who do not have tax complaints.

  1. Select the asset you want to buy

Have you already chosen where you want SDIRA to go? The next step is to select the assets you want to buy, be it cryptocurrencies, real estate, or precious metals.

If your custodian does not have established companies, you should seek an external distributor to purchase your assets.

Remember to check with your custodian before you buy, as some specialize in particular active IRAs.

Tip: Try to consider your options and determine the assets you would choose before selecting a self-directed IRA, SDIRA custodian.

  1. Complete the Transaction

If you have already completed the previous two steps, the next thing you need to do is ask your custodian to buy the assets directly from the dealer.

Types of Self-directed IRAs

In addition to the traditional IRA and the Roth IRA, there are several types of SDIRAS you can choose from. These are:

Individual 401(K)

They may qualify as a profit-sharing retirement plan with individual 401(K) options, but they are less expensive and complicated than traditional ones.

SEP (Simplified Employee Pension) IRA

These SDIRAs are designed for self-employed people, business owners, and partners with at least 24 employees. SEP IRAs are low-cost and easy to open.

SIMPLE (Savings Incentive Match Plan for Employees) IRA

It’s a retirement plan designed for small business owners or small employers looking to lower their business’s tax liability.

Health Savings Accounts (HSA)

These retirement plans require tax-deductible contributions, so they can reduce your taxable income. However, you should not pass tax charges for withdrawals if you use them to pay qualified medical bills.

Education Savings Accounts (ESA)

This type of individual retirement account is similar to the Roth IRA but requires that the funds be paid to the beneficiary’s qualified tax expenses.

Risks and Disadvantages Associated With Self-directed IRAs

Open IRA Account

SDIRAs can be very beneficial for some investors. However, asset diversification can also bring risks, including:

Less Liquidity

Many investors who choose SDIRAS decide to put their money in physical assets or real estate. Unlike highly liquid assets, such as exchange-traded or mutual funds, alternative acquisitions, can take much longer to sell. In some cases, holders who need to sell quickly set prices far below the fair market value.

Higher Fee

You can invest in SDIRAs without having to pay trading or account management fees most of the time. However, depending on your financial institution or custodian, you may have to pay for maintenance, storage, and insurance.

Limited Protection

While IRA custodians manage and hold your alternative assets, they have no duty to investigate whether or not your investment options are legitimate. In other words, you can end up losing money if you buy any precious metal or other physical goods from a dealer that doesn’t meet IRS standards. If this happens, you not only affect your investment but you may also face tax penalties.

Final Thoughts

If you want to fund your retirement but traditional IRA assets don’t sound very appealing, you can consider a self-directed IRA as an investment option. However, you should be very cautious, as there are more risks of making tax or financial mistakes and falling into traps if you choose these options.

Also, you should seek IRA financial specialists who provide investment advice in order to learn about the self-directed IRA rules, including those related to the Unrelated business income tax (UBIT) and prohibited transactions, before making a decision as important as this!

Tim Schmidt


Tim Schmidt is an Entrepreneur who has covered retirement investing since 2012. He started IRA Investing to share his expertise in using his Self-Directed IRA for alternative investments. His views on retirement investing have been highlighted in USA Today, Business Insider, Tech Times, and more. He invested with Goldco.