Self-Directed IRA

A retirement account is a highly crucial asset that can provide a stable and effective source of income once you stop working. Despite the critical benefits it can provide retirees, almost half of US households had no retirement accounts in 2022.

There are many reasons why some adults hesitate to open a retirement account. One contributing factor is that traditional accounts can only hold limited assets, such as stocks, bonds, and mutual funds. If you want a diversified portfolio for retirement, a self-directed individual retirement account (SDIRA) could be the ideal solution.

What is a self-directed IRA?

An SDIRA is a unique retirement account that can hold different alternative investments normally prohibited in traditional IRAs. While a custodian or trustee can help administer the account, the account holder has complete control over their assets, which is why it’s called “self-directed.”

SDIRAs are available as traditional IRAs, allowing you to make tax-deductible contributions. However, it can also be considered a Roth IRA, which enables tax-free distributions.

A self-directed account is best suited for two types of savers:

  • Savvy investors who understand alternative investments
  • Those who aim to diversify in a tax-advantaged retirement account

Despite being called self-directed, you are not entirely on your own when handling the account. When opening an SDIRA, you still need a custodian or trustee to administer the account.

With regular or traditional IRAs, a custodian limits the account holder’s investment options to particular approved securities. Meanwhile, with self-directed IRAs, custodians hold specialized assets within the account and are only responsible for administering assets.

A custodian of an SDIRA allows owners to invest in various alternative investments. This benefit lets account holders own gold bars, cryptocurrency, or silver ingots. 

These advantages can be appealing to confident investors who want to enjoy the tax advantages of an IRA for investments in non-traditional asset classes for diversification purposes or higher returns.

Different Types of SDIRAs

The main difference between an SDIRA and traditional IRAs is the types of investments owners can hold in the account. Generally, regular IRAs are limited to common securities like bonds, certificates of deposit (CDs), stocks, and mutual or exchange-traded funds (ETFs).

Meanwhile, SDIRAs allow account holders to invest in a broader array of assets. Examples of the assets you can hold under an SDIRA include the following:

  • Cryptocurrency IRAs

There are various self-directed IRAs designed for holding cryptocurrency. For savers who believe in the long-term viability of digital currencies, investing in a Bitcoin IRA for retirement, for example, can be a logical step. 

However, it’s worth noting that most retirement investors would be better off investing in more conventional assets.

  • Self-Directed Savings Incentive Match Plan for Employees (SIMPLE) IRAs

Another retirement plan for small business owners and workers is the Savings Incentive Match Plan for Employees (SIMPLE) IRA. With a SIMPLE IRA account, employers and employees can make contributions. This type of retirement account offers owners investment choices beyond traditional options.

  • Precious metal IRAs

This retirement account allows owners to invest in precious metals for retirement. For example, a gold IRA enables account holders to own physical gold bullion.

The downside of opening a retirement account that holds precious metals is high additional fees and costs. Precious metal IRA companies charge prices well above the market average for these assets.

  • Self-Directed SEP IRAs

Simplified Employee Pension (SEP) IRAs are designed for self-employed workers or small business owners. With this account, entrepreneurs can easily make tax-deductible contributions on behalf of eligible employees and for themselves. Additionally, a SEP account allows owners to invest in alternative assets.

The Pros and Cons of Self-Directed IRA

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SDIRAs can be an effective way for retirees to diversify investments because they empower investors to invest in various assets generally excluded from traditional IRAs. Unfortunately, they can also be confusing for many account holders.

Let us look at the pros and cons to help you determine if opening a self-directed retirement account is wise.

The Advantages

  • Tax breaks on earnings: Earnings increase in the account, and account holders must pay taxes on earnings when they make withdrawals.
  • Different assets in the account: An SDIRA allows owners to choose the investments they want to build a portfolio that aligns with specific sectors, assets, or industries.
  • Personalized and diversified portfolio: With more choices, investors can diversify holdings within their accounts and use them in their overall investing strategies.

The Disadvantages

  • Confusing and easy to accidentally violate a rule: Without the right financial advisor, account holders may inadvertently break a rule while managing their retirement accounts. This could lead to the entire account being considered distributed, resulting in the payment of required taxes and penalty fees. To avoid this mistake, you must understand what an SDIRA entails and get advice from finance professionals.
  • Custodians cannot offer their help: SDIRA custodians are only responsible for administering and holding the assets in the account. They cannot evaluate the legitimacy of an investment or verify the accuracy of any financial data offered for an investment in the account.
  • Vulnerable to fraud: Because custodians are not required to verify the legitimacy of investments, SDIRA transactions are susceptible to fraud.
  • Complex payment structure: SDIRAs have a complicated fee structure, with charges including a one-time establishment fee, an annual renewal fee, a first-year annual fee, and fees for investment bill paying.

Diversify Your Portfolio for Retirement Through an SDIRA

Self-directed IRAs can be an appealing option for savers hoping to finance their retirement with assets they cannot find at traditional retirement plans. However, if you want to diversify your portfolio for retirement, you must proceed with caution when opening an SDIRA.

Managing your retirement account requires a certain amount of investment experience. If you are an average or a casual investor, you will need the help of a professional financial advisor. Remember that with an SDIRA, it’s easy to make expensive mistakes, and tax traps are almost impossible to detect if you are new to investing.

Consider hiring a financial advisor or tax professional to help you decide whether to open a self-directed account. When looking for a financial advisor, remember that no expert will recommend that you put all your retirement funds in alternative investments. A good rule of thumb is to hold no more than 10 percent of your money in riskier stakes.