What is a Self-Directed IRA? How Does a Self-Directed IRA Work?


This is a sponsored partnership with The Entrust Group. Having more options for your retirement savings is always nice. And that’s where self-directed IRAs (SDIRAs) come in. These tax-advantaged accounts allow you to invest in real estate, small businesses, private equity, gold, oil, and more. An SDIRA differs significantly from an IRA or a 401k…

This is a sponsored partnership with The Entrust Group.

Having more options for your retirement savings is always nice.

And that’s where self-directed IRAs (SDIRAs) come in. These tax-advantaged accounts allow you to invest in real estate, small businesses, private equity, gold, oil, and more. An SDIRA differs significantly from an IRA or a 401k from a brokerage, where your options are limited to traditional assets like stocks, bonds, and mutual funds.

SDIRAs do give you more choices, but there is more work needed from you as they are a tad more complicated.

Key Takeaways

  • Self-directed IRAs can diversify your portfolio with different kinds of alternative assets.
  • SDIRAs can be set up as traditional or Roth IRAs.
  • There are cons to having an SDIRA, such as possible scams and the need for increased due diligence on the part of the account holder.

What is a Self-Directed IRA? – Complete Guide

So, what is a self-directed IRA?

A self-directed IRA (SDIRA) is simply an IRA in the eyes of the IRS.

But there is a big difference.

The most significant change with using an SDIRA is that you can invest in assets that are different from a standard retirement account (such as real estate, gold, bitcoin, and more – otherwise known as “alternative assets”), AND you can still use the same tax benefits as any other IRA.

Every investment and transaction is made on your request – not at the discretion of a financial institution.

Why have I never heard of a self-directed IRA?

Okay, so until recently, I had yet to hear of a self-directed IRA. You may not have either.

This is because SDIRAs are less common than the typical IRA you might already have. There are many different options for building your retirement portfolio out there, and this one requires more work on your end, so it’s less commonly used.

But, SDIRAs do have a wide range of potential. They are helpful for investors who want to diversify their retirement portfolio with assets beyond the usual stocks and bonds. In particular, they are an excellent option for investors with expertise in a specific area, like real estate or startups. They allow investors to use their existing retirement funds to invest in these types of assets to better take advantage of their own experiences. 

How is a self-directed IRA different from a regular IRA?

The main difference between a self-directed IRA and one that is not self-directed is the different investment options available. SDIRAs can invest in alternative assets such as real estate, private businesses, precious metals, etc. However, standard IRAs are limited to stocks, bonds, and mutual funds.

If you’re looking to diversify your assets, then this may be a retirement account that could be great for you.

Types of self-directed IRAs

With SDIRAs, you can still receive the same tax benefits as an IRA holding publicly traded assets. 

There are two main categories of self-directed accounts: traditional and Roth. Both have tax advantages, but they differ in how your contributions and withdrawals are taxed.

  1. Traditional self-directed IRA – Your contributions are made with pre-tax dollars, which could lower your taxable income. There are also no income limits on contributions.  When withdrawing the funds at retirement, you pay taxes on the distributions.
  2. Roth self-directed IRA – Your contributions are made with after-tax dollars, so they don’t reduce your taxable income. All qualified withdrawals at retirement will be tax-free, including any gains your investments have made.

It’s essential to evaluate your financial situation and goals when choosing the type of SDIRA that’s best for you. There are also income and contribution limits to remember, mainly as these are updated annually.

How does a self-directed IRA work?

To invest with a self-directed IRA, you’ll have to open an account with a financial institution offering SDIRAs, often called a custodian, administrator, or recordkeeper.

After that, you can transfer or rollover money from an existing IRA or 401(k) into your SDIRA and look for an asset to invest in. You’ll be in charge of all asset decisions (this means that it’s your job to do as much research as you can), as well as ongoing account management.

It’s crucial to remember: per IRS rules, the custodian you choose does not help you to make investment choices. There are also other rules and regulations you must follow (you can read more about this at Self-Directed IRA Rules), such as avoiding prohibited transactions and staying within the annual contribution limits.

What Can You Invest In With A Self-Directed IRA?

A self-directed IRA lets you invest in various assets compared to regular IRAs.

Common investment choices

With a self-directed IRA, you can invest in assets such as:

  • Real estate – This could be rental properties, hotels, parking garages, or even empty land.
  • Precious metals – You can invest in physical gold, silver, platinum, and palladium.
  • Private equity – This includes investing in private companies not listed on public stock exchanges, including small businesses and start-ups.
  • Cryptocurrencies – Some self-directed IRAs allow investing in digital currencies like Bitcoin and Ethereum.
  • Commodities – You can invest in oil, gas, sustainable energy, and more.

Prohibited investments in self-directed IRAs

While there are many new things that you can invest in with an SDIRA that you may not normally do, there are some that are not allowed. Here are some examples of investments that are not allowed:

  • Collectibles – You cannot invest in antiques, artwork, and stamps.
  • Life insurance
  • S Corporations

Explore over 90 alternative assets you can invest in with a self-directed IRA (and learn more about the ones you can’t) here!

Understanding a Self-Directed IRA (SDIRA)

Here are some essential things to think about when it comes to self-directed IRAs:

Due diligence

Due diligence means doing careful research and checking everything thoroughly before making an important decision. Since you are responsible for all the investment choices, you’ll want to do your homework beforehand to make sure you know all the facts and risks involved.

Legalities and regulations

You should be aware of the legalities and regulations surrounding SDIRAs. As mentioned before, certain transactions, such as investing in life insurance or collectibles, may be prohibited. There are also separate IRS deadlines for some types of assets.

In addition to the prohibited transactions listed above, it’s also essential to remember that the IRS has strict regulations concerning who can materially benefit from or transact with the SDIRA – known as “disqualified persons.” These are people like your spouse and children. For example, if you purchase a rental property, you (and your family) cannot use it for a family vacation.

Fees and expenses

SDIRAs have fees for recordkeeping and making transactions. Knowing the costs can impact how much money you make from your investments and may change your decisions.

Contribution limits and rules

Like IRAs from a bank or brokerage, SDIRAs have annual contribution limits. Be mindful of the limitations and make sure that your contributions follow the rules set by the IRS.

Withdrawal rules and penalties

You should be aware of the self-directed IRA withdrawal rules and penalties. Early withdrawals made before the age of 59.5 years may be subject to a 10% penalty and additional taxes.  Additionally, if the funds are tax-deferred, you must also pay income taxes on the distributed amount.

Pros and cons of a self-directed IRA

Advantages of self-directed IRA:

  1. Diversification – You can invest in real estate, private equity, precious metals, and other alternative assets.
  2. Tax benefits – SDIRAs have the same tax advantages as regular IRAs. You can enjoy tax benefits based on the type of IRA (traditional or Roth) you choose.
  3. Potential for higher returns – With a self-directed IRA, you can go after investments that might earn you more money than the usual choices. This could mean your retirement savings grow faster in the long run.

Disadvantages of self-directed IRA:

  1. Can be more complex – Managing an SDIRA can be a more complicated process due to having more responsibility in choosing suitable investments and having to do more research. There is also less transparency surrounding alternative assets than those traded on the public market.
  2. Higher risk – There may be higher risks, such as illiquidity, lack of regulatory oversight, and market volatility. There are also more scams in the SDIRA world because the investments differ and don’t have as much oversight.
  3. Fees and expenses – SDIRAs often have higher fees, such as custodial, transaction, and recordkeeping fees.

How to Open a Self-Directed IRA

Setting up a self-directed IRA requires a bit more work than opening one through a bank or brokerage.

Here are some steps:

  1. Find an SDIRA provider. Often referred to as an administrator or custodian, this entity is a financial institution that handles alternative investments and fulfills IRS-mandated recordkeeping requirements associated with your self-directed IRA.
  2. Ensure they can hold the asset you want to invest in. For example, not all SDIRA custodians allow single-member LLCs or cryptocurrencies. 
  3. Choose between a traditional or Roth SDIRA
  4. Create your account and pay your account establishment fee
  5. Fund your SDIRA via a transfer, rollover, or contribution

Note: Having an experienced financial advisor can be super helpful in handling your SDIRA, as they can give you expert advice on what you should do.

The Entrust Group Review

Want to open a self-directed IRA? A popular administrator option is The Entrust Group, which has been in the business for over 40 years, with over 45,000 investors and $4 billion in assets under custody.

Opening an account with The Entrust Group makes the process easy, and you can choose your funding type, including rolling over an old 401(k), transferring an existing IRA, or making a new contribution.

Keep in mind that there are increased fees associated with an SDIRA. But, The Entrust Group is open about their fee structure, which you can find on their website here. Some of their fees include:

  • Account establishment fee – This one-time fee covers the cost of opening an account.
  • Annual recordkeeping fee – This is the fee that covers IRS reporting, recordkeeping, and admin.
  • Purchase and sale of asset fees – This one-time fee covers the paperwork required to execute the purchase or sale of an asset.
  • Transaction fees – These fees are charged for transactions.

The Entrust Group has a quick calculator that you can play around with to see what your fees are. I spent some time with it to better understand the different fees; for example, if I have one asset valued at $45,000, my one-time setup fee would be around $50, and my recordkeeping fee would be $199. If I have two assets with a total value of $100,000, then my set up fee is $50, plus the recordkeeping fees of $374. However, any undirected cash in your account isn’t subject to recordkeeping fees; so you won’t be subject to these when you’re between investments. 

In summary, The Entrust Group is a reputable and experienced provider of self-directed IRA services, giving you the power to invest in many different alternative assets. If you want to diversify your investment portfolio simply, The Entrust Group may be a choice for your self-directed IRA.

Download their free Self-Directed IRAs: The Basics Guide to learn how you can take control of your financial future with an SDIRA with The Entrust Group.

Frequently Asked Questions About Self-Directed IRAs

Below are answers to common questions about self-directed IRAs.

What are the risks of a self-directed IRA?

Some risks of self-directed IRAs include the potential for fraud, and higher fees, and it may be a little more challenging to manage your alternative investments because there are more rules. And you are entirely in control of your account – so it requires more of a time investment. Also, self-directed IRAs require a custodian, and fees for these services can be higher than with a regular IRA.

Do you pay taxes on a self-directed IRA?

Yes, you do pay taxes on a self-directed IRA, but as with a regular IRA, the matter of “when” depends on what type of account you have. With a self-directed traditional IRA, your contributions may be tax-deferred, and you will pay taxes on withdrawals during retirement. Comparatively, a self-directed Roth IRA holder contributes after-tax dollars and can make tax-free qualified withdrawals.

Is a self-directed IRA better than a 401k?

It depends on your financial goals and investment preferences. A self-directed IRA can give you more control over your investments, while a 401(k) has limited investment options but may include employer-matching contributions.

How do self-directed IRA fees work?

Self-directed IRAs typically have higher fees than traditional IRAs due to the increased administrative costs associated with alternative assets. Some of the fees you may come across with SDIRAs include set-up fees, annual maintenance fees, and transaction fees.

Can I invest in real estate with a Self-Directed Roth IRA?

Yes, you can invest in real estate with a Self-Directed Roth IRA. You can also learn more about this at Self Directed IRA for Real Estate: Benefits, Risks, & Next Steps.

Are Self-Directed IRAs a Good Idea? – Summary

I hope you enjoyed this self-directed IRA guide.

While it is great that you have more options in what you can invest in, SDIRAs do require a little more work on your end.

But, if you’re looking to invest in different kinds of assets than just stocks and bonds, then SDIRAs are worth considering.

Are you interested in opening a self-directed IRA? Visit The Entrust Group to schedule a consultation with one of their experienced IRA experts.

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