What is a Self-Directed IRA and Should You Use One?

Self-Directed IRA

Self-Directed IRA

Retirement planning is crucial for everyone, whether you have thousands in the bank or millions. But affluent individuals looking to maintain long-term wealth may need to consider vehicles for retirement savings differently than most to ensure the strategic growth of their assets.

Most people have heard of or use a traditional or Roth IRA account, which allows for pre- or post-tax contributions for investment, but have you considered a self-directed IRA?

Managed correctly, self-directed IRAs can potentially allow for the accumulation of millions of dollars for retirement thanks to the utilization of alternative investments.

How does a self-directed IRA work?

Self-directed IRAs are very similar to traditional or Roth IRAs, as well as other types of accounts like SIMPLE or SEP IRAs, but the major difference is the type of investments available to the account holder.

Self-directed accounts are held to many of the same restrictions as traditional retirement savings accounts, including contribution limits and age-restricted distributions. However, while typical IRA investments include stocks, bonds and mutual funds, self-directed IRAs can also take advantage of non-traditional investments. This expanded investment freedom may lead to greater portfolio diversification and much higher tax-free or tax-deferred returns than the average IRA.

Self-directed IRAs cannot hold life insurance policies and tangible collectible investments. However, the diversified assets that you are allowed to invest in are numerous, including but not limited to:

  • Real estate
  • Precious metals
  • Cryptocurrencies
  • Livestock
  • Private company stock
  • Renewable energy

Using a self-directed IRA to invest in something you’re an expert in is the most likely path to its financial success. Experts in a particular industry enjoy utilizing self-directed IRAs to apply their expertise directly to their financial futures.

To create one, you must select a trustee to hold the account and select the investments you want for it. Setting up a self-directed IRA requires working with an IRA custodian who specializes in the asset area you’d like to invest in.

Be aware of the risks

“While self-directed IRAs offer benefits in the expanded investment freedoms and potential for higher returns, they also come with much higher risks and potential for fees and tax liability,” says Samuel Rad, Financial Advisor in Los Angeles. “It’s imperative investors understand these risks.”

Here are some of the main drawbacks:

  • The costs of setting up and managing self-directed IRAs are usually much higher than traditional IRAs. Expect to pay higher fees (however, higher returns may potentially offset these costs).
  • Finding an IRA custodian that serves your desired investment needs can be challenging. This process requires intensive research to ensure you’re choosing the right custodian for your account needs.
  • You must be prepared for potentially greater tax liability when you begin taking minimum distribution requirements in retirement.
  • You must understand the rules and restrictions regarding investments in self-directed IRAs to avoid being penalized. You cannot be directly involved in the management of an investment or use your IRA assets for personal use until retirement—something the IRS calls a “prohibited transaction.”

Is a self-directed IRA right for you?

Self-directed IRAs are not for everyone. They are best left to investors who want a more hands-on approach to their investment strategies and those who have detailed knowledge of a particular alternative investment industry.

Self-directed IRAs have the potential to create higher earnings due to these alternative investment options, but the risks and complications are also higher, so you must be sure you understand the method thoroughly before starting an account.

If you’re interested in reevaluating how you plan for retirement, discuss your retirement savings options with your financial planner in Los Angeles and see how a self-directed IRA could fit into your financial planning portfolio.

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