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Self-directed IRAs: Benefits, drawbacks and fees

A type of retirement account that lets you invest in real estate, private companies and more.

Self-directed IRAs (SDIRAs) let you hold alternative assets like real estate, precious metals or cryptocurrency in a retirement account. But these accounts can be pricey to open and maintain, and there are certain risks to watch out for when selecting and working with a self-directed IRA custodian.

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What is a self-directed IRA (SDIRA)?

A self-directed IRA is a type of individual retirement account (IRA) that provides more flexibility in terms of the investments you can hold. Whereas you can hold traditional investments such as stocks and exchange-traded funds (ETFs) in a regular IRA, SDIRAs let you also have various alternative investments. These include everything from claims to real estate to private equity to cryptocurrencies like Bitcoin (BTC) or Ethereum (ETH). Though you can invest in some of these assets indirectly through, say, an ETF, you typically can’t invest directly in these assets in standard IRAs.

Because SDIRAs can be complicated and alternative assets carry more risk and regulatory requirements, most brokerages that offer standard IRAs do not offer SDIRAs. Still, SDIRA custodians, like regular IRA custodians, must be IRS-approved. These custodians can be banks, trust companies or broker-dealers.

At a glance

  • A self-directed IRA is a tax-advantaged retirement account that allows investments in most assets. This includes traditional investments such as stocks and ETFs, as well as real estate, precious metals, cryptocurrencies, foreign currencies and other alternative assets.
  • Only certain custodians allow SDIRAs.
  • SDIRAs are best suited for experienced investors who are comfortable researching and choosing their own investments, proactively managing their accounts and navigating the unique risks of these accounts.

Understanding a self-directed IRA

Self-directed IRAs can be in the form of either a traditional, Roth, SEP or SIMPLE IRA. The biggest difference between an SDIRA and a standard IRA is the available investment options.

Whereas many IRA custodians only permit traditional investments such as stocks, bonds, ETFs and mutual funds, SDIRAs permit just about any type of investment. The law only prohibits investments in life insurance and collectibles.

As an SDIRA investor, you must be comfortable researching and managing your own investments, more so than you would with traditional assets. Alternative investments can be difficult to understand, costly and often involve complex tax rules. It’s up to you to ensure your investments meet the requirements set by law — and the failure to follow these rules can result in additional taxes, penalties and even the loss of your account’s tax-advantaged status.

Self-directed IRA contribution limits, withdrawal rules and taxes

The following contribution, withdrawal and tax rules apply to self-directed IRAs just as they do with standard IRAs:

  • Contribution limits. In 2023, you can contribute up to $6,500 total to your traditional and/or Roth IRA ($7,500 if age 50 or older). For a SEP IRA, an employer can contribute up to either $66,000 or 25% of an employee’s yearly compensation. And for a SIMPLE IRA, an employee can contribute up to $15,500 per year.
  • Withdrawal rules. The minimum age for withdrawals from an IRA is 59 and a half. Withdrawals prior to this age can incur a 10% early-withdrawal penalty. For those with a SIMPLE IRA, the penalty increases to 25% if you withdraw money within two years of when you first participated in your employer’s plan. For traditional, SEP and SIMPLE IRAs, you must start taking withdrawals from the account at age 72. Roth IRAs have no such required minimum distributions (RMDs).
  • Tax implications. With an IRA, the Traditional, SEP, SIMPLE or Roth designation determines available tax benefits. Traditional, SEP and SIMPLE IRA contributions are made pre-tax and are tax-deductible in the year the contribution is made, while Roth IRA contributions are made with post-tax cash and qualified withdrawals are tax-free.

How to set up a self-directed IRA

It’s incredibly important to conduct due diligence when selecting a custodian for your SDIRA. These accounts are more complex to open and manage and riskier to maintain than regular IRAs.

  1. Find a custodian. Research and find an IRS-approved custodian that offers SDIRAs. Note that most major brokerages do not offer this account type. Check with your chosen custodian to see which assets they allow. For example, Bitcoin IRA is a custodian that can hold both crypto assets or gold bullion for you.
  2. Select assets to purchase. Research and choose the assets you want to invest in through your SDIRA. If your custodian doesn’t allow for self-trading, you may need to direct your custodian to fund your investment on your behalf.
  3. Send funds. Deposit money and invest yourself or direct your SDIRA custodian to buy the assets on your behalf. If you’re purchasing the assets from a dealer separate from your custodian, you may have to deposit funds with both parties to pay for costs related to receiving the assets.
  4. Prepare to pay monthly or quarterly fees. SDIRA custodians typically charge monthly fees, which vary depending on your portfolio’s value.
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Advantages of self-directed IRAs

The biggest advantage of an SDIRA is that it lets you buy almost any asset with a tax-advantaged account — everything except life insurance and collectibles. Allowable assets include, but are not limited to:

Compare this to a regular IRA, which typically only lets you invest in traditional assets, such as stocks, bonds, ETFs and mutual funds. While they may provide indirect exposure to some of these assets through shares of ETFs or trusts, regular IRAs can’t compete with their self-directed counterparts in terms of available investments.

What’s more, these alternative assets may provide potentially higher returns than stocks, bonds, etc. For example, SDIRAs let you invest in private equity. Private equity is stake in a private company, or a company whose shares aren’t for sale on the public market. This type of investment has the potential to appreciate dramatically, especially if the private company eventually goes public.

An example of private equity offering outsized returns in a self-directed IRA is when famed investor Peter Theil turned a $2,000 Roth IRA into a $5 billion windfall. According to Forbes, Thiel purchased stock in PayPal, a private company at the time, in 2001 via a Roth IRA when PayPal shares were worth 30 cents apiece. By 2002, those shares were each worth $19 when eBay finalized its acquisition of PayPal. Theil eventually sold some of his stock to purchase shares in other private companies, all without facing tax implications.

Risks of self-directed IRAs

Despite their flexibility in terms of allowable investments, SDIRAs are risky on a number of levels.

The following are some of the major risks to consider:

  • You’re solely responsible for your account and its investments. The key word in “self-directed IRA” is “self.” You’re in charge of your SDIRA, which means you’re responsible for vetting the quality and legitimacy of each investment and making sure you don’t run afoul of any IRS rules. For example, the gold and silver that you hold in your account have to be of a particular quality, and it’s up to you to find a vendor that ensures the gold or silver they sell you is of that required quality. If these assets are below the required quality threshold, you risk facing fines and penalties from the IRS.
  • Lack of liquidity. It can take longer to sell assets like real estate, private equity or physical gold, because the markets for these assets tend to be less liquid than public equity markets. In other words, it can be difficult to find buyers of certain assets when you’re ready to sell.
  • High fees. Opening and maintaining SDIRAs include several fees you typically don’t find with a regular IRA. For example, fees for a self-directed gold IRA include an account setup fee (about $50), custodial fees (from $75 to a few hundred dollars) and transaction fees (about $40 for each transaction). These extra fees can cut into your gains.
  • Riskier investments. Certain assets you can purchase in your SDIRA, like alt coins — crypto assets other than Bitcoin (BTC) — are very volatile financial instruments. For instance, alt coins have historically lost up to 90% of their value within weeks.
  • Limited protections around asset quality. As mentioned earlier, some SDIRA custodians only hold your assets and don’t actually sell or evaluate the quality of assets in which you want to invest. For example, gold and other allowable precious metals must be of certain purity levels to hold them in your SDIRA. If these assets do not meet certain purity standards, you will not only lose money as a result of purchasing potentially fraudulent metals but will also face tax and other financial penalties for purchasing prohibited assets with your IRA.
  • Custodian manipulation/fraud. Because some SDIRA custodians make money per transaction, they may try to encourage you to purchase certain assets, claiming these assets might increase in value very soon. Legally, custodians aren’t permitted to do this. But if you don’t know better, it’s easy to become a victim and make poor investment decisions based on baseless pitches. If you feel you have been a victim, contact the Commodity Futures Trading Commission (CFTC) to issue a complaint.
  • Complex tax rules. If you knowingly or unknowingly break a tax rule and do or invest in something prohibited with your SDIRA, you may owe the IRS taxes and penalties. For example, if you sell, exchange or lease property you already own to your IRA as an investment, you can be penalized and incur additional taxes.

Prohibited investments

You can’t invest in life insurance or collectibles in your SDIRA. If you are caught investing in collectibles in your SDIRA, the amount invested is considered distributed and you’ll have to pay an extra 10% tax.

Examples of collectibles include but are not limited to:

  • Artwork
  • Rugs
  • Antiques
  • Metals (with the exception of certain types of bullion)
  • Gems
  • Stamps
  • Coins (except for certain exceptions, like specific types of gold and silver coins)
  • Alcoholic beverages

Self-directed IRAs vs regular IRAs

Self-directed IRAs and regular IRAs are the same in regards to contribution limits, withdrawal limits and general tax implications. But they differ in terms of fees and the investments you can hold in the account.

Because of the extra paperwork, tax burdens and complications that come with opening and managing SDIRAs, most regular IRA custodians don’t offer these account types.

Here’s how SDIRAs and regular IRAs compare:

Self-directed IRARegular IRA
Examples of investments you can hold
  • All investments you can hold in a regular IRA
  • Claims to real estate
  • Precious metals
  • Cryptocurrency
  • Private equity
  • Tax liens
  • Foreign currency (forex)
  • Stocks
  • ETFs
  • Mutual funds
  • Bonds
  • Annuities
  • Real estate investment trusts (REITs)
  • Money market funds
  • Cash
Contribution limits for 2023
  • Traditional and Roth — $6,500 ($7,500 if you’re age 50 or older)
  • SEP — Up to either $66,000 or 25% of the employee’s salary
  • SIMPLE — up to $15,500 per year
  • Traditional and Roth — $6,500 ($7,500 if you’re age 50 or older)
  • SEP — Up to either $66,000 or 25% of the employee’s salary
  • SIMPLE — up to $15,500 per year
Withdrawal rules
  • Minimum age for withdrawals is 59 and a half.
  • 10% withdrawal fee applies if you withdraw before you’re 59 and a half.
    • For SIMPLE IRAs, the fee jumps to 25% if you withdraw within two years of opening your account.
  • Traditional, SEP and SIMPLE IRAs require that withdrawals begin at age 72. RMDs don’t apply to Roth IRAs.
  • Minimum age for withdrawals is 59 and a half.
  • 10% withdrawal fee applies if you withdraw before you’re 59 and a half.
    • For SIMPLE IRAs, the fee jumps to 25% if you withdraw within two years of opening your account.
  • Traditional, SEP and SIMPLE IRAs require that withdrawals begin at age 72. RMDs don’t apply to Roth IRAs.
Where to openMajor brokerages typically do not offer SDIRAs, so you have to find a licensed and regulated IRS-approved custodian for your account.Most banks, brokerages or other financial institutions.
FeesSDIRAs involve a number of fees, including account setup fees, custodial annual maintenance fees, storage fees and transaction fees.Typically no account setup fees or no-to-little transaction fees. Though an IRA account closing fee may apply.
RisksRisks include having to vet your own investments, exposure to volatile and sometimes illiquid assets and potentially being penalized for violating tax rules.Stocks, bonds, ETFs and mutual funds, like all investments, include a degree of risk. But typically there are fewer risks associated with investing in a regular IRA as opposed to a self-directed IRA.

Do you have an IRA?

Response% of Americans
I do not have this, but plan on getting it in the next 6 months13%
I do not have this nor plan on getting it56%
I currently have this31%
Source: Finder survey by Qualtrics of 2,033 Americans

401Ks (44%) are the preferred savings vehicle in the US for retirement. However, about a third (31%) of American adults choose to put their money in an IRA.

Bottom line

Since most regular IRAs limit you to traditional investments, self-directed IRAs can be a great way to add alternative investments to your portfolio while benefiting from the tax advantages of an IRA.

Because SDIRAs are complex, with high fees and delicate tax rules, they probably aren’t the best option for new investors. Even experienced investors need to tread carefully as they navigate these complexities. If you choose to invest via a self-directed IRA, it’s recommended you consult with a tax or financial professional to be sure you stay in compliance with IRS regulations so as to not incur any unwanted fees or penalties.

Frequently asked questions about self-directed IRAs

Sources

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