What if you could invest in property, precious metals, or a startup with your retirement savings? Enter the self-directed IRA (SDIRA), a tool that grants you unique investment opportunities beyond traditional IRAs.
Read on as we explain their rules, investment options, and how to choose a custodian for your needs.
What is a self-directed IRA?
Consider an SDIRA as a regular IRA, but on steroids. Unlike standard IRAs, where you can only invest in stocks, mutual funds, and bonds, a self-directed IRA offers the same tax benefits yet allows you to invest in just about anything.
This includes real estate, precious metals, private companies, IRA LLCs, as well as alternative assets like gold or cryptocurrency.
Self-Directed IRA Rules
As a self-directed investor, you are responsible for making all the decisions and investment choices for your IRA. But with such great power comes an even greater responsibility of understanding and complying with the following SDIRA rules:
Be aware of taxes
Taxes are a core consideration when dealing with self-directed IRAs. For instance, unrelated business income tax (UBIT) applies if your IRA earns active income from real estate developments or active businesses.
Traditional self-directed IRAs offer tax-deductible contributions and tax-deferred growth, while Roth self-directed IRAs grow tax-free because contributions are made with after-tax dollars.
No self-dealing (indirect benefits)
Avoid transactions that benefit you or disqualified persons from your IRA investments. Using IRA assets for personal use, such as living in a property your IRA owns, can lead to penalties.
Avoid prohibited transactions
You can’t engage in transactions with disqualified persons, which include the account owner, their spouse, descendants, ascendants, and entities where you own 50% or more.
Submit fair market valuation (FMV)
If you hold real estate or other assets in your SDIRA, you’ll need to submit annual reports on their fair market value. The FMV report updates the IRS on any changes in your account’s worth.
Due diligence is your friend
It goes without saying: always investigate alternative investments thoroughly before committing your retirement funds. Proper due diligence includes researching the investment, understanding associated risks, and consulting with legal and tax professionals.
Remember, if you violate any of the above mentioned IRA rules, your SDIRA will lose its qualified status. The IRS may impose a 15% penalty fee for the amount involved in the prohibited transaction, which you must pay within a specific timeframe.
In case you fail to meet the deadline, the IRS can add an extra tax of 100% of the transaction amount.
SDIRA Investment Options
Most IRA custodians limit access to traditional investments. Although mutual funds, stocks, and bonds do generate passive income, they only scratch the surface of your IRA’s potential.
Ditch the boring and invest in a way that excites you. Here’s a taste of what you can add to your portfolio:
- Self-directed Roth IRA: Think Roth IRA, but with turbocharged investment options. Pay taxes upfront and enjoy tax-free withdrawals in retirement, including your investment growth!
- Self-directed IRA real estate: Become a real estate mogul within your IRA! Invest in rental properties, land, or even flip houses for passive income and potential appreciation.
- Self-directed IRA LLC: It lets you invest in businesses or partnerships directly through your IRA. Visualize owning a slice of a cool coffee shop or tech startup – all retirement-ready!
- Self-directed gold IRA: Hedge against inflation with precious metals held securely within your SDIRA. Gold and silver are popular SDIRA investments that provide protection during economic uncertainty.
- Self-directed crypto IRA: Feeling adventurous? Invest in Bitcoin or other cryptocurrencies for high growth potential; however remember, it comes with extra risk!
- Self-directed SEP IRA: This option is for self-employed folks. It’s like a regular IRA with a bigger contribution limit so you can sock away more for retirement.
- Private equity: Fund promising startups and unlock high-growth potential for your retirement funds. Although private equity investments can offer substantial returns, they come with higher risks and less liquidity.
- Tax liens: Become a lender! Invest in tax liens and potentially earn interest on unpaid property taxes. There’s some complexity here, so tread carefully.
- Foreign assets: Expand your horizons and invest in international markets. They comprise stocks, bonds, or even real estate in another country.
- Promissory notes: Act like a bank! Invest in promissory notes and earn a return on loans made to individuals or businesses. Just make sure the borrower is reliable!
- Energy: Invest in oil, gas, or even renewable energy sources. Because this sector can be volatile, be sure you understand the risks involved.
Expert’s Take
If you’re considering how to enhance your investment strategy, a self-directed IRA could be the way to go. One of the biggest advantages is the level of flexibility it offers.
Many investors want to branch out beyond conventional assets, and a self-directed IRA allows you to do just that. You can invest in real estate, buy into start-ups, or even acquire precious metals.
Prohibited Transactions in SDIRAs
Even though SDIRAs offer flexibility, the IRS restricts the following transactions to protect the retirement accounts’ integrity:
- Collectibles: Investing in items like antiques, artwork, or rare coins is strictly prohibited within your SDIRA. The IRS bans collectibles in SDIRAs because it’s hard to ensure fair pricing and prevent self-dealing.
- S Corporations: For context, an S corporation is a small business structure that pays taxes like a pass-through entity, meaning the profits or losses go directly to the shareholders’ tax returns. If your IRA holds the shares of an S corporation, it loses its tax-advantaged status.
- Life insurance: Life insurance policies cannot be part of your SDIRA portfolio. SDIRAs are for investments, and life insurance provides a death benefit. It makes such an investment more like personal financial protection that doesn’t fit within the IRA’s growth goals.
Pros & Cons of an SDIRA
SDIRAs offer numerous benefits, though there are also a few things to keep in mind. As an investor, you must understand the advantages and risks of SDIRAs to help you decide if they are suitable for your retirement strategy.
Advantages
- Investment freedom: You can choose investments that align with your interests and expertise.
- Tax advantages: Enjoy tax-deferred growth or tax-free withdrawals depending on your SDIRA type (Traditional or Roth).
- Diversification power: Expand your retirement portfolio beyond traditional assets and hedge against market volatility.
- Legacy planning: Use SDIRAs to create a tax-advantaged legacy for your loved ones or chosen charities.
- A massive IRA ecosystem: Over $12 trillion is parked in IRAs across the country. That’s a mountain of cash just waiting to be put to work! SDIRAs unlock this potential by allowing you to invest these retirement funds in alternative assets to help boost your returns and diversify your nest egg.
Risks
- Extra fees: Custodians may charge additional fees for managing alternative assets in your SDIRA. For example, you might be charged annual storage fees for real estate or transaction fees specific to buying and selling certain investments.
- Compliance challenges: Unintentional rule violations can lead to costly penalties and disqualification. Breaches in SDIRAs can occur due to exceeding contribution limits, investing in prohibited assets like collectibles, or unknowingly engaging in self-dealing with IRA funds.
- Fraudulent schemes: Many investment scams target SDIRAs due to the broader range of investment options. Be cautious of SDIRA investment scams promising high returns in rare gems, undervalued startups, or non-existent real estate deals.
How to set up a self-directed IRA
Setting up an SDIRA involves several steps to ensure compliance and alignment with your investment goals.
- Find a reputable custodian: Choose a custodian experienced with self-directed IRAs and check their fees and services.
- Understand their fees and investment options: Ensure the custodian’s offerings align with your investment strategy.
- Open and fund your account: Complete the necessary paperwork and transfer funds into your new SDIRA.
- Invest inside your new account: Start making investments and adhering to IRS rules and regulations.
Note
Custodians aren’t allowed to offer you investment advice. Therefore, conduct thorough research before investing and consult professionals for guidance as needed.
3 Best Self-Directed IRA Custodians
Choosing a reliable custodian is necessary for the effective management of your SDIRA. Here are three reputable self-directed IRAs to jumpstart your search:
Equity Trust Company
Equity Trust Company offers numerous investment options and has extensive experience with self-directed IRAs. Their services include educational resources and personalized support.
The Entrust Group
The Entrust Group provides various investment opportunities and specializes in alternative assets. They offer comprehensive services and support for managing your SDIRA.
Madison Trust Company
Madison Trust Company focuses on providing flexible investment options and excellent customer service. They offer tools and resources to help you manage your SDIRA investments.
Are self-directed IRAs a good idea?
The decision to invest in an SDIRA depends on your comfort level, investment goals, and risk tolerance. Self-directed IRAs offer flexibility and control yet come with increased responsibilities and risks.
If you’re willing to do your research and manage the stringent rules, an SDIRA might be a great addition to your retirement strategy.
FAQs
What are the contribution limits for a self-directed IRA?
The contribution limits for self-directed IRAs are the same as traditional IRAs, currently $6,000 per year or $7,000 if you’re over 50.
Who offers self-directed IRAs?
Not all custodians offer SDIRAs. Look for custodians specializing in alternative asset IRAs like Equity Trust Company, The Entrust Group, and Madison Trust Company.
How does a self-directed IRA work?
An SDIRA works like a traditional or Roth IRA but has a wider range of investments managed by a custodian. You contribute funds to your SDIRA, and they grow tax-deferred or tax-free depending on the account type (Traditional or Roth).
Are there any tax advantages of having a self-directed IRA?
Yes. SDIRAs offer tax-deferred or tax-free growth, depending on whether you choose a traditional or Roth SDIRA.
