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What Is a Self-Directed IRA (SDIRA)?

Are you thinking about opening a self-directed IRA (SDIRA)? Find out how you can use alternative assets to save for retirement and how to choose the best self-directed IRA for your financial goals.

What Is a Self-Directed IRA Account?

A self-directed individual retirement account (SDIRA) is a financial account that allows you to save using traditional assets like stocks and bonds, as well as alternative assets that can’t typically be included in conventional IRAs. Just like with traditional IRAs and Roth IRAs, a self-directed IRA account comes with tax advantages and contribution limits; however, the asset options available to the account holder, as well as the holder’s level of control over the asset mix, are expanded.

What Is the Difference Between a Self-Directed Roth IRA and a Traditional IRA?

An individual retirement account is a very popular way to build a store of wealth that you can tap into after you’ve retired. The type or types of IRA accounts you choose to add to your portfolio have a direct impact on how you save for retirement.

A self-directed IRA is very similar to a traditional IRA in some regards, but the biggest differences are in how the account is managed and which assets may be included in the account.

Traditional vs. Self-Directed IRA Account Management

Do you prefer to take an active role in your finances? When you have a self-directed IRA, you are the one in charge of all decisions pertaining to your account. Those who wish to be more involved in the management of their retirement savings and asset allocation may be great candidates to have a self-directed IRA account because the entity that holds the account—called the custodian—only serves as administrator for the account at the direction of the account holder.

Types of Assets That Can Be Included in an SDIRA

The type of alternative assets that can go in a self-directed IRA is another key difference. While only a limited range of paper-based assets like bonds and stocks are typically held in a traditional IRA, an SDIRA may also include additional tangible assets like real estate holdings and precious metals.

Annual Contribution Limits for Self-Directed IRA Accounts

SDIRAs must abide by the same annual contribution limits as other individual retirement accounts. The IRA contribution limit for all types of IRA accounts from 2019 to 2022 was $6,000 for everyone under 50 years old and $7,000 for everyone 50 and over. In 2023, the annual contribution limit increased to $7,500 for individuals 50 and over and $6,500 for all younger individuals.

Keep in mind that the contribution limit is a total amount for all IRA accounts in a given year.

Traditional vs. Roth Self-Directed IRA

You’ll need to choose between a traditional or Roth self-directed IRA, both of which provide tax benefits when saving for retirement. However, there are four key differences between these two SDIRA types that are beneficial to know about before deciding which self-directed IRA will work best for your unique financial situation.

Pre- and Post-Taxes

Roth IRAs are funded by post-tax income, which means that contributions aren’t tax-deductible, but the earnings growth is tax-free. Roth IRA withdrawals are also tax-free as long as all IRA rules are followed. Traditional IRAs are tax-deferred. This means that taxes are paid only once withdrawals are made.

Income Cap for Eligibility

Anyone can open a traditional self-directed IRA account regardless of their income. There’s no annual income cap. You can contribute to a Traditional self-directed IRA if you are under 70.5 years of age and earn taxable income.

Roth IRA accounts have a modified adjusted gross income (MAGI) cap for eligibility that’s based on the year and how you file your taxes. To be eligible for a Roth IRA account as a single tax filer, your annual income cannot have exceeded $144,000 in 2022. For 2023, the income cap for single filers is $153,000. People who are married and file taxes jointly with their spouse have a Roth IRA income cap of $214,000 for 2022 and $228,000 for 2023.

Minimum Distributions

With a Traditional IRA, you are required to begin taking minimum distributions (withdrawals) once you reach 70.5 years old. People who own a Roth IRA aren’t required to make minimum withdrawals at any point during their lifetime. However, after the account holder’s death, distributions must be taken, or there will be a 50% penalty on the distributions.

Early Withdrawals

If you need to make a withdrawal from a Traditional IRA before reaching retirement age, then you’ll need to pay regular income taxes on the amount you take out. There’s an additional 10% penalty that must be paid if you make a withdrawal before the age of 59.5.

Qualified withdrawals in a Roth IRA are tax-free and come with no penalties. The qualifications vary depending on the account holder’s age and when the account was opened. If a withdrawal is made before the age of 59.5 and before a 5-year holding period, then you’ll have to pay a 10% penalty on the amount withdrawn and taxes on the earnings. All withdrawals that are made before a 5-year holding period (regardless of the account holder’s age) are subject to taxes on the earnings as well. The penalty and taxes may be waived if the funds are used for certain types of purchases, such as buying a home.

Which Assets Can You Hold in a Self-Directed IRA?

The type of assets that can go into an SDIRA is the key differentiator from other individual retirement accounts. This is what sets a self-directed IRA apart from other Traditional and Roth IRAs. In addition to traditional assets like stocks and bonds, self-directed IRA assets can include:

  • real estate holdings
  • franchise assets
  • business assets
  • foreign currency
  • cryptocurrency
  • tax liens
  • livestock
  • precious metals

If you currently own or plan to own alternative assets like these, you may wish to consider opening a self-directed IRA. In order to do that, though, you’ll need a self-directed IRA custodian.

What Is a Self-Directed IRA Custodian?

All IRA accounts, including self-directed IRAs, require a custodian to act as the trustee. A self-directed IRA custodian administers the SDIRA and holds the account assets for the owner. The custodian also ensures that the account remains compliant with all IRS rules for IRA accounts.

The self-directed IRA custodian can be a:

  • bank
  • credit union
  • financial institution
  • brokerage firm

The self-directed IRA custodian should have experience handling SDIRAs with alternative assets, particularly the type of assets you plan to own.

What Are the Rules for Self-Directed IRAs?

Just as with other financial accounts, self-directed IRAs have to meet certain requirements and adhere to specific regulations, many of which are the same for Traditional and Roth IRAs. However, the possible inclusion of alternative assets means that self-directed IRAs must follow a few additional rules.

Assets That Can’t Be Included in an SDIRA

SDIRAs allow for the inclusion of alternative assets, but that doesn’t mean every type of asset can be included in the account. Collectibles and life insurance are among the assets that can’t be included in self-directed IRAs. You may want to consult with a financial advisor or retirement specialist if you’re unsure whether an asset can be included in an SDIRA.

Individuals Who Can’t Be Involved in a Self-Directed IRA

In addition to certain assets being disallowed, some individuals also can’t “conduct business” within an SDIRA. These people are referred to as “disqualified persons.” They include:

  • The SDIRA account owner
  • A beneficiary of the SDIRA account
  • The spouse of the account owner
  • Lineal ascendants and descendants
  • Account fiduciaries (custodians, advisors, etc.)
  • Any entity in which the SDIRA owner has 50% or more interest
  • Any entity that is 50% or more owned by a disqualified person
  • Business partners

No one on this list is allowed to take money out of the self-directed IRA or conduct any sort of business using the account (outside of approved withdrawals or distributions for the account owner or beneficiaries).

Asset-Specific Regulations

The main draw of an SDIRA is the ability to include alternative assets. These types of assets can sometimes come with specific rules and regulations that must be followed. For example, there are gold IRA guidelines that must be adhered to if precious metals are included in your SDIRA portfolio. Here again, it may be advisable to seek counsel with a financial expert who can explain what other regulations may need to be followed.

In addition, a number of rules and regulations must be followed for any IRA account. The self-directed IRA custodian is tasked with ensuring that all self-directed IRA rules and regulations are followed. If you have any questions or concerns about self-directed IRA rules after an account is established, you may wish to discuss them with your custodian.

What Are the Benefits of Self-Directed IRAs?

IRAs are commonly used to save for retirement because they come with unique tax benefits, but that’s only one of the potential upsides to opening a self-directed IRA. Below are a few more of the benefits to opening an SDIRA.

More Control Over Asset Selection

The primary benefit of owning a self-directed IRA is having more control over the assets included in the account. You have the freedom to choose what’s in your retirement portfolio without being limited to paper-based assets.

More Opportunities for Diversification

Another one of the key benefits of a self-directed IRA is that such IRAs can provide additional opportunities for diversifying your retirement portfolio. Many more asset classes can be included in an SDIRA compared to Traditional and Roth IRAs. A well-planned diversification strategy may help protect your portfolio during market downturns.

Potential for Greater Returns

More diversification can help lower a portfolio’s overall risk exposure. This may help contribute to greater returns within a self-directed IRA. Unlike traditional and Roth IRAs, which heavily allocate account holders’ funds to assets like stocks and bonds, a self-directed IRA’s assets don’t have to be as tied to major financial markets.

How to Open a Self-Directed IRA

Once you’ve decided that an SDIRA makes sense for your unique financial situation and goals, you’ll need to open an account. The process is slightly different from opening traditional IRAs, and fewer companies offer SDIRAs. Here are the steps to follow to open a self-directed IRA.

Step 1—Determine Which Assets You Would Like to Include in Your Self-Directed IRA.

The first thing you’ll need to do is determine which assets you’d like to hold within the account and then find distributors of those products or assets.

Step 2—Find a Self-Directed IRA Custodian.

Once you know what type of assets will be in the SDIRA, you can begin your search for a custodian. Some custodians handle any type of self-directed IRA, while others only manage accounts with a particular type of asset. For example, since U.S. Money Reserve is a distributor of precious metals, the company works with SDIRA custodians that specialize in accounts containing precious metals.

Step 3—Fund the SDIRA.

The custodian can help you establish the self-directed IRA account, but once it’s set up, you’ll need to make a contribution. SDIRAs are typically funded in one of three ways:

  • with a preexisting IRA rollover or transfer
  • with a preexisting 401(k)
  • by making contributions via a bank

Once your account is funded, you can work with your custodian to purchase assets for the self-directed IRA on your behalf. Would you like to include precious metals in your SDIRA? U.S. Money Reserve’s IRA Account Executives can walk you through the process of opening a precious metals IRA and work directly with your custodian to help you fund and add precious metals to your account. Our free Gold IRA Information Kit is a good resource for learning more about this simple process.

Who Offers the Best Self-Directed IRA?

Who provides the best self-directed IRA account is a matter of personal preference. Often, your opinion of who offers the best self-directed IRA may come down to the type of assets you wish to include in the SDIRA.

If you’re unsure of which company to utilize for your self-directed IRA account, you may wish to consider consulting with a financial advisor familiar with your financial situation. They can help you go through the benefits of working with each company based on factors like years until retirement, type of assets you wish to hold in the account, and your long-term financial goals. A financial advisor can also help you practice due diligence regarding your account, something a custodian would not be responsible for.

Convenience is another factor that you may wish to consider when selecting a company to help you establish your self-directed IRA.

U.S. Money Reserve makes it quick and easy to open an SDIRA that includes precious metals. Request your free Gold IRA Information Kit to learn more.

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