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What is a self-directed IRA?

A self-directed IRA (SDIRA), is a type of individual retirement account that can hold numerous investments that otherwise couldn’t be held in a typical IRA. Despite that, the only real difference between an SDIRA and a typical IRA is who offers them, and what assets they can hold. 

The difference between an SDIRA and an IRA

Most IRAs allow you to invest in assets such as stocks, bonds, ETFs, UITs, and publicly traded REITs. Nevertheless, there are still some assets you aren’t allowed to invest in using traditional IRAs. This is where SDIRAs come in. They can hold investments such as cryptocurrencies, precious metals, private equity, notes, and real estate. With traditional IRAs, you are more restricted in the kind of assets that can be held. For example, if you want to invest in real estate in a traditional IRA, you may be limited to doing so through the use of REITs and other real estate-related stocks. With SDIRAs, there are still certain restrictions that need to be followed but you have much more flexibility in the kind of investments that can be made. For example, you can purchase investment real estate directly from your SDIRA. 

As mentioned above, a key difference between the two retirement accounts is who offers them. Most conventional brokerage firms do not offer self-directed IRAs. However, some well-known companies do. For example, Schwab offers this through their PCRA (Personal Choice Retirement Account). 

Additionally, when owning an SDIRA it is the custodian’s job to hold your assets for you. However, they can in no way offer investment advice. In a traditional IRA, conventional brokerage firms generally may and will offer financial advice. 

Retirement account limitations

Since a self-directed IRA is a type of retirement account, it must follow some of the same rules as a regular IRA:

  • $6,000 total deposit limit annually.
  • $7,000 total deposit limit annually if you are older than 50 
  • If younger than 59 ½, you are required to pay a 10% premature distribution tax and any additional income taxes on the funds if you withdraw money, except under a few special circumstances.

Traditional and Roth IRA account

Like traditional IRAs, self-directed IRAs can also be either regular or Roth accounts. But what is the difference?

In a Roth IRA, the money you contribute is post-tax money. This means you pay your taxes first, and then invest your money into the account. Once the investment is in the account, it accrues tax-free and you’re also able to withdraw your funds tax-free. However, you can only take money out tax-free if you have had the account for at least 5 years, and you are over the age of 59 ½. 

In a traditional IRA, the money you contribute is pre-tax money. Furthermore, your money grows tax-free, but when you take money out it will be taxed and you will be charged a 10% penalty if you withdraw it before the age of 59 ½. 

Generally, it is said that if you believe you’re going to make more money during retirement, it is better to have a Roth IRA. But if you are confident you will make more before retirement, a traditional IRA is a better option. 

Conclusion

As you can see there is a wide variety of options when opening and funding retirement accounts. The option you choose will depend on a variety of factors. No one retirement account is best by itself. The better question is, which retirement account is right for you? Hopefully, this article provided enough information to at least let you start asking the right questions to decide which type of account is right for you.