Self-Directed IRAs: For the DIY Investor

Let’s face it. IRAs are not usually the most titillating topic of conversation at dinner parties. However, with self-directed IRAs, retirement investing doesn’t have to be boring. Most traditional IRAs are taken care of by a company or a bank, so the investor doesn’t actually have a lot of interaction with it. He or she probably won’t even touch it for many years. Like a slow flame on the backburner, traditional IRAs are absolutely useful, but not too exciting.

What Is A Self-Directed IRA?

Self-directed IRAs, on the other hand, have a little more gusto when it comes to investing. A self-directed IRA is more dynamic than a traditional IRA, and allows the investor to have a lot of say over what investments are contributing to the account. Rather than just feeding a bank account, self-directed IRAs allow the investor to use their own interests, assets and knowledge to craft a personalized retirement account with the potential for a lot of monetary growth as well as personal reward. Some examples of investments include real estate, precious metals and even franchises or start-up businesses.  Self-directed IRAs are for those who want to turn off the snooze button and have more voice in the direction of their retirement investments.

Who Opens A Self-Directed IRA?

For those with the entrepreneurial spirit and the investing savvy, self-directed IRAs can be exciting as well as profitable. But self-directed IRAs are not for everyone. Let us not sugar coat the issue. Self-directed IRAs take substantially more work than traditional IRAs because the investor is behind the steering wheel, calling the shots and making the moves, while a traditional IRA typically sits until fruition. Self-directed IRAs are more ideal for the savvy investor who has the knowledge and confidence to take a little more risk for a greater reward because you will be relying on your own judgment rather than a bank’s set interest rates.

Typical self-directed IRA investors include Angel investors of private entrepreneurs or non-profits, people who own real estate or who are knowledgeable about buying real estate, and commodities investors who want a profitable way to invest their gold and silver. Also, people who are not necessarily avid investors but who are presented with a great investment opportunity often have the bulk of their money tied up in their life savings account, so it sometimes makes sense to use an IRA for that golden opportunity.

No matter what level investor you are, it’s also a good idea to have a traditional IRA open concurrently with your self-directed IRA. Traditional IRAs tend to have slower growth rates but are also more stable, and it’s perfectly legal to have both. Anyone who is earning income, or whose spouse is earning income, can open a self-directed IRA account either before retirement or during. But one thing is for sure, self-directed IRAs are not for the lazy investor.

Self-Directed IRA Rules

Again, without any sugar coating, self-directed IRAs come with their share of rules and stipulations. It’s extremely important to pay attention to these guidelines to stay legal. Here are some of the most basic.

1) Investors are not allowed to operate direct transactions on their account; they have to go through a legitimate account custodian.

2) No self-dealing allowed, i.e. no investing in a vacation home and then using it.

3) No using personal funds to support the IRA investment, as in purchasing real estate with a loan or a personal banking account.

This is no complete list, so it’s important to consult with a professional before investing. Also, be sure to check the acceptability of your investments. See below for some examples of what is allowed and not allowed in a self-directed IRA.

List of Common Permitted Investments in a Self-Directed IRA:

  • Real estate – residential and commercial properties, land, renovation or new construction
  • Mortgages and other loans
  • Private hedge funds
  • Precious metals like gold and silver, rare coins, bullion, bars
  • Limited partnerships
  • Commercial paper and notes
  • Tax liens

List of Common Prohibited Investments:

  • Life insurance
  • Artwork
  • Antiques
  • Rugs
  • Gems
  • Stamps
  • Rare Coins (exceptions for some minted by the U.S. Treasury)
  • Personal property
  • Alcohol

Traditional IRA Vs. Self-Directed IRA

There are a few different options when it comes to saving for your retirement. The differences between a traditional and self-directed IRA have already been covered briefly – namely, the investor chooses what goes into a self-directed account, while a traditional account is mostly stagnant and set on a slow but steady growth plan.

The main advantage of a traditional IRA is that most contributions are tax-deductible, unlike a self-directed IRA or Roth IRA. Any transaction made within the traditional IRA account is free from taxation, however, withdrawals from a traditional IRA are subject to taxation.

Conversely, in a Roth IRA the taxation goes the other way around. Contributions are subject to taxes, but withdrawals are tax-free.

More similar to a Roth IRA than a traditional IRA, contributions made to a self-directed IRA are subject to taxation, and you won’t reap capital gains benefits when you make withdrawals. Furthermore, since the investing is personalized, if you suffer a loss, you won’t be able to deduct that, either. Otherwise, basic tax benefits protect transactions within the account.

However, not to get too confusing but both a traditional IRA and a Roth IRA can be self-directed. Furthermore, rollover rules allow assets in some traditional accounts to be transferred to a Roth IRA or self-directed IRA. Be sure to follow up with a professional on the details of each.

Don’t Get Caught Up In Fraud

Because of all the detailed stipulations surrounding self-directed IRAs and the potential for very high returns, one very important thing to guard against is if someone is trying to sell you a self-directed IRA service and you don’t fully understand what you’re getting into. As mentioned earlier, self-directed IRAs are not necessarily simple investing, though if you know what you’re doing, they can be very lucrative. Unfortunately, scams abound and are directed specifically at senior citizens who may already have a sizeable retirement account. Don’t transfer money to anyone offering free lunches or too-good-to-be-true interest rates!

On the other hand, you can still be smart about your investments to make a good amount of dough. For example, if you know that gold bullion and U.S.-minted coins are acceptable investments in a self-directed IRA service, you might be able to take advantage of the rising prices of precious metals. In this case, investors are not allowed to store the metals in their home; a bank, a vault or legitimate third party will have to keep the investments for you, and you will always have to translate your investment wishes through a custodian. But the point here is that knowledge is power, and if you spend the time to do the right research and make sure you know the risks and benefits of a self-directed IRA, it can be an exciting and lucrative opportunity.