Self-directed IRAs aren’t new; they’ve been around for years but haven’t gained popularity until recently. Unlike IRAs managed by brokerages or other financial services companies, what you invest in isn’t limited by a broker’s area of expertise or willingness to invest broadly. Though there are additional tax regulations regarding allowed and prohibited transactions, self-directed IRAs allow a level of freedom and control not offered by other types of IRAs.
The question becomes, is a self-directed IRA right for you?
Control is the great draw of a self-directed IRA. Not limited by the area of expertise of a broker or financial manager, investors are free to invest in what they know. The IRS describes prohibited transactions and excluded investments, leaving a great range of investments available for the knowledgeable investor. Some of the more common alternative investments include real estate, livestock, private businesses, precious metals, tax liens, and more. The level of control afforded to investors with a self-directed IRA allows them to invest in that which they are knowledgeable.
One necessary component of a self-directed IRA that can feel limiting is the requirement of a qualified trustee or custodian to hold and administer to the investor’s assets. Custodians will have areas of expertise that delineate the types of alternative investments for which they are willing to act as custodians. However, they are present to act on your behalf, not limit how you choose to invest your money.
The flipside to the greater control and freedom afforded a self-directed IRA is that greater responsibility is placed on the investor. Custodians are not required to advise investors, nor are they required to alert you if you are making a tax misstep. Investors are expected to do their own due diligence and come to the table with risks well-assessed.
As with all investment opportunities, it is always recommended that investors confer with their tax professional, attorneys, or other financial professionals before investing. With self-directed IRAs in particular, retaining a tax professional for advice can help investors avoid the host of tax pitfalls that accompany the tax regulations. Prohibited transactions can void the account’s tax-exempt or tax-deferred status, resulting in penalties at best and dismantling of the account at worst.
A self-directed IRA is not suitable for everyone. The amount of time and effort invested in a self-directed IRA is substantially more than with an IRA managed by “third parties”. A higher level of risk is conferred upon the individual with the increased freedom afforded by a self-directed IRA. However, a knowledgeable investor with the requisite time available to them can successfully manage a self-directed IRA with potential gains that are greater than with IRAs invested in CDs, stocks, and bonds.