Self-Directed IRA (SDIRA): Definition, Benefits, and FAQs

What is a self-directed IRA? Why open a self-directed IRA if you already have an employer-sponsored retirement plan or 401(k)?

There is no excuse for not saving for your retirement. Everyone should be socking money away for their future. Period. The sooner you start to save for retirement the better your chances of achieving financial security.

Relying on Social Security will not be enough to pay the bills once you retire. In a survey by Nationwide, two-thirds of Americans worried that Social Security will run out of funds during their lifetime. Furthermore, half of the surveyed believe that benefits will be cut in the near future. 

There is no doubt that your current IRA or work-sponsored 401(k) will play an essential role in your financial plan, but you may be able to benefit further with the unique investment options available through a Self-Directed IRA (SDIRA).

What is a Self-Directed IRA?

Most people have heard of an IRA. An Individual Retirement Account (IRA) is an investment account for retirement savings. Most common types are traditional IRAs and Roth IRAs. For self-employed people and small-business owners, there are SEP IRAs and SIMPLE IRAs. 

A self-directed IRA is slightly different than a "regular" IRA. A self-directed IRA allows you to buy alternative investments that are either prohibited or unavailable via most regular retirement accounts. 

An SDIRA allows more investment options, increased control and greater diversification in your retirement savings. The account is "self-directed," which means you will need to do your own research and due diligence before making any investment decisions.

Unlike your 401(k), you will be responsible for the management of your assets and ensuring that your IRA and investments are compliant with the IRS...

Sound intimidating? 

You may feel that you won’t be able to handle these responsibilities. This has opened up a market for businesses that specialize specifically in setting up self-directed IRAs for their clients. These IRA specialists are available to help ensure your SDIRA account is set up correctly and that you keep the IRS happy.

For example, you may have seen companies advertising "Gold IRA" investments. The term "Gold IRA" is really just a marketing term for a self-directed IRA that holds physical precious metals.

These companies are gold bullion dealers that focus specifically on setting up SDIRAs that hold gold bars and coins.

These precious metals dealers are willing to set up your account, advise you on investment options, and walk you through each step. They have built relationships with SDIRA custodians, vault storage companies, and are able to facilitate the entire process. 

With a "regular" IRA or 401(k), your investment options are limited to stocks, bonds, mutual funds, annuities, and few other common types of assets. An SDIRA opens up your world to a whole new array of "alternative" options.

Companies such as these Gold IRA dealers act as facilitators that make navigating the SDIRA landscape possible for average investors. An SDIRA is a great way to diversify retirement funds outside of the box.

What Can You Hold In an SDIRA? 

Here are some of the investment options available to you:

• Physical Precious Metals
• Bitcoin and other Cryptocurrencies
• Commodities
• Real Estate
• Hedge Funds
• Private Equity Funds
• Venture Capital Funds
• Private Businesses
• Promissory notes
• Tax Lien Certificates
• Intellectual Property
• And many more options are available

Your investment potential is nearly limitless in a SDIRA. You can add exposure to asset classes not available through most 401(k) retirement plans. You can diversify into alternative investments, all while taking advantage of the tax benefits available through an Individual Retirement Account. 

It goes without saying that you should always educate yourself on alternative asset investing before making any investment decisions. Complex investments may not be suitable for everyone. 

How Do You Open a SDIRA?

The process of opening and investing with a SDIRA is similar to other types of IRAs. 

Your self-directed IRA can be either traditional or Roth.

A traditional IRA contribution is pre-tax which means it is tax deductible and distributions will be taxed. On the other hand, Roth IRA contribution is after-tax which means you cannot take a tax deduction but distributions will be tax free. 

Let's return to our "Gold IRA" example above. How do you transfer or rollover retirement funds into an SDIRA and use it to buy gold bars and coins?

Your first step is to choose a gold bullion dealer that specializes in these SDIRA investments. Fortunately, there are a number of these gold IRA companies to choose from.

A short list of reputable Gold IRA specialists:

• Goldco Precious Metals 
• Augusta Precious Metals
• Regal Assets
• Noble Investments
• Advantage Gold
• American Bullion
• Birch Gold Group

Note that with the popularity of cryptocurrencies in recent years, all of these above companies have now added bitcoin, ethereum, litecoin, and other digital currencies as options for your self-directed IRA.  

Any of these IRA specialists can then walk you through the account set-up process. As mentioned above, they have already working relationships with SDIRA custodians, vault storage companies, and gold shipping service companies.

These relationships mean streamlined and efficient service and often lower negotiated fees than if you approach the SDIRA custodian to do business directly.

Your account executive can work directly with your custodian, facilitate any transfer or rollover of funds, advise and set up your gold vault storage, and even steer you towards the precious metals that are IRS-approved for your IRA.

The Gold IRA company can basically take care of all of the moving parts to ensure your SDIRA is set-up without issues.

These gold bullion dealers all have their own preferred custodians, but should be flexible if you choose one outside of their list. Be sure to ask your account executive for a schedule of fees to fully understand all of the costs involved in opening and maintaining the IRA.

There will be account set-up fees (some companies waive this fee), annual custodial fees, and vault storage costs for your precious metals (the IRS doesn't allow you to store your IRA at home).

Related article: The Home Storage Gold IRA: Scam or IRS Approved?

After discussing with a gold firm and SDIRA custodian, you should know whether you want your account set-up as a traditional or Roth IRA. In most instances, the custodian will help weigh your options.

And lastly, you just need to fund your account. You can contribute up to $6,000 in total to your SDIRA per year. That limit is higher for people over the age of 50.

The most common scenario is when investors rollover or transfer funds from one retirement account to the new SDIRA account. In a transfer, retirement funds are moved directly from one custodian to another. The funds are never liquidated or held in your possession.

In a IRA rollover, you actually receive a check and it's up to you to transfer the funds over to your new IRA. This must be done within 60 days of receiving the distribution in order to avoid tax.

Work with your IRA specialist and custodian to ensure that this "rollover" is done following IRS guidelines in order to avoid a taxable event.

Once the funds are received, your gold company can help you select the IRS-approved precious metals (or cryptocurrencies) that you'd like to invest in. These self-directed IRA gives you complete control. The custodian will oversee the account and allow you as the SDIRA account holder to invest in any type of investment allowed by law. 

Your gold IRA company can then assist in setting up the vault storage and the shipping of metals to your storage facility. Not only are your investments secure and IRS compliant, but many of these gold firms will also fully insure your investments.

If you're able to work with a reputable company, getting started with an SDIRA is simple. Refer to the next section to see some of the benefits of having a SDIRA compared to a normal IRA. 

Benefits of SDIRA Investment Options

When you are creating an investment portfolio, it is important to have a diversified portfolio. You should know to not put all your eggs in one proverbial basket. 

The easiest way to diversify is to include different asset classes in your portfolio. You can also diversify within asset classes. The possibilities for diversification are vast in a regular IRA but with SDIRA the possibilities are (almost) endless. 

Typically, you will have stocks, bonds, funds, CDs, and annuities in your retirement account. 

Self-Directed IRA drastically increases your investment options. The additional options are some of the most versatile investments you can possibly utilize in your retirement portfolio. 

With an SDIRA you will have access to investment options that can make diversifying easy and effortless. And don’t forget that minimizing risk of loss and preserving capital is vital but so is generating great returns, especially if you are young.

SDIRA investment options will allow you to create portfolios that can greatly alter your risk/reward profile. For instance, adding just twenty percent exposure to hedge funds can increase portfolio Sharpe ratio while decreasing total portfolio risks.

Sharpe ratio measures portfolio performance per unit of risk; therefore, a higher ratio is better. Some of the best hedge funds are able to generate higher returns without taking additional risks.

Let's look closer at some of the many investment options in your SDIRA...

Precious Metals & Commodities

Tangible assets in which you can invest include precious metals and commodities. Specific gold, silver, platinum, and palladium bars and coins are acceptable for your IRA.  

Why gold?  Many like the yellow metal because it has proven to be an inflation hedge and it has returned on average 8% annually since the 1970s. 

Retirees often also turn to precious metals as the safe-haven asset to protect a portfolio against economic downturn.

Note that NOT all precious metals can be included in your IRA. For example, rare or numismatic collector coins are not approved. As explained in the section above, your gold IRA account executive will help select the right metals for your account. 

Related article: Gold IRA Tax Rules - The IRS and Your Precious Metals

Commodities are another great option for diversifying your portfolio. For instance, researchers found that in an asset class research, the Bloomberg Commodity Index exhibited very low correlation to all other asset classes.

Bitcoin & Other Cryptocurrencies

Bitcoin in your retirement? It's not for everybody, but holding cryptocurrencies in a self-directed IRA is growing in popularity. 

Financial experts are on both sides of the argument when it comes to the future of bitcoin. Based on the uncertainty in the crypto market, most advisors would likely not advise holding more than 5% of your portfolio into bitcoin.

If you believe in the future of bitcoin, and can afford to speculate a portion of your 401(k) in digital currency, then add cryptocurrencies to your IRA. In recent years, investors have benefited greatly from the gains seen in bitcoin, ethereum, litecoin, and other more established altcoins.

There is a growing marketplace for companies that now facilitate investors in rolling over or transferring retirement funds into these self-directed IRAs. Although these SDIRA accounts can support a selection of cryptocurrencies, they are often referred to more generally as "Bitcoin IRAs."

Hedge Funds

You might have read that hedge funds haven’t been doing so great lately but that’s not entirely true. Hedge funds are a unique investment vehicle designed to outperform and capture alpha during times of distress.

On top of that, hedge funds’ fees have drastically been reduced making them even more attractive investment. It should be noted that not all hedge funds are created equally and due diligence is necessary to pick the right hedge fund for your portfolio.

Venture Capital Funds

Similarly, venture capital funds are another excellent investment choice due to its low correlation to traditional asset classes like stocks and bonds. You can decrease your portfolio’s risk while taking advantage of some of the highest returns amongst all asset classes. 

Real Estate

Self-Directed IRA even allows you to invest in real estate. Real estate can be a great tool for generating income and it is a hard asset. An asset that is considered an inflation hedge with lower return volatility.

Real estate options within SDIRA are endless. You can invest in residential, commercial, foreclosures, unimproved land, leases, tax lien certificates, mortgage notes, building bonds, and many other real estate investments. 

One crucial diversification tip to remember is that you need global exposure in your portfolio to have a truly diversified portfolio. SDIRA allows you to do exactly that with offshore real estate investments. 

Additionally, retirees can look to generate a steady income stream by investing in commercial real estate. Investing in commercial real estate can allow you to lock in your rental income in a world with low interest rate environment without having to take significantly higher risk to achieve a decent return. 

Self-Directed IRA: Is It For You?

You should note that you are not allowed to use your SDIRA to purchase real estate for personal use. You should also be aware of prohibited transactions so that you don’t get into any legal trouble with the IRS. There is additional information available to you in the FAQ. 

SDIRA isn’t right for everyone. Why? Because you need to do your homework before making any investments in your SDIRA account, especially investments in alternative assets.

If you are willing and able to put that extra effort then you can improve your portfolio performance and reduce risk. SDIRA is all about giving you full control of your financial future so that you can protect yourself against economic fluctuations.

Self-Directed IRA Custodians

Below is a short list as an example of some of the more established self-directed IRA custodians. 

Equity Trust: In business since 1974, Equity Trust is a trusted SDIRA custodian.

Goldstar Trust Company: A pioneer in the self-directed IRA market, Goldstar Trust Company is a leading custodian for your alternative assets.

Kingdom Trust: An independent qualified custodian, Kingdom Trust currently serves more than 100,000 clients and has over $12 billion in alternative assets under custody.

Midland Trust: Founded in 1994, Midland Trust holds more than $2 Billion is assets through self-directed IRAs.

Millennium Trust Company: Founded in 2000, the Millennium Trust Company manages over 27 Billion from their headquarters in Illinois.

New Direction IRA: This custodian has been in business for more than fifteen years and holds more than $2.2 Billion in assets. 

Strata Trust: Founded in 2009, Strata Trust serves over 26,000 SDIRA clients.

Frequently Asked Questions 

I never knew I can invest in assets besides stocks and bonds within my retirement account. Is this even legal?

Most people are misinformed about their investment options. Additionally, most retirement plans stick with traditional investments such as stocks, index funds, or ETFs. You have had the right to invest in all of the "non-traditional" investment options outlined above since IRAs were made legal through Employee Retirement Income Security Act of 1974 (ERISA). One reason most plans limit your investment options is because they want to push in-house investments that earn them higher commissions. Another reason is that many of the alternative investments are too complex for most investors so they do it to protect you. Nevertheless, self-directed IRAs have been legal since 1975.

Is a self-directed IRA risker than a regular IRA?

As outlined above, an SDIRA gives you options to invest in assets that could potentially diversify your portfolio and reduce risk. Alternative assets require you to do additional due diligence. SDIRA lays out a wide range of investment options in front of you. It's not for everyone as average folks might not want to be in full control of their retirement investments. If there is an alternative investment like gold or bitcoin that you want in a tax-advantaged account, an SDIRA gives you the option. Otherwise, SDIRA is no more risker than any other retirement plan. It is important to state that ALL investments carry risk. 

What investments are not allowed in a SDIRA?

SDIRA does have some restrictions on investment options. There are three types of investments you are NOT permitted to invest in your SDIRA account. You are not allowed to invest in life insurance contracts, collectibles (art, cars, stamps, coins, etc.), and S corporations. You also cannot purchase real estate you already own. 

You should also know about prohibited transactions. There are three prohibited transactions: direct, self-dealing, and conflict-of-interest. Direct prohibited transaction involves a disqualified person and his/her retirement account. A self-dealing prohibited transaction is when you use your IRA assets for personal gains. Lastly, a conflict-of-interest prohibited transaction occurs when a disqualified person who happens to be a fiduciary and he/she is involved in a transaction regarding their IRA assets. These transactions rules are in place to protect and encourage people to save for retirement rather than exploit it for tax benefits.

Some of these assets available in SDIRA plan don’t trade in an open market so how are they valued? How will I know how much money I have saved in my retirement account?

It is true that many of the investment options in SDIRA don’t trade in a marketplace. IRS has required those assets to be valued at fair market value. Fair Market Value (FMV) is value of an asset based on what a knowledgeable, willing, and unpressured buyer would likely pay to a knowledgeable, willing, and unpressured seller in the market. 

How much does an SDIRA cost to set up?

Fees for SDIRA depend on the custodian. Usually, you can expect five different types of fees. They are establishment, administration, transaction, termination, and annual fees.

Account setup and administration fees are usually less than $100. Termination fees can as high as $300. Transactions fees depend on the asset type. Annual fees depend on the custodian and you should ask for a fee schedule to determine your annual fees.

Is SDIRA account insured by FDIC?

As long as retirement funds are first deposited with an IRA custodian/administrator, it is insured by the FDIC. The standard insurance amount is $250,000 per depositor, per insured institution, for each account ownership category.