What Is a Self-Directed IRA?

Definition and Examples of a Self-Directed IRA

Updated on December 7, 2021

What Is a Self-Directed IRA?

With a self-directed IRA, you work with a custodian that is more likely to allow you to choose from a wider variety of investments for your retirement portfolio that go beyond what an IRA custodian would normally suggest or allow.

Alternate definition: A self-directed IRA allows you more leeway to choose investments that might be considered “alternative” investments
Acronym: SDIRA

How Does a Self-Directed IRA Work?

IRAs are held by custodians that usually provide a limited menu of assets to invest in. Custodians can include brokerages, trust companies, and banks. In many cases, custodians steer investors toward asset classes such as stocks, bonds, and CDs. It’s also possible to find some custodians that allow you to invest in real estate through Real Estate Investment Trusts (REITs).

A self-directed IRA, on the other hand, allows more freedom to the investor. The custodian usually disclaims some of its fiduciary duties to the investor, and that makes it possible for you to choose assets that might be considered “alternative.” The self-directed IRA still works like any other IRA, but you can keep different types of investments in the IRA, including:

Real estate
Cryptocurrencies
Tax lien certificates
Promissory notes
Private securities

Prohibited Transactions

As with other IRAs, you receive the tax benefits associated with a tax-advantaged retirement account. However, you have to follow the same rules you would for regular IRAs, too. The IRS prohibits you from investing in properties that you live in or maintain.

Note

If you hold actual real estate in your self-directed IRA, you have to show that you aren’t actively involved in the management of an associated rental business or day-to-day operations related to the upkeep of the property.

Other types of prohibited transactions include:

Borrowing money from your SDIRA
Selling property you own to your SDIRA
Using your SDIRA as collateral for a loan

Are There Any Penalties?

The penalties associated with a self-directed IRA are the same as what you’d see with any other IRA. In most cases, there’s a 10% penalty if you withdraw funds before you reach age 59 ½. However, if you have a Roth account, you can still withdraw contributions at any time without paying the penalty.

Additionally, there might be restrictions on the types of assets you can hold in the self-directed account, and you might face penalties if you don’t adhere to them. For example, you can’t hold rare collectible coins or most gold bullion in your SDIRA. Your custodian can help you navigate this and other issues.

Is a Self-Directed IRA Worth It?

Whether a self-directed IRA is worth it depends on your goals with your retirement plan. Depending on the situation, a self-directed IRA can provide you with the potential to see greater growth in your wealth. However, you might also take on increased risk.

One of the biggest issues related to self-directed IRAs is the possibility of fraud. You might not receive all the information you need to make decisions about alternative investments, and some unscrupulous custodians might hide some of the details about investments that might not be properly protected against certain losses.

Realize that many custodians of self-directed IRAs don’t actually evaluate the investment quality of the assets involved, so it’s on the investor to properly vet what they include in their retirement accounts. Plus, some investments aren’t very liquid, so selling them can be difficult. When you’re ready to make withdrawals, you need a good exit plan to ensure that you can unload the assets.

Note

Many self-directed IRAs have a complicated fee structure, and these fees are often higher than what you’d see with other custodians. Fees can cut into your earnings, and unless you see returns to make up for it, a self-directed IRA might not be worth it.

Alternatives to a Self-Directed IRA

Among the more popular alternatives to self-directed IRAs are retirement accounts offered by investment brokerages, which include Roth and traditional IRAs and 401(k) plans. Many of the best online brokers offer IRA choices that include simple and liquid assets, such as stocks and bonds, that can be used to build a retirement portfolio. Robo-advisors will even do the work of choosing the investments for you, based on your risk tolerance and timeline.

Traditional IRA vs. Roth IRA

You can choose a traditional or a Roth when you have a self-directed IRA. For 2021 and 2022, there is a combined contribution limit of $6,000 to your IRAs, with an additional catch-up contribution of $1,000 if you’re at least 50 years old.

	Income limit	Tax-deductible contributions	Early withdrawal penalty	Taxes on distributions	Required minimum distribution?
Traditional IRA	No	Yes, based on the retirement plans available through your job	Yes, unless you meet an exception	Yes	Yes, starting at age 72
Roth IRA	Yes	No	Yes, unless you meet an exception	No	No

Where To Open an SDIRA

You can open a self-directed IRA with an independent investment advisor or wealth manager. In general, though, you might need to meet asset minimums or other requirements in order for someone to work with you.

Examples of brokerages that allow SDIRAs include:

Community National Bank
Midland Trust
GoldStar Trust
SunWest Trust Inc.

Key Takeaways

Self-directed IRAs allow you to add “alternative” assets to your retirement portfolio.
The account holder is responsible for due diligence since SDIRA custodians don’t give financial or investment advice.
Most investors need to work with a specialized firm to access self-directed IRA services.

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Sources

The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.

U.S. Securities and Exchange Commission. "Investor Alert: Self-Directed IRAs and the Risk of Fraud." Accessed Dec. 7, 2021.
Internal Revenue Service. "Retirement Topics - Prohibited Transactions." Accessed Dec. 7, 2021.
Internal Revenue Service. "What If I Withdraw Money From My IRA?" Accessed Dec. 7, 2021.
Internal Revenue Service. "Investments in Collectibles in Individually Directed Qualified Plan Accounts." Accessed Dec. 7, 2021.
Internal Revenue Service. "Traditional and Roth IRAs." Accessed Dec. 7, 2021.