A self-directed individual retirement account (SDIRA) is a type of individual retirement account (IRA) that can hold a variety of alternative investments not normally offered through traditional IRAs. Although the account is administered by a custodian or trustee, it is directly managed by the account holder—the reason it is called “self-directed.”
Available as either a traditional IRA (to which you make tax-deductible contributions) or a Roth IRA (from which you take tax-free distributions), self-directed IRAs are best suited for savvy investors who already understand the alternative investments and who want to diversify in a tax-advantaged account.1
For investors, there are two main reasons to take on the risks of self-directed IRAs: 1- to seek higher returns, 2- greater diversification.
There is no denying the importance of diversification in your portfolio. A well-balanced mix of investments is critical for managing risk and riding the waves of market volatility. While the typical investor may turn to a mix of stocks, mutual funds, and bonds to diversify, many others are seeking opportunities outside the traditional markets. Alternative investments such as real estate, private equity or cryptocurrencies may be more alluring for these types of investors.
Alternative investments can add a new layer of diversification, as well as yielding tax advantages if you are holding them in a self-directed individual retirement account. According to the U.S. General Accounting Office, nearly a half a million investors own self-directed IRAs, with collective assets valued at $50 billion dollars. The primary advantage of a self-directed IRA is to invest in items that may not be allowed by a traditional IRA custodian. With a regular IRA, investment options are limited to publicly traded securities, such as mutual funds. A self-directed IRA gives investors greater control over their investment options and how they access those assets.
Investors can transfer all or part of the funds they currently have in any type of tax deferred savings account, whether that is a traditional IRA, a 401K, or a Roth account, into a self-directed IRA account. There are many, many SDIRA account providers, and the process is very similar to that of opening a savings account at your bank. It is important that every investor do their own due diligence prior to choosing their account provider, and/ or custodian.
Once an investor has opened and funded their SDIRA account, they can choose to use the SDIRA company as their custodian. With this option, the investor must fill out paperwork for each investment transaction and wait for their custodian to make the transfer. Another choice for savvy investors would be to create a Limited Liability Corporation, where the LLC is 100% owned by the SDIRA account. The LLC then opens a checking account that can be funded by the investors SDIRA account, and now the investor has checkbook control over their own money. The key is that if the investor follows the simple IRS rules mentioned above, they can grow their nest egg with the same tax benefits as a traditional IRA. Most importantly, with this option, the investor is in control to make decisions on which investments to buy and sell.
With this option, investors gain a new level of freedom to match their investments to their investment style. Where an investor allocates their SDIRA investment dollars is strongly influenced by their time horizon and preferred strategy. The most popular of choices for buy-and-hold investors seems to be Private Equity and Real Estate.
May all your investments bring you happy returns.
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“Self-Directed IRA (SDIRA), Jean Folger, Investopdeia