What is a Self-Directed IRA? Everything You Need to Know

While the 401(k) plan is tied to an employer, the traditional Individual Retirement Account (IRA) can be opened by anyone. You don’t get the tax break if you make over a certain amount, but millions of Americans utilize IRAs to build nest eggs.

One of the drawbacks of the IRA is the limited investment options. You’ve got more choices than 401(k)s, but most IRAs are limited to the bread-and-butter investment options, such as stocks, bonds, exchange traded funds (ETFs), and mutual funds. If you want to put money into an alternative type of investment, you’ll have to eschew the tax break unless you can open a self-directed IRA (SDIRA). An SDIRA works very much like traditional or Roth IRAs, but with a few crucial differences. Read on to learn more about self-directed IRAs.

If you need assistance with your finances, work with a professional financial advisor from Good Life Financial Advisors of Mt. Pleasant. We’re ready to help create a personalized plan for your specific needs.

What Makes a Self-Directed IRA Unique?

A self-directed IRA allows the inclusion of many investments forbidden in regular IRAs and 401(k)s because of its special structure. All IRAs are self-directed in the sense that the individual benefactor controls what goes into the account, but to allow the alternative investments, an SDIRA must be hosted by a specific custodian. That’s why “self-directed” has to be in the name of the account—usually, these types of investments require specific guidance.

So what’s allowed in an SDIRA? Well, pretty much anything. You can use equities, fixed income, and derivatives like in your usual IRA, but you can also invest in commodities, real estate, limited partnerships, and more. The only things you absolutely can’t invest in are life insurance policies, collectibles, or S-corp stocks.

You won’t find SDIRAs offered at traditional brokers like Fidelity or TD Ameritrade. You’ll need to seek out a special type of trust company that offers SDIRAs (and usually only SDIRAs). Self-directed in this sense means you’re on your own to navigate the waters of these intricate investments.

Rules and Considerations

The self-directed IRA is subject to the same rules and regulations as traditional and Roth IRAs. The annual contribution limits are the same, including the extra catchup contributions for folks over 50.

You’ll need to choose between a traditional or Roth structure in your SDIRA:

  • Traditional SDIRAs get tax breaks upfront.
  • Roth versions enjoy tax-free growth after contributions have been made. If you make over $140,000 annually, you won’t be eligible for the Roth option.

Fees are another important factor to consider when opening an SDIRA. The fee structure can be complicated and you’ll almost certainly pay more to set up and maintain the account than you would a regular IRA at a discount broker.

Disqualified Persons

SDIRAs also must adhere to certain rules because of the investments involved. The most potentially hazardous rule is the one forbidding transactions that qualify as self-dealing. Prohibited transactions and disqualified persons are the two crucial terms here.

A disqualified person cannot benefit from the holdings in the IRA before retirement is reached. This means anyone directly close to you, such as your spouse, parents, children, and yourself included, cannot personally benefit from the IRA. For example, you can’t put an LLC established by one of your children into your IRA and reap tax benefits.

Prohibited Transactions

A prohibited transaction is a broad topic covering anything that would disqualify your IRA from receiving a tax break. Owning ineligible assets like jewelry or art in your SDIRA would count as a prohibited transaction.

Many of the trickiest prohibited transactions occur when dealing with real estate. For example, you can’t pay out of pocket for maintenance to a property owned by the IRA, only the IRA can fund those repairs. You also can’t lend money to a disqualified person through your SDIRA (that means yourself!) and you cannot use it to buy property for personal use.

Be very cautious, because if the IRS catches you in a prohibited transaction, your entire account could be labeled as distributed and your tax break goes away. One slip-up is all it takes, so if you find yourself needing a room for the night, pay for a hotel and don’t sleep in your rental property’s office.

Final Thoughts

A self-directed IRA isn’t for everyone. If you don’t understand how alternative investments like commodities, real estate, and hedge funds work, you might consider sticking with a traditional or Roth IRA offered by your usual broker. It’s easy to diversify through stocks and bonds and there are plenty of funds offering exposure to sectors like real estate, precious metals, and energy.

However, if you’re looking for assets that can’t be accessed elsewhere, an SDIRA might be your only avenue. You’ll need to understand the risks and rewards and it’s highly recommended to seek assistance from a qualified investment advisor since the SDIRA broker cannot offer advice. Real estate and hedge funds are opaque investments, so resist the urge to do it alone. SDIRAs add risk to your overall portfolio, but savvy investors can reap gains beyond the scope of traditional stocks and bonds.

Work With an Experienced Financial Advisor

If you have any questions about self-directed IRAs, reach out to a team member from Good Life Financial Advisors of Mount Pleasant today! We’re happy to assist you.


The opinions voiced are for general information only and are not intended to provide specific advice or recommendations for any individual.

All investing involves risk including loss of principal. No strategy assures success or protects against loss.

A Roth IRA offers tax deferral on earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals earnings prior to age 59 1/2 or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.

Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal. Withdrawals prior to age 59 1/2 may result in a 10% IRS penalty tax in addition to current income tax.