How much do you have in retirement savings? How do you think you’re doing relative to your friends, family, and coworkers?

Spoilers: nearly half of all Americans don’t have retirement savings of any kind.

Some of it has to do with finding the right retirement savings plan for you. Here, we’re breaking down what a self-directed IRA is, what you need to know, and how to make this plan work for you.

What is a Self-Directed IRA?

First, let’s cover the most basic question: what is a self-directed IRA?

Actually, it’s pretty much what the name implies.

A self-directed IRA is a form of individual retirement account in which the investor is in charge of making all investment decisions.

For those who are late to the party, an IRA is a type of investing tool which individuals can use to earmark and earn retirement funds using a variety of financial products, including stocks, bonds, or mutual funds.

It’s not to be confused with a traditional or Roth IRA, which each have their own benefits but are distinct.

Potential Benefits

There are two primary reasons that investors would choose a self-directed IRA over a traditional or Roth IRA or a 401(k):

  1. Higher expected returns
  2. Diversification of your investment portfolio

If you know your way around investing in lesser-used assets like real estate or you’re not afraid of investing in companies that aren’t publicly traded, this type of IRA gives you the opportunity to capitalize on your know-how and turn it into money in the bank.

And hey, who doesn’t want to increase their retirement savings?

A fair warning: if you have no idea what the last paragraph meant, or you don’t know what diversifying your portfolio is or why you need to do it, this isn’t the retirement fund for you.

The benefit of this type of fund is the opportunity to be creative and to double your returns. But you need to know what you’re doing enough to know how to be creative.

Potential Risks

With this in mind, there are a number of key risks you need to be aware of with this type of IRA.

Since it gives you more wiggle room to invest as you please, the IRS is more fussy about making sure you follow the rules.

For example, there’s the no self-dealing rule, which prohibits investors from certain transactions around the IRA. The easiest example is if you invest in a rental property through the IRA, the air conditioning unit breaks, and you decide to save money by fixing it yourself.

That’s considered furnishing services to the IRA, which means the entire account will be considered distributed to you (translation: taxable) plus penalty fees.

There’s also the fact that, while you are able to invest in more diverse assets than you would be elsewhere, those assets are often illiquid. In other words, if you fall on hard financial times, you won’t be able to sell your assets to hold you over.

Why You Haven’t Heard of This Before

Because it’s, well, self-directed.

That means that the custodian and administrators are not legally allowed to offer you financial advice of any kind when it comes to your assets in the IRA.

So if you took out a self-directed IRA with American IRA and then you had a question about your assets, they legally cannot help you.

They tell you this explicitly. Unsurprisingly, investors are bad at listening.

That said, there are some financial advisors who haven’t heard of self-directed IRAs. In that case, you shouldn’t be going to them for advice anyway because they won’t know if they’re breaking the rules.

Rules Around Self-Directed IRAs

With that in mind, let’s talk about the rules around this type of IRA.

Since you have more diverse assets than in other types of IRAs, the IRS likes to get up in your business to make sure you’re not doing anything you shouldn’t be while they’re not looking.

As such, the rules surrounding this type of IRA are very strict and can be confusing if you’re not careful.

Self-Managed vs. Self-Directed

There’s a key difference in this type of IRA when it comes to self-managed versus self-directed.

As with all types of IRAs, investors can choose from a variety of investment options allowed under the IRA trust agreement. The constraint is that the investor is somewhat limited in their choices of assets since custodians determine what assets they’ll handle based on tax regulations.

A self-directed IRA contains many more illiquid assets which custodians are not allowed to handle under tax regulations, so the custodian will not handle certain assets on your behalf.

Questions to Ask Yourself

The rules surrounding this type of IRA can be confusing, but you can help clarify them by asking yourself a few key questions.

Are You Double-Dipping?

This brings you back to the no self-dealing rule.

If you’re benefiting from the assets of your own IRA (like if you stayed in a rental property you bought through your IRA) that’s the kind of transaction prohibited by the IRS. The same basic principle applies to other types of IRA assets.

Basically, if transactions are simultaneously good for you and good for your IRA, that’s considered double-dipping.

Is Your Investment Allowed in an IRA?

Nearly anything you want to buy as an asset is allowed with an IRA.

Note that the operative word is almost.

Luckily for you, the list is short. Your IRA can’t own life insurance or collectibles (like antiques). That’s it.

Of course, you should also avoid owning corporations through your IRA. It’s not prohibited, but it causes tax issues within the corporation that aren’t worth the trouble.

Making the Most of Your Florida Life

Think you’ve got the financial know-how to try owning a self-directed IRA?

It’s your future. Time to invest in it.

If you’d like to collect a little more financial know-how in other areas, check out our blog for more tips, like this post on the most popular retirement options for women or these five things you need to know about paycheck deductions.

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