How Self Directed IRAs Work: Everything You Need to Know

When it comes to saving for your retirement, there are several options available. However, the best option for you is going to depend on your own unique situation and goals. IRAs — or individual retirement accounts — are a popular form of retirement accounts that come in a variety of forms. A self-directed IRA, for example, is different from other types of IRAs because of the kinds of assets you can own in the account. A regular IRA is more suitable for people who prefer common investment vehicles, such as stocks and bonds.          

Self-Directed IRAs: Rules and Limitations

As of 2019, your self-directed IRA total contributions cannot be more than $6,000. However, if you’re 50-years-old or older, you can contribute up to $7,000.¹ According to the IRS, this limit does not apply to rollover contributions or qualified reservist repayments.¹ A rollover happens when funds are distributed from one retirement account (such as an IRA) and deposited into the same — or a different — account. 

Generally, when you roll over a distribution to your retirement account, you will not have to pay taxes on it until you withdraw the funds.² When you do this, your money is able to grow on a tax-deferred basis. However, if you don’t roll over this money, it will likely not be taxable unless you qualify for any exceptions.² A qualified reservist, on the other hand, is someone who is inactive in the military, and then called to duty. In this situation, the person could be eligible to withdraw from their self-directed IRA early without having to pay a penalty fee. 

Advantages of Self-Directed IRAs

If you’re someone who prefers having more options, a self-directed IRA could be a good fit for you. With a self-directed IRA, you can invest in a variety of companies, properties and operations. If you’re passionate about a certain field or industry, a self-directed IRA offers the opportunity to put your knowledge to the test. Instead of investing in things you know nothing about, you’re able to go after investments you actually have an interest in, which can make the experience much more enjoyable. It’s important to note that regardless of the type of IRA you have, you’re going to need to have a person or company hold the account for you.

Regarding a self-directed IRA’s tax advantages, your contributions could either be fully or partially tax-deductible, depending on a variety of factors.³ Oftentimes, both the earnings and gains in your IRA are not taxed until they are distributed.³ Sometimes, this money may not be taxed at all.³ However, if your spouse has a retirement plan at work and your income level exceeds a certain amount, your total tax deduction may be reduced.¹

Disadvantages of Self-Directed IRAs

If you’re someone who’s interested in a self-directed IRA, it’s important to consider the amount of responsibility required. Because your custodian will be passive — as in they will simply hold the account without providing investment advice — you will need to educate yourself on investment best practices if you want to generate consistent, positive returns. Additionally, you’ll be in charge of managing paperwork and transactions, which requires ongoing dedication. 

In some ways, a self-directed IRA is a part-time job, so you want to think carefully about your own capabilities and time before you make the commitment. For some people, a self-directed IRA may be appealing because, in a way, it forces you to be current with the times. If you don’t, you risk losing a considerable amount of money. A self-directed IRA might be a good fit for people who enjoy the challenge of investing, and who are eager to learn and grow as the market fluctuates. If this doesn’t sound like you, a traditional or Roth IRA may be a more suitable option.

^{1 https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-iras-contributions}

^{2 https://www.irs.gov/retirement-plans/plan-participant-employee/rollovers-of-retirement-plan-and-ira-distributions}

^{3 https://www.irs.gov/publications/p590a}

This content is developed from sources believed to be providing accurate information, and provided by Twenty Over Ten. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.