Self-Directed IRAs

Self-directed IRAs are a type of IRA that allows holders to invest in alternative asset classes not open to regular IRAs, like cryptocurrencies, real estate, commodities and private placements. While they are held by custodians, account holders are responsible for managing investments.

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    Marguerita M. Cheng, CFP®, CRPC®, CSRIC®, RICP®

    Marguerita M. Cheng, CFP®, CRPC®, CSRIC®, RICP®

    CEO of Blue Ocean Global Wealth

    Marguerita M. Cheng, CFP®, CRPC®, CSRIC®, RICP®, is the chief executive officer at Blue Ocean Global Wealth. As a CFP Board of Standards Ambassador, Marguerita educates the public, policymakers and media about the benefits of competent and ethical financial planning. She is a past spokesperson for the AARP Financial Freedom campaign.

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    Barbara O’Neill, Ph.D. CFP®, AFC®, CRPC®

    Barbara O’Neill, Ph.D. CFP®, AFC®, CRPC®

    Owner and CEO of Money Talk

    With an extensive 41-year tenure at Rutgers University, Barbara O'Neill has established herself as a highly knowledgeable personal finance expert. As a Certified Financial Planner™ and Accredited Financial Counselor™ professional, she possesses a wealth of expertise in the field. She currently serves as the owner and CEO of Money Talk, where she actively engages in writing, speaking and reviewing personal finance content. In 2020, she notably authored the book Flipping a Switch, delving into various aspects of personal finance.

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  • Updated: August 23, 2023
  • 9 min read time
  • This page features 10 Cited Research Articles
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APA Cheng, M. M. (2023, August 23). Self-Directed IRAs. Annuity.org. Retrieved June 22, 2024, from https://dev.annuity.org/retirement/ira/self-directed-iras/

MLA Cheng, Marguerita M. "Self-Directed IRAs." Annuity.org, 23 Aug 2023, https://dev.annuity.org/retirement/ira/self-directed-iras/.

Chicago Cheng, Marguerita M. "Self-Directed IRAs." Annuity.org. Last modified August 23, 2023. https://dev.annuity.org/retirement/ira/self-directed-iras/.

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The desire of every investor — including investors in retirement accounts — is to maximize return on investment. As a result, investors with greater risk tolerance are always on the lookout for opportunities to earn higher returns.

Self-directed individual retirement accounts (IRAs) exist as a way for relatively more risk-tolerant investors to seek higher returns on their retirement accounts. Similarly, they appeal to some investors as a way to further diversify their investment portfolio at the asset class level.

However, the pursuit of higher returns and broader diversification comes with its own risks. Consequently, smart retirement planning must include weighing the benefits and the risks before making a choice.

What Is a Self-Directed IRA?

A self-directed IRA (SDIRA) is a type of IRA that allows holders, also called investors, to hold a variety of alternative investments that are not available for regular IRA (traditional IRA and Roth IRA) holders.

The investment assets available to regular IRA holders include stocks, bonds, mutual funds, exchange-traded funds (ETFs), real estate investment trusts (REITs) and certificates of deposit (CDs). In addition to these regular assets, an SDIRA allows you to invest in a number of alternative investments.

Like regular IRAs, a self-directed IRA requires the appointment of a custodian that will administer the IRA and hold its invested assets for safekeeping. However, searching for a custodian that can administer self-directed IRAs can be a daunting process.

First, many custodians who administer regular IRAs will avoid SDIRAs, limiting the pool of possible custodians. Second, apart from finding a custodian who administers SDIRAs, you must be specific and find one that supports investment in the particular assets you are interested in.

Consider a self-directed IRA for a potential high return and broad diversification of retirement savings, but only if you have a high investment risk tolerance and specialized investment knowledge.

Investment Options for Self-Directed IRAs

Investors can have greater control and diversification of retirement funds through self-directed IRAs. They also have the flexibility to choose from a wide range of alternative and exotic investments.

Investment options for self-directed IRAs include:

  • Real estate (with exceptions, like the property that you live in)
  • Commodities like gold, silver, oil and gas
  • Cryptocurrency
  • Private placement
  • Tax lien certificates
  • Water and mineral rights
  • Livestock
  • Lands

Types of Self-Directed IRAs

A self-directed IRA can either be a traditional SDIRA or a Roth SDIRA. There are also SEP, Simple, Individual 401(k), HSA and Coverdell ESA self-directed IRA options.

Types of Self-Directed IRAs

Traditional SDIRA:
A traditional SDIRA works like a traditional IRA in that contributions to this account type are tax-deductible while distributions are taxed at the point of withdrawal. Similarly, withdrawals at age59 ½ years and above are penalty-free.

Also, like a traditional IRA, required minimum distributions (RMD) begin at age 72.

Roth SDIRA:
Like a traditional Roth IRA, contributions to a Roth SDIRA are not tax-deductible but withdrawals from the account are tax-free. An income ceiling applies to contributions.

Unlike a traditional SDIRA, there are no required minimum distributions for a Roth SDIRA. Withdrawals after age 59 ½ years are penalty-free only when the account is at least five years old.

Self-Directed IRA Rules

When it comes to SDIRAs, certain rules differ from conventional IRAs. It is important to understand that you alone are responsible for all activity within your IRA. This includes following the laws and regulations that govern IRAs, such as avoiding prohibited transactions and adhering to investment restrictions. 

Ultimately, it is your duty to stay informed and compliant with IRA regulations.

Disqualified Persons 

It’s also essential to be aware of the various types of disqualified persons, as engaging in transactions with them can result in the loss of your IRA’s tax benefits and the imposition of penalties. 

Examples of Disqualified Persons

  • You
  • Your spouse
  • Your direct descendants, parents, grandparents, great-grandparents and their spouses
  • Any beneficiary of the IRA
  • Any corporation or partnership
  • Any estate in which you have a 50% or higher interest
  • Anyone providing services to the SDIRA
  • Investment advisors and managers
  • Your custodian
  • Your trustee

Prohibited Transactions 

According to the IRS, a prohibited transaction is when you, your beneficiary or any disqualified person makes improper use of your IRA. There are four primary types of prohibited transactions. 

Examples of Prohibited Transactions Involving SDIRAs:

  1. Transferring IRA income or assets for the benefit of a disqualified person
  2. The sale, exchange or leasing of a property between a disqualified person and an IRA
  3. Furnishing goods, services or facilities between a disqualified person and an IRA
  4. Extension of credit or cash loan between a disqualified person and an IRA

Investment Restrictions

The IRS also bars you from investing in three asset classes with a self-directed IRA.

Prohibited SDIRA Investments:

  • Life insurance
  • S corporations
  • Collectibles
    • Art
    • Antiques
    • Alcoholic beverages
    • Certain tangible personal property
    • Coins (except for gold and silver coins minted by certain national mints and of a certain purity)
    • Gems
    • Metals (except gold, silver, platinum and palladium bullion of specified purity)
    • Rugs
    • Stamps

Contributions, Withdrawals and Taxes

A self-directed IRA follows annual contribution limits, withdrawal restrictions and required minimum distributions (RMDs) similar to traditional IRAs.

Examples of Main Rules for Traditional SDIRA Contributions, Withdrawals and Taxes

  • Total IRA deposits across all accounts are subject to annual contribution limits. In 2023, that would be $6,500 for people under the age of 50, and an additional $1,000 catch-up contribution for people 50 years of age and older.
  • Qualified withdrawals during retirement are taxed as ordinary income.
  • Early withdrawals before age 59½ without qualifying exceptions result in a 10% penalty and regular income taxes.
  • Starting at age 73, RMDs are mandatory, based on year-end account balance and life expectancy.

How To Set Up a Self-Directed IRA

If, after evaluating the benefits and risks, you are interested in self-directed IRAs, you can open your own account by following the process outlined below.

Steps To Open a Self-Directed IRA

  1. Decide on the alternative investments you are considering. It’s better to identify the broad asset classes you want to include in your self-directed IRA before researching ‌custodians. This is because not all custodians allow all alternative investments permitted by the IRS.
  2. Find a custodian that allows investment in those asset classes. Once you have decided on the broad asset classes, you can start searching for custodians that fit the bill. Apart from selecting one that allows the asset class you are considering, you should also evaluate custodians based on fees, integrity and customer support. It’s better to find the right one at the start, because there is a fee involved in changing custodians later on.
  3. Open an account with your chosen custodian. Once you have selected a custodian, request to open an SDIRA and complete all ‌paperwork.
  4. Research your proposed investment opportunities. Since the custodian won’t do it for you, ‌take responsibility for conducting due diligence for every investment opportunity. Ensure you consult your financial advisor (if you have one) about any investment.
  5. Choose a broker that will facilitate the transaction. The broker helps you purchase whichever alternative investment you are interested in. This could be a bitcoin exchange or a real estate agent, for example‌.
  6. Give investment orders to your custodian. Once you have decided on a broker, you can then order your custodian to fund and complete the transaction. When this is done, your custodian holds the investment for safekeeping.

Opening a self-directed IRA is simple. What is more difficult is deciding whether to own one in the first place. Therefore, ensure you spend time thoroughly evaluating this option — and speak with your financial advisor — before making a decision.

Benefits and Risks of Self-Directed IRAs

Self-directed IRAs provide flexibility and diversification for investors but also come with risks such as fees, prohibited transactions and potential fraud. It’s essential to research and fully understand the benefits and risks of SDIRAs before making investment decisions.

Benefits of Self-Directed IRAs

Self-directed IRAs provide investors with more flexibility by increasing the number of asset classes that investors can explore. When they refuse to limit themselves to the world of stocks, bonds, mutual funds, ETFs, REITs and CDs, investors can explore other options that might even have more potential than the classes they have grown used to.

Advantages of Self-Directed IRAs

Broader Diversification of Your Investments
With a variety of investment options available, you can expand your portfolio beyond the restrictions of typical IRAs and diversify your investments.
Greater Choice of Investments and Assets To Include in Your IRA
You can select the investments of your choice, enabling you to create a portfolio that aligns with your preferred sectors, industries or assets.
The Potential of Receiving Higher Returns
Self-directed IRAs offer investors the chance to explore a wider variety of asset classes that goes beyond traditional options. This allows for the possibility of discovering investments with higher returns.
Tax Breaks on the SDIRAs Earnings
Your account’s earnings will increase over time, and depending on which type of SDIRA you choose, you may have the potential for tax-free or tax-deferred growth. 

Learn why alternative asset classes may be beneficial for investors from financial expert Thomas J. Brock, CFA®, CPA.

Risks of Self-Directed IRAs

Self-directed IRAs also come with their own risks.

Some risks of self-directed IRAs include:

Fees
There are many fees involved in a self-directed IRA. When added together, they can become very expensive to maintain. Common fees include a lump sum establishment fee, a first-year annual fee, an annual renewal fee and fees for settling investment bills.
Prohibited Transactions
There are certain transactions that are prohibited for self-directed IRAs by the Internal Revenue Service (IRS). For example, you cannot borrow money from your SDIRA, sell property to it, live in a property purchased from your SDIRA or use personal money to repair or renovate an SDIRA-acquired property.

Failure to comply will result in penalties, interests and a forfeiture of tax benefits.

Due Diligence
As the name implies, you choose the investments in your self-directed IRA. Your custodian won’t give you financial advice or typically conduct due diligence on your investment choices.
Illiquidity
Selling some alternative investments can be very hard because they are not as liquid as traditional investments. Take real estate as a typical example. This can be a significant problem if you have a traditional SDIRA where you are required to make RMD at 72.
Limits on Possible Investment
While self-directed IRAs widen the range of investments, the IRS exempts assets such as life insurance, S corporation stocks and collectibles.
Fraud
In 2018, after stating that custodians have no duty to help you select investments, the SEC warned about the tendency of fraudsters to allure SDIRA holders with fraudulent investments. Much of this warning centered on certain self-directed IRAs allowing investment in digital assets like cryptocurrencies. The SEC warned of ‌fraudsters using the allure associated with digital asset classes to entice investors with a promise of high returns.

Again, they warned, SDIRAs allow investors to hold alternative investments that, unlike publicly traded securities, may have limited financial information available. Even when financial information is available, a public accounting firm may not audit it as is normal practice.

Higher Risk
Alternative investments, though potentially more profitable, are also potentially riskier because of high volatility. The same assets that can move wildly to the upside can also fall drastically to the downside.

Self-Directed IRAs vs. Traditional IRAs

A self-directed IRA has the same contribution limits as a regular IRA: in 2023, that’s $6,500 (and an additional $1,000 catch-up contributions if you are 50 years of age or older.) And while a traditional SDIRA and a Roth SDIRA are like a regular traditional IRA and a Roth IRA, there are some notable differences.

The first major difference between self-directed IRAs and regular IRAs lies in the expanded range and variety of investment assets that the former permits.

Another difference is that self-directed IRAs usually have a smaller pool of custodians.

Third, unlike regular IRAs, you choose and manage the investments you want in your account. Custodians don’t give you any financial advice or conduct extensive due diligence on your behalf. Since it’s self-directed, you take responsibility for your own choices.

As the U.S. Securities and Exchange Commission puts it, “Custodians for self-directed IRAs disclaim most duties to investors.” As a result, they won’t typically evaluate “the quality or legitimacy of any investment in the self-directed IRA or its promoters.”

Editor Malori Malone contributed to this article.

Please seek the advice of a qualified professional before making financial decisions.
Last Modified: August 23, 2023

10 Cited Research Articles

Annuity.org writers adhere to strict sourcing guidelines and use only credible sources of information, including authoritative financial publications, academic organizations, peer-reviewed journals, highly regarded nonprofit organizations, government reports, court records and interviews with qualified experts. You can read more about our commitment to accuracy, fairness and transparency in our editorial guidelines.

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