Individual retirement accounts (IRAs) are tax-deferred savings accounts intended to provide a source of income for retirement. Contributions to IRAs are made by the individual account owner and, depending on the particular type of IRA, by the individual's employer as in the case of a 401(k). The funds are held by a financial institution that invests them in traditional portfolio options such as stocks and mutual funds.
- Individual retirement accounts (IRAs) are savings accounts intended to provide a source of income for retirement.
- Funds invested in a non-self-directed IRA are usually overseen by a brokerage house that invests and manages the account.
- A self-directed IRA, which can be a traditional IRA or Roth IRA, allows the account owner to make investment decisions.
- Self-directed IRAs are helpful since they provide the owner with more flexibility in choosing investment options.
Differences Between Self-Directed IRAs and Traditional IRAs
When funds are invested in a non-self-directed IRA, they are usually managed by a brokerage house that invests the funds.
With a self-directed IRA, which can be either a traditional IRA or Roth IRA, the account owner directs all of the investment decisions through a custodian or broker. As a result, the owner has a much greater degree of flexibility in choosing investment options. This option may also reduce the fees charged because the custodian isn't involved in the investment transactions—only the investor.
A self-directed IRA may be a little more challenging to set up than a standard IRA, but many investors find the freedom is worth the extra work.
IRA Prohibited Transactions
The Internal Revenue Service (IRS) creates the rules for all retirement accounts, and all IRAs are prohibited from certain transactions regardless of the specific type of IRA. Account-holders cannot take a personal loan against their funds or participate in other self-dealing activities, such as business transactions in which they or family members are personally involved.
IRA Contribution Limits
The IRS has established annual limits as to how much money can be contributed to an IRA. The annual contribution limit to both traditional and Roth IRAs—including self-directed IRAs—is $6,000 for 2020 and 2021. Individuals who are aged 50 and over can deposit an extra $1,000 each year as a catch-up contribution.
Alternative Investments for Self-Directed IRAs
Within the IRS restrictions, self-directed IRA funds may be used to invest in a diversified portfolio beyond traditional stocks and bonds. The owner of a self-directed IRA can invest in partnerships, real estate, and the precious metals market.
Self-directed IRAs cannot be used to purchase insurance instruments or collectibles. However, an account holder can direct the custodian of the self-directed IRA to invest in the silver market but cannot order the purchase of collectible silver coins.
A popular investment choice for those with self-directed IRAs is real estate. Funds from the IRA can be used to purchase a foreclosed property, for example, which will then be held in the name of the IRA custodian. The self-dealing restrictions apply, though, prohibiting the account holder from living at the property.