Self-Directed IRA vs. Traditional IRA: What Are the Differences?

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 SEP-IRA. The funds are held by a financial institution that invests them in traditional assets, such as stocks, bonds, and mutual funds.

Key Takeaways

  • 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. Of course, the account-holder can make trading decisions and direct the brokerage. The broker must also get the account holder's permission to make trades—unless the IRA is held with a money manager who has discretionary power over the account.

With a self-directed IRA (SDIRA), 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.

The main difference between an SDIRA and other IRAs is the types of investments you can hold in the account. In general, regular IRAs are limited to common securities like stocks, bonds, certificates of deposit, and mutual or exchange-traded funds (ETFs).

But SDIRAs allow the owner to invest in a much broader array of assets—what are commonly called alternative investments. As such, an SDIRA requires greater initiative and due diligence by the account owner.

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.

Not every SDIRA custodian offers the same range of investments. So, if you’re interested in a specific asset, such as gold bullion, make sure it’s part of a potential custodian’s offerings.

Remember that SDIRAs are self-directed, which means custodians aren’t allowed to give financial advice. As such, traditional brokerages, banks, and investment companies usually don't offer them to their clients. That means you need to do your own homework. If you need help picking or managing your investments, you should plan on working with a financial advisor.

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 private placements, limited partnerships, tax lien certificates, and precious metals.

Self-directed IRAs cannot be used to purchase insurance instruments or collectibles.

Collectibles include a wide range of items, including antiques, artwork, alcoholic beverages, baseball cards, memorabilia, jewelry, stamps, and rare coins. This affects the kind of precious metal that a self-directed Roth IRA can hold. For example, 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.

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 2021 and 2022. Individuals who are aged 50 and over can deposit an extra $1,000 each year as a catch-up contribution.

Article Sources
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  1. Internal Revenue Service. "Retirement Plan Investments FAQs." Accessed Dec. 11, 2021.

  2. Internal Revenue Service. "Issue Snapshot - Investments in Collectibles in Individually-Directed Qualified Plan Accounts." Accessed Dec. 11, 2021.

  3. Internal Revenue Service. "Retirement Topics - Prohibited Transactions." Accessed Dec. 11, 2021.

  4. Internal Revenue Service. "IRS Announces 401(k) Limit Increases to $20,500." Accessed Dec. 11, 2021.

  5. Internal Revenue Service. "Income Ranges for Determining IRA Eligibility Change for 2021." Accessed Dec. 11, 2021.

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