With traditional individual retirement accounts (IRAs), your investment options are usually restricted to securities such as stocks, bonds and mutual funds, so if you’re looking to branch out with more-novel choices, such as real estate and precious metals, a self-directed IRA is your ticket. You get more investment options and the same tax perks. The one catch: You have to find a custodian who handles these accounts and there aren't that many of them.
As with other IRAs, you can either invest with pre-tax dollars and enjoy tax-deferred growth or, if you choose a self-directed Roth IRA, you can buy assets that won’t be taxed when you hit retirement.
The wider range of investment options with a self-directed IRA gives you the opportunity to pursue assets that have a potential for higher yields over time. Among them: tax lien certificates, private placement securities, gold and even restaurant franchises. (For more, see Self-Directed IRA: The Right Move for You?)
The catch? You’re also taking a much bigger risk. Many of the investment options that people tuck into a self-directed IRA are volatile by nature. What’s more, the custodian – which is a bank, a federally insured credit union, a savings and loan association or an entity approved by the Internal Revenue Service (IRS) to act as a trustee – doesn’t vet the investments you undertake.
That’s where the “self-directed” part comes in. It’s your responsibility to conduct the due diligence on the securities and other assets you buy. You’re also accountable for understanding the tax consequences of these less common investments. For example, if your IRA includes a rental property for which you carry a mortgage, some of your investment income could be taxable. A custodian won’t dig into those implications for you.
That’s not to say that all custodians are created equal. Roughly two dozen companies are currently licensed by the IRS to provide these services, and some have better reputations – as well as more experience with certain investment categories – than others, so it pays to do your homework. As self-directed IRAs are something of a niche market, you won’t find well-known names, such as TD Ameritrade or Fidelity, in the mix. Therefore, it’s important to ask the right questions when you shop around.
Here are some of the factors to consider.
There are certainly advantages to a self-directed IRA, but there are also some pretty serious risks. One of them is putting your trust in a custodian that you later find isn’t up to par. Asking the right questions ahead of time will help ensure that your assets are in good hands.