What Is a Self-Directed IRA (SDIRA)?

A self-directed individual retirement account (SDIRA) is a type of individual retirement account (IRA) that can hold a variety of alternative investments normally prohibited from regular IRAs. Although the account is administered by a custodian or trustee, it's directly managed by the account holder—the reason it's called "self-directed."

Available as either a traditional IRA (to which you make tax-deductible contributions) or a Roth IRA (from which you take tax-free distributions), self-directed IRAs are best suited for savvy investors who already understand the alternative investments and who want to diversify in a tax-advantaged account.

Key Takeaways

  • A self-directed IRA (SDIRA) is a type of traditional or Roth IRA.
  • You can hold a variety of alternative investments, including real estate, in a self-directed IRA that regular IRAs can't own.
  • In general, self-directed IRAs are available only through specialized firms that offer SDIRA custody services.
  • SDIRA custodians can't give financial or investment advice, so the burden of research, due diligence, and management of assets rests solely with the account holder.

Understanding a Self-Directed IRA (SDIRA)

The main difference between SDIRAs 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. With an SDIRA, you can hold precious metals, commodities, private placements, limited partnerships, tax lien certificates, real estate, and other sorts of alternative investments.

As such, an SDIRA requires greater initiative and due diligence by the account owner.

How to Open a Self-Directed IRA (SDIRA)

With most IRA providers, you can only open a regular IRA (traditional or Roth), and can only invest in the usual suspects: stocks, bonds, and mutual funds/ETFs. If you want to open a self-directed IRA, you’ll need a qualified IRA custodian that specializes in that type of account.

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

The website SelfDirectedIRA offers a list of IRS-qualified account custodians.

SDIRA custodians aren’t allowed to give financial advice (remember, the accounts are self-directed)—which is why traditional brokerages, banks, and investment companies usually don't offer these accounts. 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.

Traditional vs Roth Self-Directed IRA (SDIRA)

Self-directed IRAs can be set up as traditional IRAs or as Roths. But keep in mind, the two account types have different tax treatment, eligibility requirements, contribution guidelines, and distribution rules.

A key difference between a traditional and Roth IRA is when you pay the taxes. With traditional IRAs, you get an upfront tax break, but pay taxes on your contributions and earnings as you withdraw them during retirement. On the other hand, you don’t get a tax break when you contribute to a Roth IRA. But your contributions and earnings grow tax-free, and qualified distributions are tax-free, as well.

Of course, there are other differences to consider. Here’s a quick rundown:

  • Income limits. There are no income limits for traditional IRAs, but you must make less than a certain amount to open or contribute to a Roth.
  • Required minimum distributions. You must start taking RMDs at age 70½ if you have a traditional IRA. Roth IRAs have no RMDs during your lifetime.
  • Early withdrawals. With a Roth IRA, you can withdraw your contributions at any time, for any reason, with no tax or penalty. Withdrawals are tax-free and penalty-free after age 59 1/2, provided the account is at least five years old. With traditional IRAs, withdrawals are penalty-free starting at age 59½ (remember, you have to pay taxes on traditional IRA withdrawals).

These same rules apply to whichever version of a self-directed IRA you have.

SDIRAs also have to abide by the general IRA annual contribution limits: For 2019, that’s $6,000 per year, or $7,000 if you’re age 50 or older.

Investing in a Self-Directed IRA (SDIRA)

Self-directed Roth IRAs open up a large universe of potential investments. In addition to the standard investments—stocks, bonds, cash, money market funds, and mutual funds—you can hold assets that aren’t typically part of a retirement portfolio.

For example, you can buy investment real estate to hold in your SDIRA account. You can also hold partnerships and tax liens—even a franchise business.

However, the Internal Revenue Service (IRS) forbids a few specified investments in self-directed IRAs, whether it’s the Roth or traditional version. For example, you can’t hold life insurance, S Corporation stocks, any investment that constitutes a prohibited transaction (such as one that involves “self-dealing”), and collectibles.

Collectibles include a wide range of items, including antiques, artwork, alcoholic beverages, baseball cards, memorabilia, jewelry, stamps, and rare coins (note that this affects the kind of gold that a self-directed Roth IRA can hold). Check with a financial advisor to be sure you aren’t inadvertently violating any of the rules.

Self-Directed IRA (SDIRA) Risks

SDIRAs have lots of benefits. But there are a few things to watch out for:

  • Prohibited transactions. If you break a rule, the entire account could be considered distributed to you. And you’ll be on the hook for all the taxes, plus a penalty. Make sure you understand and follow the rules for the specific assets you hold in the account.
  • Due diligence. Again, SDIRA custodians can’t offer financial advice. You’re on your own. Make sure you do your homework and find a good financial advisor if you need help.
  • Fees. SDIRAs have a complicated fee structure. Typical charges include one-time establishment fee, first-year annual fee, annual renewal fee. and fees for investment bill paying. These costs add up (and cut into your earnings).
  • Your exit plan. It’s easy to get out of stocks, bonds, and mutual funds: just place a sell order with your broker and the market takes care of the rest. Not so with some SDIRA investments. If you own an apartment building, for example, it will take some time to find the right buyer. That can be especially problematic if you have a traditional SDIRA and need to start taking distributions.
  • Fraud. Even though SDIRA custodians can’t offer financial advice, they will make certain investments available. The Securities and Exchange Commission (SEC) notes that SDIRA custodians don’t typically evaluate “the quality or legitimacy of any investment in the self-directed IRA or its promoters.”