A self-directed IRA is an individual retirement account that allows for investments beyond the scope of traditional IRAs. This implies that with self-directed IRAs, the contributor can invest in other assets that are usually restricted from traditional IRAs. Assets that are restricted from traditional IRA investments include cryptocurrencies, precious metals, and real estate assets. Someone with a self-directed IRA can invest in these assets.
Potential for Higher Returns
The higher the risk, the higher the potential of its returns. This is what self-directed IRAs offer to contributors, the chance to make higher returns than traditional IRAs. Because you are exposed to a wider repertoire of investable assets, this means that your money-making opportunities have also increased. You can invest your retirement contributions into high-risk assets like Bitcoin and take advantage of mortgage rates and invest in real estate.
Increased Diversification
Self-directed IRAs offer a wider range of diversification than traditional IRAs. This means that contributors can better hedge their risks if they manage their investments properly. This allows investors to structure their portfolios according to the macro-economic conditions rather than being stuck in a limited number of assets that are correlated as in the case with traditional IRA investments.
A more cautious investor can invest in inflationary havens such as gold or real estate. Likewise, he can take advantage of bull periods and invest in stocks or cryptocurrencies. The availability of options allows for better management of funds.
Access
Self-directed IRAs give you direct access to your funds which means that you can execute investment decisions more quickly than when using traditional IRAs. Also, this access means that you manage your funds yourself unlike in the case of traditional IRAs where you need to obtain approval from the custodian.
Lower fees
Because the funds in a self-directed IRA are managed directly by the contributor without the intermediary of a custodian, this attracts lower fees than traditional IRAs. Money which you would have paid to your custodian if you wanted to make some investment decisions in traditional IRAs is absent in a self-directed IRA.
Less Liquidity
Some assets are less liquid than others, as such selling them may take time and incur losses for the holder. Some of the asset classes which are permitted in self-directed IRAs such as real estate or precious metals are illiquid. This implies that the seller may get less than the market value. This contrasts with which stocks or ETFs are allowed in traditional IRAs and are very liquid.
Limited protection from custodian
Self-directed IRA custodians are only accountable for administering and holding the assets and not investigating their quality or legitimacy. This means one can invest in a fraudulent asset or engage in transactions that do not meet the purity standards of traditional IRAs. As such, self-directed IRAs offer limited protection to contributors.
Higher susceptibility to violating for IRS regulations
The lack of protection makes one susceptible to violating IRS rules. The lack of guidance from the custodian means that investors may invest in asset classes that may lead to violating IRS regulations if one does not have a clear understanding. This is unlike traditional IRAs where the custodian vets everything to ensure you do not violate the rules regarding certain types of investments.
If one invests in unapproved assets in your IRA this attracts severe penalties from Uncle Sam. If you borrow money from a self-directed IRA, sell property, obtain a securitized loan securitized using the self-directed IRA or use a self-directed IRA to buy property for personal use, this may bring up issues when it comes to taxation.
The IRS would assume you liquidated all your assets in the account at their fair value on the first of the year. If these assets appreciated in value during the holding period in the self-directed IRA, you would owe any applicable taxes, plus possible penalties for early withdrawal. As such, it is very important that you understand the rules which guide investment in specific assets you may want to hold in your account.
Self-directed IRAs offer investors a chance to expand their retirement portfolio and explore opportunities in other asset classes. This type of IRA account is perhaps more suitable for young investors who have a lot of time to make adjustments. However, the key word to making self-directed IRAs a worthwhile investment is discipline.
Some describe self-directed IRAs as retirement accounts on steroids. It may be so. The purpose of saving for your retirement is to secure a comfortable life when you are no longer productive and able to work. As such, before you opt for a self-directed IRA, you have to make sure that your investing game is tight.
This implies you have to have the discipline and the track record to make your investments worthwhile. Since you do not have the protective covering of traditional IRAs and are exposed to riskier assets, the importance of conducting due diligence can never be over-emphasized.
Photo by Austin Distel on Unsplash
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