Self-Funded IRAs: Everything You Need to Know

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One of the best things about the world of retirement investing is that it offers plenty of options in terms of what you can invest in, when and how. You can customize your investments to your individual goals and investing style, and you’re free to create a strategy that works well for your needs. But precisely because you have so many account options, becoming more knowledgeable about them is the key to choosing which kinds of investments are right for your portfolio. Many people choose individual retirement accounts (IRAs), which are some of the most popular types of retirement investments.

With traditional IRAs, your account manager has a high level of oversight about the types of assets the money in your account can be invested in. But, there are other types of IRAs that allow you to capitalize on non-traditional investments yourself, too. Some investors turn to self-funded IRAs to invest in these diverse assets. If you’re interested in learning more about self-directed IRAs, find out more about some key details, including their advantages and disadvantages.

What Are Self-Funded IRAs?

The terms “self-funded IRA” and “self-directed IRA” are used interchangeably, but you’re more likely to hear someone refer to this type of retirement account as a self-directed IRA in everyday use. It’s also common to refer to the account using the acronym SDIRA.

SDIRAs follow the same IRS guidelines as regular IRAs. You can contribute a set amount per year towards investing in assets to grow your retirement savings. A bank, broker or other custodian oversees the money in the account and the performance of the investments themselves.

With SDIRAs, the account holder has greater control over deciding which types of assets they apply their contributions to. Usually, you can invest IRA funds in financial products like exchange-traded funds, mutual funds, stocks, bonds and other traditional, relatively stable securities. With an SDIRA, however, custodians allow account holders to invest in a broader range of diverse securities.

Some people use SDIRAs to invest in business startups. These retirement accounts also support investing in real estate and buying commercial and residential property as retirement investments. High-quality precious metals, like gold and silver, are another option to add to an SDIRA. Cryptocurrency is an increasingly popular investment type for SDIRAs, too.

How Do Self-Funded IRAs Work?

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Although you have greater freedom with the types of assets you keep in an SDIRA, you may still be limited by the regulations of the custodian you choose. Custodians are responsible for managing the assets in an IRA and ensuring the account meets government regulations before you start withdrawing from it during retirement. Some SDIRA custodians allow you to invest in any non-traditional assets that the IRS allows. Others only specialize in a few and won’t manage SDIRAs with certain types of assets you want to hold. 

Usually, custodians will only hold your contributed funds and oversee the investments in your assets. Unlike using a brokerage custodian who may complete the investments for you, investing in an SDIRA may require you to choose a professional third party to work alongside the custodian to complete the investment. If you want to invest in precious metals, for example, you may need to find a reputable dealer for your custodian to purchase from. Similarly, you need to find a startup investment firm if you want to make investments in businesses, and you need a real estate contact if you want your custodian to make real estate investments for you.

How to Open a Self-Funded IRA

Major brokerages don’t always offer SDIRA products. You might need to form a relationship with a new financial institution to find someone to oversee your SDIRA. To open a self-funded IRA, start by finding a custodian that allows you to add the investment types you prefer. The custodian will explain the terms of your IRA, the ways you can make contributions and any fees that apply to the relationship. Then, you may need to find a third-party professional the custodian can work with to purchase non-traditional assets for you. 

Once you connect your custodian with a third-party professional who’s acceptable to both of you, you make your annual contributions and keep your custodian up to date about your current investment choices. The custodian collaborates with the third party to make purchases on your behalf and manage your assets. 

How Do Self-Funded IRAs Differ From Traditional IRAs?

For clarity, an SDIRA is either a Roth IRA or a traditional IRA. The term traditional IRA is used here to differentiate self-directed IRAs from those for which custodians or brokers make investment decisions. With a traditional IRA, the custodian makes investment choices on your behalf.

In an SDIRA, you’re in the proverbial driver’s seat for investment decisions as long as you abide by IRS rules and the custodian’s regulations. While that does mean more control, the responsibility to vet the investments and the sources from which you’ll purchase the assets is mainly yours. 

Advantages and Disadvantages of Self-Funded IRAs

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The biggest advantage of using an SDIRA is the opportunity for much higher returns than you might usually expect from traditional assets. If you invest in a startup, for example, that business could be the next Apple by the time you retire. In decades, precious metals or cryptocurrency could become significantly more valuable than paper money. 

For many investors, the draw of SDIRAs is the ability to invest in diverse assets, which can be both an advantage and a disadvantage. The prospect of getting a much higher return than traditional assets offer is a huge advantage, but there’s a flip side to that coin: The potential to take a significant loss is a disadvantage. While you also have the potential to earn a considerable return, these non-traditional assets are riskier than others.

There’s also more work involved in owning an SDIRA. If you want to invest in a traditional IRA, you can open an account with almost any custodian at any bank. If you’re set on having a certain type of non-traditional asset, however, you’ll need to find a custodian who allows that asset and is experienced in managing SDIRAs. You also have the added work of finding a third-party dealer or professional for your custodian to spend your funds with. 

Tax rules can be easier to break with an SDIRA, too. An early withdrawal with a traditional account is clear because it involves withdrawing money from the IRA. With an SDIRA, you could unintentionally make an early withdrawal by benefiting from the IRA-purchased assets in some way before retirement.

While SDIRAs offer an appealing opportunity to earn significant gains on the investments they hold, there’s still the opportunity to endure equally significant losses. That’s why financial experts don’t recommend that anyone invests all of their retirement savings in an SDIRA. It’s often the more prudent choice to have an SDIRA in addition to a traditional IRA — and for contributions to the traditional IRA to make up the majority of your IRA-based retirement savings.