If you are considering retirement investment plans, then chances are you must have heard of self-directed individual retirement accounts.
While there are different ways of investing in self-direct IRAs, the concept behind them all is the same. Click here to learn more about a type of self-directed IRA.
We believe that finding out all you can about something before getting involved in it is the best way to decide if it’s a good path to follow. Because of this, we believe you need to know all you can about self-directed IRAs, from what it is, how it works, and even the pros and cons involved.
Hence, we will be discussing everything you need to know about self-directed IRAs in this article.
Self-Directed Individual Retirement Account – What Exactly is it?
Self-directed IRAs refer to a particular type of retirement account. This means you can use the account to save towards retirement, the accounts are usually tax-advantaged, just like regular IRAs. Also, like regular retirement plans, these special accounts have contribution limits.
However, what distinguishes this plan from the others is that special asset classes can be held in them.
Assets That Can Be Held in them
The following are some of the assets that can be held in these accounts:
- Foreign currency (this is held in forex IRAs)
- Startups (done through crowdfunding platforms)
- Tax liens
- Precious metals such as palladium, platinum, silver, and gold. Precious metals held in retirement accounts have to meet some purity standards
- Real estate assets
- Cryptocurrencies such as Ethereum and Bitcoin
While you would hold regular assets like mutual funds, bonds, and stocks with regular retirement plans, self-directed plans open the door to several possibilities. This may be why they are gaining popularity as people are interested in harnessing these possibilities to ensure financial stability at retirement.
How to Set-Up One
The following are the steps involved in setting up a self-directed individual retirement account:
1. Get a Custodian
Custodians of these retirement accounts could be a trust company, bank, or any other financial institution that is IRS-approved. However, before you choose your custodian, ensure you do proper research, be sure that they are reliable and trustworthy. One way to do this is to read customer reviews about them.
2. Select the Products You Want to Invest In
Since the options here are more when it comes to asset type, you want to properly weigh your options and conclude on what you want. Once you know what you want to invest in, you would need to get a dealer to purchase the asset from.
3. Finish the Transaction
Now, the custodian upon your request will buy the asset from the dealer. The custodian will be in charge of the whole transaction.
4. Plan the Withdrawal When It Is Ready
Here, the withdrawal rules are the same as regular IRAs. You will be charged a 10 percent penalty if you make your withdrawal when you are below 59 and a half years old. This retirement plan also follows the required minimum distribution rule. So, you must start withdrawal once you become 72 years old.
However, since the asset classes in this plan are not conventional, their liquidity is lesser. This means withdrawals are a lot more complicated.
When it comes to self-directed individual retirement accounts, there are two main benefits, and these are higher returns and better diversification.
1. Higher Returns
The asset types you could invest in are more; hence, you can choose assets that have higher risks but higher rewards.
The assets you can invest in with this plan usually have more rewards than the rewards you would get from stocks and bonds.
2. Better Diversification
When it comes to retirement investments, investors are often concerned that inflation and market volatility can law waste to their savings. Hence, being able to purchase unconventional assets means they can preserve their saving’s value even over a long period.
For instance, gold investment for a very long time has been considered as a reliable hedge against market volatility and inflation. However, this is true when considered on a long-term basis. But, if the investment is done short-term, then the volatility it is susceptible to can even be equated to that of stocks and bonds.
Therefore, while investing in safe assets like precious metals will diversify your investment portfolio, it doesn’t mean you are fully protected against loss.
The following are some of the major disadvantages of a self-directed IRA:
1. Less Liquidity
Turning your asset into fiat currency when you wish to withdraw may be more complicated and take longer since the asset is unconventional. Assuming you even sell off your investment fast, you may be selling it lesser than its market value.
2. Extra Fees
Sometimes, an IRA can be opened without trading or account management fees. But, with self-directed accounts, you may need to pay some account-related charges. Also, you may be charged some extra fees depending on what you are investing in.
For instance, if you choose to invest in precious metals, you most likely will be charged storage, insurance, and maintenance fees. These fees are simply the basics; some other fees may be charged based on the custodian you choose.
3. You May Violate IRS Rules
The IRS has certain rules concerning individual retirement accounts. You can visit https://www.irs.gov/ to learn more about this.
When it comes to self-directed accounts, these rules are more and can be more stringent. Therefore, the chances of you breaking one of these rules are higher. Your account can be penalized if you ever break the rules.
Investing for retirement is among the best financial choices anyone can make for themselves. There are several alternatives open to you when it comes to retirement plans, one of which is self-directed IRAs. With a self-directed IRA, you can invest in unconventional assets for your retirement. This article is a guide on every important thing you need to know about this special type of individual retirement accounts.