Is a Self-Directed IRA Right for You?

See which IRA is right for you.

Individual Retirement Accounts (IRAs) come in many types and varieties. Consider the traditional IRA, the Roth IRA, the self-directed IRA (SDIRA), the self-directed Roth IRA, the Simplified Employee Pension (SEP) IRA and the SIMPLE IRA.

Since the SEP and SIMPLE plans are typically plans employed by business entities, and this article is directed to individual account management, we will focus on the individual accounts. The Roth is the only IRA that allows for tax-deferred accumulation and tax-free distribution; however, there is no tax-deduction at the time of contribution.

The traditional and SDIRA allow for a tax-deduction in the year of contribution as well as tax-deferred accumulation of earnings within the account, but the investor is taxed at ordinary income tax rates at time of withdrawal. The annual contribution limits to the traditional, Roth and self-directed IRA accounts are the same: $5,500 for those under age 50 and $6,500 for those over that age. Each account can be funded by opening an account or by executing a direct custodial transfer or direct rollover.

Keep Reading: A Review of the Best IRA Providers

The purpose of this article is to highlight some of the issues involving custodial and management options of SDIRAs, traditional and Roth IRAs. So we will reserve the tax implications regarding contributions and distributions for another time.

Services Provided by Trustees or Custodians of Roth or Traditional IRAs

  •  Custody of assets
  •  Transaction processing
  •  Records maintenance
  •  Issuance of investor statements
  •  Assistance with rules and regulations pertaining to certain prohibited transactions
  •  Performance of other administrative duties on behalf of the self-directed IRA owner

Investment Options Differ Among IRAs

Traditional and Roth IRAs offer investment options including stocks, bonds, certificates of deposit (CDs), mutual funds, annuities, unit investment trusts and exchange-traded funds.

Account owners of SDIRAs can invest in the list above as well as in nontraditional assets, such as real estate, private mortgages, private company stock, oil and gas limited partnerships, precious metals, livestock, intellectual property, commercial paper, private placements, energy, oil and gas and other assets.

Pros and Cons of SDIRAs

Let’s consider two common philosophies of investing: strategic and tactical. A simplified vision of the strategic approach contends that money held by the investment will be invested entirely in the market. The potential to lose all of the gain and possibly the principal is always present.  Most mutual funds adhere to this model.

The tactical model, however, provides for the investor to enjoy gains in a rising market while mitigating losses when the market drops. Most wealth managers provide this service since many investors are uncertain about how to react to market fluctuations and trends. It’s not uncommon for investors to make poor decisions when the market drops, resulting in a lower account performance.

The biggest challenge facing retirement investors who want to “unlock” their funds and move them out of the control of the traditional financial services industry and into a SDIRA is simply a lack of knowledge. The primary benefit of a Traditional or Roth IRA is that the investor will have an advisor from a brokerage firm or bank to assist them with investment choices.

If, however, the investor wants to take control over the type(s) of investment in their retirement account, then they might benefit from an SDIRA account.  They must be willing to take on a big responsibility in overseeing and managing their investments.  This lone-wolf investor should be very familiar with the technicalities of the markets and investment trading. He or she needs to be emotionally capable of withstanding the potential thrills and woes as their fortunes ride the ups and downs of the markets.

Who’s Right For an SDIRA, Traditional or Roth IRA?

  • Jim, 65, is planning to retire next year. A diligent saver, Jim never had the time or inclination to follow investments closely. Jim would probably do best to meet with an advisor who can help him define investment objectives, risk tolerance, income objectives, long-term care concerns and estate/legacy wishes. He will probably fare best with an IRA managed by a professional.
  • Sarah, 50, is an accountant who has consistently contributed the maximum to her 401(k) over the years and has always selected her own investments. After making a job change, Sarah has decided to move her former 401(k) into an IRA. Her profile as an account with a significant history of dealing with large sums of money in critical situations makes her a more viable manager of her own accounts.
  • David, 40, a teacher and noted researcher at MIT, has invested the maximum allowable amount in his 401(k) each year. He has not altered any of his investment selections since first opening the account years ago. Since he has expressed little interest and has virtually no experience in investment management, and is soon to have a significant increase in income, David will most probably benefit from the intense scrutiny and assistance of a qualified professional investment manager.

A self-directed IRA or self-directed Roth IRA can provide an investor with broad investment liberties. As with most things, however, these freedoms come with a price. In this case, that price is risk. Your IRA account probably represents a significant portion of what will become your retirement income. Exposing your savings and the quality of your retirement lifestyle to the potential financial management deficiencies and emotional vulnerabilities of an experienced investor (you) might be a dangerous proposition. Unless you have in-depth technical training in the behavior of markets as well as in the nuances of trading and have learned to withstand the emotional roller coaster ride of your fortunes, then a professionally-managed account is probably your best option.

Remember, someone else might be directing the activity within your IRA, but you have the ultimate say over the choices made on your behalf. You should feel free to review your account status according to the guidelines you set out when your account was opened. Regardless of who is steering at any given moment, you remain the captain of your IRA.