Self-Directed IRA Rollovers: What You Need to Know

A Self-Directed IRA (SDIRA) may provide numerous benefits to an investor. First, SDIRAs may be an attractive option for individuals who prefer the “Do It Yourself” (DIY) approach to life. In addition, self-directed IRAs allow retirement savers to seek out alternative investments that are often not allowed in standard IRAs. For example, alternative investments may offer the possibility of higher returns (though often with higher risks) and meaningful diversification, as alternative assets don’t always move in the same direction as public stocks and bonds.

SDIRAs enable investors to hold alternative assets in their retirement accounts. All retirement accounts must be funded in an IRS-compliant manner, and self-directed IRAs are no exception. In this article, we’ll take a deeper dive into funding a SDIRA, with an emphasis on rollovers from a 401(k) or other qualified retirement plans.

Rules and Income Limits for Traditional and Roth IRA

It’s important to remember that the IRS has numerous rules for IRAs.¹ For both Traditional and Roth IRAs — the two most common IRA account types for individuals — retirement investors can make yearly contributions provided you stay within annual IRS limits and follow all IRS rules.

There are differences between Traditional and Roth IRAs. Contributions to a Traditional self-directed IRA are tax-deductible. The investments in a Traditional IRA can grow tax-free, but the individual pays tax at their marginal rate upon withdrawal. In the case of Roth IRAs, contributions are made with after-tax dollars (provided your income is below the IRS threshold to contribute to a Roth IRA). However, the account can grow in a tax-deferred manner, and qualified withdrawals are tax-free as well.²

How to Fund a Self-Directed IRA

There are three general ways to fund a self-directed IRA:

An investor may make a Contribution using money held outside a retirement account. The Contribution limit in 2024 is $7,000, although those 50 years old and older may contribute up to $1,000 extra if they didn’t max out their contributions in previous years.

Rollovers: Rollovers are initiated primarily by rolling over a 401(k) or other qualified retirement account, like a 403(b). In some cases, a user can also usually fund a self-directed individual retirement account by rolling over a lump sum defined benefit pension payout into a SDIRA.³ If you have a pension, it may be worth considering a pension rollover to fund a self-directed IRA.

Transfers: Transfers involve moving funds from an existing IRA to a SDIRA. In this case, the account type (IRA) would remain the same, but the custodian (which administers the account) changes. An investor can complete an unlimited number of Transfers each year, while there are some limitations on the number of Rollovers that can be completed in a calendar year.

To stay on the right side of the IRS, it’s important to understand self-directed IRA Rollover rules.⁴

How a Self-Directed IRA Rollover Works

Let’s look at an example to show how a rollover works to fund a self-directed IRA. Imagine you recently left your job with a 401(k) valued at $750,000. You’re looking for more freedom to invest in alternative assets, which you can’t do in a 401(k). In this example, you've liquidated the holdings in your 401(k) — mutual funds — into cash in preparation for the Rollover.

• Direct Rollovers

  You have two options when it comes to rolling over your 401(k) into a self-directed IRA. One option is known as a Direct Rollover, and it’s the simplest way to conduct a Rollover. A Direct Rollover involves two steps:

  1. You would open a SDIRA (with a company such as Forge Trust). After opening the account, you would then complete a Deposit Notification Form.
  2. To transfer funds from your 401(k), you would fill out any forms your Plan Administrator requires to have a check or wire issued. There are also third-party providers that can assist with the rollover process.

• Indirect Rollovers

  Alternatively, you can elect to do an Indirect Rollover. With an Indirect Rollover, you would request and receive the 401(k) funds from a previous employer-sponsored plan. As per IRS rules, you have 60 days from when the check was issued by your employer to deposit the funds into another retirement account, such as a self-directed IRA.⁵ When you roll over your old retirement account into an IRA, you can preserve the tax-deferred status of your retirement assets without paying current taxes or early withdrawal penalties at the time of transfer.

Keep in mind that with Indirect Rollovers, 20% of the total you request from your employer is subject to withholding tax. To avoid potential tax consequences, you have the option of making up the 20% withheld to contribute the full amount distributed from the plan. Please consult with your advisor on what best fits your goals.

After completing the Rollover (Direct or Indirect), you do some research and decide to invest some of the $750,000 in assets (like private company shares) that you couldn’t access in your regular IRA or other qualified retirement plan. Remember that unlike a traditional IRA custodian, a self-directed IRA custodian — like Forge Trust — cannot offer advice on how to invest your SDIRA.

The Differences Between Transfers and Rollovers

While SDIRA Transfers and Rollovers may seem similar, they are different methods for funding your self-directed IRA. A SDIRA Transfer involves moving funds from one IRA (such as a Traditional IRA) to a SDIRA. The account types are the same, and it’s known as a Transfer because only the custodians are changing and there is no tax reporting, if done properly.

Rollovers work differently. An IRA Rollover generally involves rolling over cash or other funds held in a previous employer-sponsored plan — such as a 401(k) — into an IRA (in this case, a SDIRA).

Self-directed IRAs can be a great choice for DIY investors who want to own alternative assets in their retirement accounts. If you decide that a self-directed IRA is right for you, Forge Trust can assist with the process of opening and funding your account. We can help you move or roll over a 401(k) or transfer assets from a traditional IRA into a SDIRA to help you take control of your retirement investing. Click here to learn more.

Self-directed IRAs are not for everyone, but they can be a good option for sophisticated investors who want to take control of their retirement savings in a tax-advantaged manner. You may choose a SDIRA if you understand the potential benefits and risks of various alternative investment opportunities. While these investments may carry higher risk than traditional investments, they also may offer the potential for higher returns and greater diversification than traditional asset classes.