What is a Self-Directed IRA?

You’re probably familiar with the term “DIY”— Do It Yourself. Whether it’s renovating your kitchen, trimming your hedges, or filing your taxes, some people just prefer to handle a task themselves. The good news is that DIY can extend to retirement saving, too. With a self-directed IRA (SDIRA), you can directly manage your retirement savings — and invest in a wide range of assets that traditional brokerage firms, such as Fidelity and Charles Schwab, may not allow to be held in the IRA accounts they offer customers.

Investors are typically interested in self-directed IRAs for several reasons.¹ First, SDIRAs allow account holders to invest in alternative assets —investments beyond traditional stocks, bonds, mutual funds, and exchange-traded funds (ETFs) — that often cannot be held in IRAs from traditional brokerages. Alternative assets have the potential for higher returns than publicly traded stocks or bonds, though they often come with more risk than “regular” investments.

Second, these alternative assets may offer compelling diversification benefits to an investor’s portfolio, as they aren’t always correlated with public stock and bond markets. Finally, sophisticated investors may value the freedom offered by SDIRAs, letting them save for retirement with more choices while enjoying the same tax benefits associated with traditional IRAs.

Self-Directed IRAs, Defined

A self-directed IRA is a type of retirement account that is permitted to hold alternative assets — investments that are not generally allowed in regular retirement accounts. Like an IRA, SDIRAs may also hold more common investments such as mutual funds, publicly traded stocks, bonds, and ETFs, but investors have more flexibility with a SDIRA.

A SDIRA is directly managed by the individual account holder; however, as with all IRAs, a self-directed IRA must be administered by a custodian. The custodian may not offer advice as to which investments are suitable for the investor — hence the term, “self-directed.”²

How Self-Directed IRAs Work

As with all IRAs, a retirement saver can make annual contributions to a self-directed IRA. For 2024, the maximum contribution is $7,000. Those 50 and older may also take advantage of up to $1,000 in yearly catch-up contributions, assuming they didn’t max out their contributions in previous years.³

In many cases, an account is transferred or rolled over from a regular IRA or 401(k) account to fund a SDIRA. Once the account is funded, a SDIRA holder may invest in any of the product lines administered by their custodian, so long as they stay within the rules prescribed by the IRS for this specific kind of retirement account.

Why Use a Self-Directed IRA?

Investors may gravitate toward self-directed IRAs for the freedom to invest outside of traditional asset types. Whether it’s private debt, real estate, or private company shares, many investors believe in the potential for alternative assets to outperform traditional investments. Alternative assets may also provide returns that are not correlated with traditional assets, which has the potential to provide greater diversification for an individual’s portfolio.

Self-Directed IRAs Have the Same Tax Benefits as Regular IRAs

SDIRAs don’t just allow investors to hold a broad array of investments — they also come with important tax benefits. Depending on the type of self-directed IRA (traditional or Roth), an individual may enjoy tax advantages such as tax-deductible contributions, tax-deferred withdrawals, or qualified tax-free withdrawals.

Comparing Self-Directed IRAs with Other IRAs

Self-directed IRAs operate in a similar manner to other IRAs. Like with all IRAs, you’ll generally need to wait until you reach age 59½ to access the funds without a penalty. The key difference is simply the kinds of assets they’re allowed to hold. SDIRAs may hold assets that are not allowed in traditional IRAs.

SDIRAs can be opened for a range of IRA types, though the most common tend to be traditional and Roth IRAs. Here are the differences between these account types:

• With a traditional IRA, an investor can make annual tax-deductible contributions, subject to certain limitations. The investments in the account can grow tax-deferred, and the individual pays tax at their marginal rate upon withdrawal. With a Roth IRA, contributions are made with after-tax dollars. However, the account can grow tax-deferred, and qualified withdrawals are tax-free, following a required holding period.

A Note on Income Limits

There are no income limits for traditional self-directed IRAs. But investors who earn more than a specified amount may not contribute to a Roth self-directed IRA.⁴

Types of Investments Allowed in Self-Directed IRAs

A SDIRA may hold traditional investments — stocks, bonds, and mutual funds, for example. But it also may hold alternative assets, such as:

• Private debt and direct lending
• Investment real estate
• Private company shares
• Partnerships
• Limited Liability Companies (LLCs)
• Tax liens
• Certain precious metals, such as gold and silver

Prohibited Investments in Self-Directed IRAs

The range of permitted SDIRA investments is broad, but not unlimited. The IRS especially wants to ensure that SDIRA account holders avoid “self-dealing,” meaning that you need to maintain an arm's length from your IRA investments. Investors should consult with a tax advisor to understand prohibited investments before opening an SDIRA.

Pros and Cons of Self-Directed IRAs

It’s important to be aware of both the pros and cons of SDIRAs. On the positive side, self-directed IRAs give account holders the opportunity to invest in a broader range of assets — especially those not permitted to be held in brokerage IRAs. This combination of freedom and discretion offers the potential for higher returns and greater portfolio diversification, though likely with more risk. What’s more, savers can still benefit from the favorable tax treatment enjoyed by both traditional and Roth IRA account holders.

Potential drawbacks include less liquidity, meaning you may not be able to sell the asset or sell it as easily as traditional assets. For one thing, many SDIRA-allowed alternative assets are illiquid, meaning they can’t easily be sold.⁵ Second, in some cases, self-directed IRA fees may be higher than a regular IRA given the complexity associated with administering the account. Third, while you can designate a personal advisor, a SDIRA custodian cannot provide an investor with advice or guidance. Finally, investors could unknowingly violate one of the rules regarding self-directed IRAs — leading to adverse tax consequences in the process.⁶

For investors looking to go the DIY route, a self-directed IRA may be worth considering. SDIRAs offer individuals saving for retirement significant flexibility when it comes to how their money is invested. Alternative assets, which continue to gain popularity⁷, may be held in SDIRAs, making them attractive for investors not satisfied with traditional investments.

Forge Trust Co., a subsidiary of Forge Global, Inc., is an IRA custodian that offers self-directed IRA services for investors.

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.