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Self-Directed IRA – Rules, Investment Options & How It Works

What is a Self-Directed IRA?

A Self-Directed Individual Retirement Account (SDIRA) is an individual retirement account (IRA) that gives you more control over your retirement savings. Although a trustee or a custodian administers SDIRA, it is directly managed by the account holder, hence the name “self-directed.” Self-directed IRAs allow you to make various investments that are usually unavailable from regular IRAs. A Self Directed IRA can be either Traditional or Roth.

A traditional IRA contribution is before tax, meaning the contribution amount is tax deductible therefor lowering your taxable income. On the other hand, a Roth contribution is after-tax – meaning you do not get a tax deduction. Later in life, when it comes time to take a distribution from the IRA, the Traditional distribution will be taxed, but the Roth distribution will be tax-free! If you are a savvy investor looking to diversify in a tax-advantaged account, Self-Directed IRAs are well suited to your investment needs.

Understanding a Self-Directed IRA (SDIRA)

A self-directed IRA differs from other types of IRAs in terms of the investments that can be made. Regular IRAs are limited to investing only in bonds, stocks, mutual funds, and other common investments. But with an SDIRA, you get more options to explore, like real estate, precious metals, limited partnerships, commodities, or privately-owned companies in the investment market.

One of the major benefits an SDIRA investor has is that they may achieve higher returns and portfolio diversification while also mitigating the risks.

How does a Self-Directed IRA work?

The SDIRA follows the same setup as a standard IRA in many ways. In 2023, individuals under age 50 can contribute up to $6,500 to their retirement accounts, with an additional $1,000 catch-up contribution available for those over 50. In 2024, the contribution limit rises to $7,000, while the catch-up contribution remains unchanged. You can open a self-directed IRA with pre-tax and post-tax contribution rules. Here is how an SDIRA works:

  • Open a Self-Directed IRA Account

    You’ll need to appoint a qualified IRA custodian specializing in such accounts.

  • Fund the Account

    Transfers and new contributions are the main funding vehicles for self-directed IRAs. Transfers can come from the following: Any qualified retirement account can be rolled over or transferred to a Traditional IRA. Only Roth funds can roll over to a Roth IRA. For example, IRAs, SEPs, KEOGHS, MONEY PURCHASE PLANS, 401(k) s, 401 a’s, etc., can be rolled over.

  • Identify Where to Invest

    You can invest in stocks, mutual funds, and CDs or expand your investment portfolio by investing in precious metals, real estate, etc. After deciding where to invest, you will write a check from the LLC, and “that’s it.”

  • Request Funds to Purchase IRA Investment

    There are two main ways to employ a Self-Directed IRA. People who don’t know about using an underlying LLC send instructions to the custodian to send a check or wire and purchase the investments in the name of the IRA. This is what custodians prefer because it allows them to charge for activity fees, etc., continuously. The second and most preferred way is to use an underlying LLC. At Self Directed Retirement Plans LLC, we establish state-approved LLCs for each client. The LLCs are “owned” by the Self-Directed IRA and become the investment arm of the IRA. Our clients open a checking account for the LLC at a bank of their choice. We assist them in transferring the funds from the IRA (custodian) to the new self-directed IRA LLC checking account. Now they have a truly Self-Directed IRA with checkbook control. When an investment opportunity arises, they write a check and immediately take advantage. There isn’t any waiting for permission etc. The custodian really doesn’t know what you do with the llc on a daily basis so they send a letter at year end asking “what do you believe the value of the llc is – you answer them and they send an IRS form 5498 to the government.

What are the Types of Self-Directed IRAs?

There are two main types of a self-directed IRA:

  • Traditional Self-Directed IRA

    A traditional self-directed IRA is a tax-deferred retirement account where you can make various investments. Since it is a tax-charged retirement savings account, you will receive income tax deductions when you make an IRA contribution.

  • Roth Self-Directed IRA

    A Roth self-directed IRA retirement savings account allows you to grow money tax deferred and eventually tax-free. You fund your Roth self-directed IRA with pre-tax dollars, meaning the tax is already deducted during the contribution. Moreover, you also receive income tax deferrals during the contribution perios , which will help your investment to grow in value.

Traditional vs. Roth Self-Directed IRA

Although Self-Directed IRAs can be set up as a traditional IRA or a Roth, they have different eligibility requirements, tax treatments, contribution guidelines, and distribution rules.

A key difference between a traditional and Roth IRA is the tax treatment of each of these accounts. With a traditional IRA, you are not taxed on your contributions, but taxes are applicable when you withdraw your contributions during retirement. On the other hand, with a Roth IRA, you pay taxes when you make your contributions, your contributions and earnings grow tax-free, and your withdrawals/distributions during retirement are also tax-free.

Here’s a quick rundown of other differences

Traditional IRA Roth IRA

Income limits

There are no income limits There are income limits that needs to be met according to the IRS rules

Required minimum distributions (RMDs)

Must start taking RMDs at age 72 No RMDs during your lifetime

Early withdrawals

You can withdraw penalty-free starting at age 59½. All withdrawals are taxable. Withdrawals are tax and penalty-free after age 59½ if you have had the account for a minimum of five years.

How to Set Up a Self-Directed IRA?

At Self Directed Retirement Plans LLC, we assist and guide clients through every phase of establishing a truly self-directed IRA. Educating the client is a large part of our service. In many cases, this is a new and sometimes scary world the client is entering, and we do our best to inform the client and make them comfortable with their decision.

Below is a brief description of the steps we take to establish a self-directed IRA.

  1. Establish the new self-directed IRA account.
  2. Assist the client in transferring their funds.
  3. Create a new state LLC that becomes the investment arm for the SD IRA.
  4. Using an SS4 IRS form, we obtain a new EIN for the LLC.
  5. We create a proprietary operating agreement for the LLC.
  6. We coordinate with the custodian all the required documents, such as transfer requests, Direction of Investment Letters (used to fund the LLC), LLC operating agreement, banking instructions, etc.
  7. One of the most important things we do is make ourselves available to answer all the client’s questions along the way, especially down the road. Nothing beats years and years of experience.

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Benefits of Self-Directed IRA

  • 01

    Diversified portfolio for potential growth

    A Self-Directed IRA allows you to diversify your financial portfolio into lucrative assets like property, mortgage notes, foreign currency, annuities, raw land, limited liability companies, and many other investments. If you have the required knowledge and expertise to succeed with a particular investment type, you can leverage the asset to help secure your financial future.

  • 02

    Build Wealth for Future Generations

    A self-directed IRA brings you the freedom to diversify your financial portfolio into lucrative assets like property, mortgage notes, foreign currency, annuities, raw land, limited liability companies, and many other investments. If you have the required knowledge and expertise to succeed with a particular investment type, you can leverage the asset to help secure your financial future.

  • 03

    Excellent Tax Advantages

    Being a tax-advantaged account, a Traditional Self-Directed IRA brings you the benefit of significant tax deductions, which help you create lasting wealth. With a Roth IRA, you can combine tax-free profits with investing diversity for long-term financial freedom.

  • 04

    Complete Control

    You have full control over your retirement funds as long as you make investments that meet your retirement plan’s requirements.

Checkbook Control

The Checkbook control allows the IRA holder to make investment decisions, write a check, and take charge. Checkbook control eliminates the need for a Third Party Administrator or TPA. Most custodians adhere to the TPA model because it is very profitable. Imagine having to “ask” the custodian’s permission to invest your own money. Not only is it expensive, but very time-consuming. Compare that with the ability to immediately make a decision, write a check, and add assets to the self-directed IRA!

Checkbook Control self directed IRA

Risk of Self-Directed IRA

No doubt, there are several benefits of opening a self-directed IRA. But there are also several risks of a self-directed IRA plan, such as:

  • Prohibited Transactions

    When you open a retirement savings account in an SDIRA, you are presented with the “no self-dealing” rule, which means that you cannot borrow money from your IRA, sell the property to it, and make other interactions.

  • Due Diligence

    Another risk of investing in a self-directed IRA is that custodians and administrators are not allowed to give you financial advice. So, you must do major research and choose the best financial advisor for additional help.

  • Fees

    SDIRA follows a complicated fee structure where typical charges include a one-time establishment fee, an annual renewal fee, a first-year annual fee, and fees for investment bill paying. However by using the underlying llc, you eliminate many of the custodian’s ongoing fees.

  • Exit Plan

    The exit plan for SDIRA is can be complicated or not. Certain investments are not liquid and therefore require some aforethought. However if you invested wisely, the investments you want to liquidate should not be a big problem. Real estate is an example of thinking ahead before selling off.

  • Fraud

    The SDIRA custodians do not necessarily evaluate the legitimacy of the investments in the self-directed IRA.

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Self-Directed IRA (SDIRA) Investment Options

The investment options with a self-directed IRA are virtually limitless, provided that the guidelines laid down by the IRS are followed. Some of the permissible alternative investments are but not limited to:

  1. Real Estate – Residential and Commercial

  2. Raw Land

  3. Precious Metals

  4. Trust Deeds/Mortgage and Mortgage Pools

  5. Private Notes and Loans – e.g., Loans to a non-disqualified person for a car, etc.

  6. Private Stock Offerings – also referred to as PPMs

  7. Limited Liability Companies – LLCs

  8. Limited Partnerships – LPs

  9. Tax Certificates – Tax Liens

  10. Annuities

  11. Options

  12. Currency

  13. Futures

  14. Commercial Paper

  15. Cryptocurrency

  16. Startups

  17. And MANY other investments

Self-Directed IRA (SDIRA) Rules

Although the guidelines for self-directed IRAs are almost similar to other retirement accounts, it’s important to get familiarized with Self-Directed IRA rules and regulations. These include prohibited transactions, distribution rules, IRA contribution limits, and more.

  1. IRA Contribution Limits
    • In 2023, individuals under 50 can contribute a maximum of $6,500 to their retirement accounts, with an added $1,000 catch-up option for those over 50. However, in 2024, the contribution limit increases to $7,000, while the catch-up contribution remains steady at $1,000. This means that starting in 2024, individuals can save an extra $500 towards retirement, with no change to the catch-up contribution allowance.
  2. Disqualified persons
    • The IRA holder and his or her spouse, ancestors, lineal descendants, and their spouses.
    • Investment advisors and managers.
    • Any corporation, partnership, trust or estate in which the IRA holder has a 50% or greater interest.
    • Anyone providing services to the IRA, such as a trustee or custodian.
  3. Prohibited Transactions
    • Collectibles – artwork, rugs, antiques, metals, gems, stamps, collectible coins
    • Beverages – think 1956 single malt scotch at $6,000 per bottle!
    • Stock in an S-Corporation
  4. IRA Distribution Rules
    • IRA distributions, or the withdrawal of an asset or cash, can be made at any time. However, certain criteria will determine whether there are penalties and taxes associated with any distribution.

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