Are Self Directed IRAs a Good Idea?
Self-directed IRAs give you the flexibility to invest in assets that reflect your passions, knowledge and experiences while diversifying your retirement portfolio.
Alternative investments do come with some risks. For instance, many such as real estate and precious metals don’t trade like regular stocks so quickly can’t be sold quickly when needed.
1. They offer more investment options and flexibility
Self-directed IRAs enable investors to invest in alternative assets such as real estate, precious metals and private equity that fall outside the realm of traditional retirement accounts. Such investments often offer higher returns than conventional stocks or mutual funds.
However, these investments must adhere to stringent IRS regulations. You cannot invest in property you plan to live in or buy for personal use and you should choose a custodian who knows all about the asset class in which you plan to invest.
Self-directed IRAs also allow you to gain from nontraditional investments without needing to include them on your tax return every year. This diversification helps protect retirement savings against sudden market dips that occur when specific asset classes experience large declines.
2. They allow you to invest based on your knowledge and experience
Self-directed IRAs offer many advantages for investing in assets that suit your expertise and passions, such as real estate that one of my clients understands due to his expertise as an appraiser. He was then able to use this property to generate substantial income.
Self-directed IRAs allow investors to take advantage of more flexible investments, including alternative ones like real estate and gold that may not be permitted under traditional brokerage-based IRA accounts. However, it’s still crucial that prices and asset values listed on account statements are accurate – this can be accomplished either through professional valuation from an independent third-party expert, or researching tax assessment records.
Self-directed IRAs require careful adherence to IRS rules regarding prohibited transactions, which become increasingly complex when dealing with alternative asset classes. If you violate these rules, serious IRS penalties could ensue; it’s therefore advisable to consult with a licensed investment professional prior to opening one yourself.
3. They come with higher fees and complicated recordkeeping
Self-directed IRAs present additional costs and complexity, as they often deal with high-risk investments such as real estate. Many clients have used their IRA funds to buy and sell properties; this requires active involvement to avoid breaking IRS regulations regarding prohibited transactions which could jeopardise tax benefits you might gain.
Investors must ensure they carefully vet investment opportunities and make well-informed decisions, while understanding all of the complexities surrounding recordkeeping and maintaining compliance.
When purchasing property, for instance, you will most likely need to hire someone who will collect rental payments and deposit them directly into your IRA account. Furthermore, extensive research must be performed into local markets in order to make sure you aren’t overpaying.
Additionally, your retirement funds should not be used to purchase collectibles or sentimental items (like that first-edition comic book you’ve always coveted) without conducting due diligence on disqualified individuals and prohibited transactions.
4. They often deal with high-risk investments
Investing for retirement typically entails purchasing stocks, bonds, mutual funds and other traditional market assets; but if you wish to invest in riskier assets such as precious metals or real estate you must open a self-directed IRA first.
Investment accounts allow you to select alternative investments, like commercial real estate or promissory notes, that would otherwise not be available through traditional brokerage firms. But these investments may be more volatile and risk losing value over time.
Additionally, you will have to handle much paperwork, transactions and communication, which requires considerable dedication. Finally, there may be the risk of encountering a prohibited transaction or breaking IRS regulations that requires extra caution and oversight.
If you are considering opening a self-directed IRA, be sure to meet with an independent advisor to determine if it meets your investment goals and risk tolerance. Every investment carries some level of risk.