What is a self-directed IRA?

December 6, 20229 min read
What is a self-directed IRA?
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If you’ve ever heard the term and wondered, “what is a Self-Directed IRA,” you’re not alone. But if you’re looking for an individualized investment opportunity, a Self-Directed IRA (SDIRA) could be a viable option. That said, there are guidelines and regulations surrounding Self-Directed IRAs that you need to be aware of. As always, to get the most out of this type of investment, it’s an important thing to do your due diligence. Let’s take a look at what a Self-Directed IRA is, how it works, and what you need to know about this particular retirement account.

What is a Self-Directed IRA?

A Self-Directed IRA is an individual retirement account that allows you to invest in more diverse and less common assets. A Self-Directed IRA can be either a Traditional IRA or a Roth IRA with access to ETFs and differs from a simple IRA plan.

While regular IRAs and simple IRAs offer options to invest retirement savings in the stock market, bonds, and mutual funds, for example, a savvy Self-Directed IRA holder can invest in an array of areas that would be otherwise unavailable. 

In addition, Self-Directed IRA assets and IRA funds must be held by an IRA custodian or trustee. And since custodians aren’t allowed to give investment advice, as the account holder, you’ll need to personally manage these assets.

What are the potential benefits of a Self-Directed IRA?

Diversifying your portfolio: On top of the built-in tax benefits and tax advantages of holding an IRA, a Self-Directed IRA has additional perks including the opportunity for portfolio diversification. Diversifying your portfolio is often tied to unsystematic risk reduction. By supplementing your traditional investments with a dynamic range of investment options spanning various industries, you counterbalance your portfolio in case one industry is negatively affected by market volatility. This strategy can help protect your traditional or non-traditional investments in an economic downturn.

Increasing your investments’ potential: The potential benefits of investing in a variety of industries are twofold. Along with protecting your assets during market fluctuations, you can also increase your growth opportunities. Rather than relying on the growth of just one industry, you can reap the potential benefits of multiple industries making capital gains simultaneously.

Leveraging your expertise: If you’re already involved in insurance products or the real estate industry, for instance, you can leverage your knowledge and experience to make investments in the insurance or real estate space. As we mentioned, the brunt of the due diligence is on you as the IRA account holder, so having that insurance or real estate knowledge in your back pocket prior to investing can serve as an advantage.


How does a Self-Directed IRA work?

In many ways, Self-Directed IRAs work much like other types of IRAs—they provide investors long-term tax-efficient investment accounts for retirement. Given the increased responsibility of the account holder, however, these IRAs are ideally held by seasoned investors and those who are already familiar with alternative investments and non-traditional investments. 

It’s worth noting that rules and regulations surrounding Self-Directed IRAs are unique to this type of retirement account, so it is important that even experienced active investors thoroughly familiarize themselves with these different rules before opening and investing with a Self-Directed IRA. Below are a few things to take into account when deciding whether a Self-Directed IRA is right for you.

Self-Directed IRAs have contribution limits just like other IRAs. Just like Traditional and Roth IRAs, if you’re under 50, the maximum annual contribution limit you can make to your Self-Directed IRA is $6,000. This increases to $7,000 if you are over 50 years old.  

There are some prohibited transactions when investing with your SDIRA. According to Internal Revenue Service (IRS) regulations, prohibited transactions are certain transactions that occur between a retirement plan and a disqualified person and investing in assets not eligible in retirement plans.

What is a disqualified person? Great question. A disqualified person includes your fiduciary (someone who acts on your behalf to manage your assets), lineal descendants, and their spouses. These prohibited transactions are specific to Self-Directed IRAs. Below are just a few examples of prohibited transactions:

  • Purchasing property for personal use
  • Paying too much for the management of your IRA plan 
  • Investing in the business of a friend or family

With a Self-Directed IRA, you need to think about your exit plan. If you’re using your Self-Directed IRA to invest in alternative investments, non-traditional investments, and alternative assets—for example real estate assets—it can be more illiquid than, say, investing in stocks or bonds. This is important to take into account, especially if you have a Traditional Self-Directed IRA and are reaching the age when distributions become mandatory (currently, when you reach 70½ years old). It’s also important to keep note of any applicable early withdrawal penalty that could impact your gross income from this investment decision.

What is the difference between a Self-Directed IRA and a Roth or Traditional IRA?

The key differences between a Self-Directed IRA investor and a Roth or Traditional IRA investor are the areas for qualified plans and who manages these investment products.

Roth and Traditional IRAs are typically used to invest in mutual funds, bonds, and CDs—the usual suspects. Unlike Traditional IRAs and Roth IRAs, Self-Directed IRAs allow you to invest your own money in alternative assets such as real estate, art, marine, among others.

Investing in these non-traditional assets gives the account holder flexibility, but at the same time requires increased due diligence. As the name suggests, these accounts are self-directed, therefore you manage them yourself. This requires more time and initiative on your end, as you do not necessarily have a third party advising you.


Are there different types of Self-Directed IRAs?

As we just mentioned, there are different kinds of IRAs, the two most common being Roth and Traditional. A Self-Directed IRA can be either a Traditional IRA or a Roth IRA (see what’s the difference between the two in detail). Before jumping in and opening an IRA, it’s important to do your research and to determine the best IRA type for your goals and investment experience. 

The primary differences between these two IRA types lie in the way they’re taxed, income limits, early withdrawal rules, and their required minimum distributions. Below is a brief introduction to each and their minimum distributions. 

Roth IRAs: Your IRA contribution limits are not tax-deductible, so you are taxed when you contribute to your IRA rather than when you withdraw from it. There are also gross income restrictions on Roth IRAs, so you must make less than a certain amount or be in a lower tax bracket to make a Roth IRA contribution. Additionally, you have the freedom to withdraw from your IRA at any time.

Traditional IRAs: Per these IRA rules, your IRA contributions are tax-deductible; therefore, you are taxed on your withdrawals. You’ll experience tax-free growth on an eligible retirement plan or qualified retirement plan from your IRA providers. Unlike Roth IRAs, traditional IRA contributions do not have any earned income limitations or maximum amount, but they do insist that you start withdrawing from your accounts at age 70 ½.

How do you open a Self-Directed IRA?

When it comes to opening a Self-Directed IRA, there are steps to follow to help ensure you get the most out of your investments. Following these steps will help you start on the right track.

  1. Step 1 – Understand the SDIRA process: Before making any concrete decisions, you’ll first want to familiarize yourself with the SDIRA process. You can then build a plan of action—determining possible industries you would like to invest in, shopping around for reputable SDIRA service providers and custodians, choosing which type of account you want to open, and deciding on an exit plan should you need to sell quickly.
  2. Step 2 – Decide where you want to invest: This is the exciting part, but it also requires significant research. Be sure to do your homework when exploring various industries and their investment opportunities to ensure you’re well-versed in the type of asset you plan to invest in. You may also want to hire, or at least speak with, a financial advisor at this time as they can help you make the most appropriate decisions for your retirement and overall financial goals and financial situation.
  3. Step 3 – Select a custodian: A Self-Directed IRA custodian is a financial institution that holds an individual’s investments. Banks, brokerages, credit unions, insurance companies, and non-bank trust companies can all serve as custodians. As we mentioned earlier, they are also required by the IRS, meaning you must open the SDIRA at one of these custodian entities before investing in any assets. 

    When looking for a custodian, feel free to shop around to find one that fits your price bracket and to ensure they specialize in the industries or account types you’re looking to invest in. Additionally, protect yourself from fraud by checking potential custodians’ licensing and registration.

Are there cons to a Self-Directed IRA?

They’re complex. While a wide range of investment options is exciting and can help protect your retirement assets from market swings, depending on your knowledge and your custodian, they can be complicated – unlike a workplace retirement plan, simplified employee pension (SEP) or savings incentive match plan. Since you’re managing your investments yourself in this case, the stakes can be higher for new individual investors. For educational purposes, do added research.

They hold potential penalties. Being aware of the rules and regulations surrounding Self-Directed IRAs is important to avoid getting hit with transaction fees or other fees and penalties. As mentioned above, there are prohibited transactions to avoid, such as the “no self-dealing” rule, which prevents you from borrowing money from your IRA or using it as security for a loan. Breaking these rules can come with heavy tax penalties for retirement savers, so it’s important to familiarize yourself with prohibited transactions.

Fraudulent investment issuers. Finding the right custodian for your Self-Directed IRA is important. In 2018, the SEC alerted investors to fraudulent custodians who had given poor or self-serving investment advice or tax advice and even spent client retirement money. The SEC warned the public of the risk of fraud hiding behind custodians, making it appear as if the investment was either produced by the custodian or approved by the custodian. Custodians don’t look into the quality of prospective investments and IRA distributions, only into making sure it is properly held in the IRA. To avoid getting duped, steer clear of any custodian that is eager to give you investment advice or legal advice (this is prohibited by the SEC).


As you shop around for a Self-Directed IRA custodian, be as rigorous as you would with vetting the asset classes and actual investments you invest in. Be sure to check their licensing and registration, verify prices, asset values, and other account information before hiring your custodian.

Are there fees associated with a Self-Directed IRA?

While the fee structure does vary depending on the investment offering and the custodian you choose, there are consistencies between the types of fees that you can potentially accrue.

Custodian fees are fairly common as they generally serve as fees for the various services they provide. From collecting on your rental properties to account owner holding fees, you can end up paying anywhere from $500 into the thousands of dollars per calendar year on custodian fees alone. As a general rule, custodians charge the following fees at various rates, depending on factors including the portfolio value and their specialty so you’ll need enough cash to pay the full amount of each:

  •     Establishment fee
  •     Annual maintenance fee each tax year
  •     Paying bills via cashier’s check
  •     Paying bills via wire transfer
  •     IRA rollover to another custodian
  •     Termination fees

Now that you know what a Self-Directed IRA is, and are aware of some of the benefits and drawbacks of opening one, you can decide whether this is a good option as a retirement account for you.

Interested in opening a Self-Directed IRA? We can help. The Yieldstreet platform allows accredited retirement investors to help diversify their retirement portfolio by investing retirement funds in alternative asset investing with their SDIRA.