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What You Should Know About Self-Directed IRAs

It’s never too early to start thinking about your retirement plans. In fact, it’s wise to create a retirement plan in the early stages of your life as the sooner you start saving, the better. A good retirement plan can help you achieve peace of mind in your golden years and give you the financial means to enjoy the years after you stop working. If you have just started to look into retirement plans, you may be feeling overwhelmed about all of the different options and things to consider. One increasingly popular option is a self-directed individual retirement account (IRA), which has many benefits over other plans.

To help everyone who is looking to make arrangements for their future, here is what you should know about self-directed individual IRAs. 

1. What is a Self-Directed IRA?

A self-directed IRA is a variation on a traditional retirement plan in which you can hold more variable investment options than those available through a regular individual retirement account. The experts at TheEntrustGroup.com explain that while regular IRAs limit their holders to relatively common securities such as stocks, bonds, or mutual funds, self-directed ones open their owners to a much broader array of assets. Opening a self-directed IRA allows you to invest in real estate, privately held companies, precious metals, commodities, tax lien certificates, and other types of investments. 

It is important to note that self-directed IRAs are only available through specialized companies that are authorized to offer SDIRA custody, so if you are thinking about going with this retirement plan, find yourself a custodian to agree to the deal.

2. What is the Difference between Traditional and Roth Self-Directed IRAs?

You can set your IRAs as either traditional IRAs or Roths. Still, it’s important to know the differences in terms of tax treatment, eligibility requirements, contribution guidelines, as well as the distribution rules of these two options. While with traditional IRAs, you get an upfront tax break and pay taxes as you withdraw them, you are tax-free for most of these contributions and earnings when you have a Roth IRA. However, you have to make less than certain income limits to open a Roth. 

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You can only start taking required minimum distributions at age 72 as a traditional IRA holder, while you can do the same thing at any age during your lifetime as a Roth account owner. A Roth also allows you to withdraw anytime, with no penalty, while penalties may be applied for early withdrawals from your traditional IRA. 

3. How can you Open a Self-Directed IRA?

Even though brokerage firms offer custodian service for many types of IRAs, most of them don’t offer self-directed options. To open this specific type of account, you will need to contact a broker who specializes in them, including some banks and trust companies. The type of investments that these providers will agree to handle will vary from broker to broker, so shop around before signing up for a plan. Given the complexity of this procedure, a lot of self-directed IRA holders seek the help of a financial advisor to ensure that they are making the right decision. It’s important to keep in mind that some investments, such as collectibles and life insurance, are still forbidden in self-directed IRAs, so make sure you are well versed with the regulations. 

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4. What are the Pros and Cons of Self-Directed IRAs?

Self-directed IRAs are highly attractive because they allow the holder to seek higher returns and greater diversification of investments. With some knowledge of investments in certain sectors, you will be able to take advantage of higher yields and less volatility. A lot of creative and knowledgeable investors have found ways to make sizable returns with their IRA account, but this is not a game for the unsophisticated. 

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Self-directed IRAs can, however, also come with substantial risks. One of the biggest cons is prohibited transactions, such as the “no self-dealing” rule, which may end up causing you to owe penalties and interest. It is also up to you to make the investment decisions and map out future revenue and expenditures to determine if each investment makes financial sense. Even though you can invest in a wider array of assets with a self-directed IRA, they are often illiquid, which means that you may find it difficult to get money out in case of an emergency. This specific type of retirement plan also has a complicated fee structure, so it’s important that you do your homework before making any decision.

Choosing a retirement plan is one of the most important financial decisions you will have to make in your life. A wise decision can reward you with happy golden years, while a bad one may cause you many troubles in later life. While many people succeed with a self-directed IRA, it requires you to do your homework as your provider will not give any financial or investment advice. The burden of research rests solely with you, but so do the rewards.

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