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What's a Self-Directed IRA and Do I Need One?
This was a recent question from a long-time friend and reader...
A friend and reader recently emailed me,
“I have been wanting to set up a call to discuss with you what you may know about Self-Directed IRAs. Do you facilitate them in your capacity? Or understand how they work? Would love to learn more and get your perspective on the pros/cons...”
We discussed this on a call a couple of weeks ago. It was good to catch up with you, Kelley!
Perhaps you’ve also wondered what a Self-Directed IRA is and whether it’s something you need?
The short answer is no, you don’t need one.
Let me explain.
To begin with, what is an IRA?
It’s an “Individual Retirement Account” though if we want to get technical about it, we’d call it an Individual Retirement Arrangement like the IRS does here.
The IRS makes the rules, after all…
I’ve been asked by many people over the years some version of “what’s your current rate on an IRA?”
Because some peoples’ only exposure to an IRA is through a traditional bank where they setup an IRA and your only option is to purchase a Certificate of Deposit (CD).
Many banks & credit unions continue to offer this IRA structure.
But an IRA is merely an account. Or “arrangement” 😉
Within your IRA account you can - depending on the financial institution where you set it up - invest in a money market, a CD, stocks, bonds, mutual funds, and ETFs.
Basically any publicly available investment.
My clients’ IRA accounts at Schwab are setup this way.
Whether it’s a traditional IRA, a rollover IRA, or a Roth IRA, we have a lot of flexibility in the types of investments that can be utilized.
But what if you want to put your IRA money in a non-public investment?
Investments like precious metals, crypto currency, a piece of real estate, a private company, or another non-public investment?
Well, this is where Self-Directed IRAs are an option.
Remember above when I said you don’t need a Self-Directed IRA?
Most people aren’t very good at capturing the returns offered by more traditional investments, so less traditional, private investments literally aren’t necessary to support your financial plan and your life.
And Wall Street is supremely capable of creating new, interesting, and generally worthless investment products they can pitch to you as part of your regular, non Self-Directed IRA portfolio holdings.
Even though some of the investment choices available to you in a traditional IRA structure are garbage, you have no shortage of options.
So again, you don’t need a Self-Directed IRA.
But you might want one, despite my advice.
I have a couple of clients that have set up a Self-Directed IRA.
One invested some funds into a startup company founded by a family friend. One with a track record of success.
Another wanted to invest some of their IRA funds into a piece of real estate.
I didn’t set these accounts up for them.
Schwab doesn’t offer these. Neither does Fidelity or most of the financial brands you’re familiar with.
But just search on Google for “Self-Directed IRA” and you’ll find about 12 million results.
But before you run out to open a SDIRA to invest some of your retirement funds, there are a few things to consider:
You’re on your own. They’re called “self-directed” for a reason. While we can still include them in your financial plan, this will be an investment that you’ll have to monitor and manage. You already know how I feel about them.
Be sure you understand all the fees. Based on my limited experience it’s common for a Self-Directed IRA to have a setup fee, an annual fee, and a lot of other, often complicated, fees which can add up. Here’s an example. And these fees are in addition to any fees associated with the investment you want to make within the SDIRA.
These accounts are often associated with fraud. See this warning article on the SEC’s website.
These types of investments are often illiquid. That can be a problem in general, but even more so within the confines of an IRA account. And this is still an IRA account, which means it’s subject to Required Minimum Distributions.
For real estate held in a Self-Directed IRA, you’ll lose some of the benefits of personally owned real estate. For example, if it’s in an IRA you likely won’t be able to deduct real estate taxes paid. Be sure to consult your tax advisor on these details.
Despite all these possible down sides, perhaps there are situations where you’re convinced that a Self-Directed IRA makes sense for you.
As I mentioned, I have a couple of clients that have set these up. And I know other folks that have utilized them.
Doing some research for this email, I found one estimate that there is over $300 Billion in Self-Directed IRA account.
And while that pales in comparison to the estimated $10 Trillion total IRA market, it’s still a lot of money.
But I’m sticking with what I said earlier.
Do you need a Self-Directed IRA?
No, you don’t.
But you might decide you want one nevertheless.
If you do, just be careful and make sure you understand all the details.
What do YOU think about Self-Directed IRAs?
Hit reply and let me know…
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Links & Things
From Farnam Street, a reminder on why the “news” isn’t good for you. And I know some of you reading this are consuming waaaaay too much news…
Why You Should Stop Reading News (this applies to watching too)
A worthwhile thought exercise:
Imagine you are at the end of your life and you are granted the ability to repeat one day. Which period of your life do you choose to repeat? Which phase of life would you want to go back to? Does that tell you anything about how you should be spending your time today?
I’m glad you’re here. And I’m grateful to have you as a reader.
If you have any questions or an idea for a future email letter, blog post, or YouTube video, I'd love your input.
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Until next Wednesday,