Tax-advantaged retirement accounts like 401(k)s, traditional IRAs, or Roth IRAs are designed to help the average worker save for retirement in a world where pensions have largely become a thing of the past. But you can’t invest in just anything in these accounts; while investing in the stock market or in bonds isn’t guaranteed to grow your wealth, stocks and bonds are heavily regulated, provide investors with financial information, and are reasonably trustworthy.
But what if you want to invest in something else while still getting those tax advantages? Crypto, for example, or gold? You’d need to explore a self-directed retirement account.
What’s a Self-directed Retirement Account?
A self-directed retirement account allows account holders to invest in a variety of alternative investments in addition to the more traditional holdings allowed in most traditional IRAs and other retirement plans.
Self-directed IRAs (traditional or Roth) are the most common form of self-directed retirement plan, but there are self-directed custodians that offer other self-directed retirement accounts such as solo 401(k)s, SEP-IRAs and SIMPLE IRAs. Typically, an investor interested in holding alternatives in a retirement account will open an account at a custodian that specializes in self-directed retirement accounts in addition to the more standard versions of retirement accounts they may already hold.
The same contribution rules apply to self-directed retirement accounts as apply to traditional retirement accounts. Any annual contributions to a self-directed retirement cannot exceed the total annual contribution limits for the type of account, including contributions to conventional IRAs or other retirement accounts.
What Can I Invest in With a Self-directed Retirement Account?
There are a number of alternative investments investors can hold in a self-directed IRA or other self-directed retirement account.
- Precious metals including gold (subject to certain restrictions in an IRA), silver, platinum or palladium bullion or coins
- Real estate including commercial properties, raw land, apartment buildings and condominiums
- Farmland
- Cryptocurrencies of various types
- Commodities including agricultural commodities and energy related commodities; commodity futures can also be an option
- Hedge funds
- Private equity investments
- Crowdfunding
- Structured settlements
Advantages of Self-directed Retirement Accounts
Investing in alternatives inside of a self-directed IRA or other retirement account can provide benefits beyond those found in traditional retirement accounts.
Added diversification
The ability to invest directly in a wide range of alternative assets inside a self-directed retirement account can offer an added level of diversification to your tax-advantaged retirement investments.
Alternative investments are often subject to different influences and pressures than traditional stocks and bonds, giving investors the opportunity to help balance the risk and rewards of traditional investments and aid towards minimizing volatility.
Potential higher returns
Alternative investments may have the potential for higher returns than more traditional investments, although they may also have greater risk potential. Focusing a portion of a retirement portfolio on alternative investments may help investors outpace inflation and build savings for the long term.
Tax Advantages
The whole point of saving and investing in tax-advantaged retirement accounts is, well, the tax advantages. Some alternative investments may be subject to a significant tax bill if they’re held in an ordinary brokerage account. Putting them into a tax-advantaged account will help investors manage and anticipate those taxes.
Cons of a Self-directed Retirement Account
While they offer a number of advantages for retirement savings, self-directed retirement accounts do have their cons, or at least areas to be aware of.
Increased investment risk
While the account itself doesn’t carry increased investment risk, alternative investments very well might. Holding them in a self-directed retirement account doesn’t ameliorate those risks.
All investments involve risk and may lose money (including principal). Be sure that you understand the potential risks of any investment you’re considering. Do your due diligence and/or consult a financial advisor; the custodian of the self-directed retirement account is prohibited from providing any sort of advice or financial guidance.
Higher fees
In some cases, a self-directed IRA or other type of retirement account may carry higher fees than an IRA with a conventional custodian. This is in part due to the nature of the investments allowed in these accounts and also due to the costs of buying, selling and potentially holding some alternative investments.
Investors will want to plan for those fees and also account for them when calculating net returns.
Complex regulations
Some alternatives carry complex tax and legal requirements regardless of what kind of account you hold them in. But IRAs and other retirement accounts have additional rules for investing in and holding certain assets.
For example, there are a number of investments you may not hold in an IRA of any sort. These include collectibles such as artwork, coins (except certain U.S. coins and types of bullion), stamps, rugs, antiques, and beverages. Additional prohibited holdings include S-corp. stock, most precious metals, and insurance policies.
Self-directed IRAs also have what are called prohibited transactions.1 IRS rules prohibit transactions between your account and a disqualified person, which generally includes direct family members or a business that is either under the account holder’s control or the control of a disqualified person.
For example, allowing an adult child to live in an investment property owned inside your self-directed account, whether or not they paid rent, qualifies as a prohibited transaction. There are also restrictions that may prohibit the account owner from doing work themselves on property owed in their retirement account.
It is critical that you fully understand prohibited transactions so you don’t inadvertently trigger one. It could result in the asset becoming disallowed in the account and might trigger a potentially costly taxable distribution from the account that could also include an early withdrawal penalty. A prohibited transaction could also cause the entire self-directed retirement plan to become disqualified.
Is a Self-directed Retirement Account Right for You?
A self-directed IRA or other type of self-directed retirement account might be right for you if you’re an experienced investor who is looking to diversify your investment portfolio beyond more common investments like stocks, bonds, mutual funds and ETFs.
A self-directed retirement account may be a good solution if you have a long-term time horizon and are comfortable with higher risk and potentially higher reward investments. It can also be a good choice if you have a specific direct investment in an alternative asset like real estate, or a private equity stake in a company that you feel would be appropriate to be held in a retirement account.
Be sure that you understand all of the potential tax implications of a self-directed retirement account and that the investment time horizon for the alternative investment(s) you are considering fits with your own retirement time horizon and your potential need for the money.
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