Individual retirement accounts, or IRAs, have some fantastic tax benefits and are excellent vehicles to save for retirement. However, if you open an IRA with a broker, you're generally limited to stocks, bonds, cash investments, and related investment vehicles like mutual funds.
There's a lesser-known alternative to the standard IRA, known as a self-directed IRA. This is a tax-advantaged retirement account designed to let investors put their retirement savings to work with non-traditional assets.
Here's an overview of what a self-directed IRA is and some of the pros and cons of using one for your own retirement savings.
What is a self-directed IRA?
In simple terms, a self-directed IRA is an individual retirement account that lets investors hold non-traditional investments with their retirement money. For example, a self-directed IRA can be used to hold real estate assets. These IRAs have some big advantages over traditional options.
Diversification is one advantage -- many investors aren’t comfortable with all of their assets being invested in stocks and bonds.
It’s also a great way to shelter non-traditional investments from taxation. For example, if you own cryptocurrencies through an IRA, you won’t owe a dime in capital gains tax if you sell. The money stays in the self-directed IRA, tax-deferred (or tax-free, in the case of a Roth IRA), until you withdraw it.
What types of investments can you make in a self-directed IRA?
You can hold stocks and bonds in a self-directed IRA, just as you could with a standard IRA. However, the main reason most investors open self-directed IRAs is to invest in assets that are otherwise unavailable to IRA investors.
The possible investments you can make in a self-directed IRA include (but aren’t limited to):
- real estate, including land;
- gold, silver, and other precious metals;
- cryptocurrencies; and
- investments in private businesses, such as a passive interest in a partnership.
There are some things you cannot buy in a self-directed IRA. Just to name a couple of the most common examples, you can’t own collectibles or jewelry through your account (if you’re unsure about the line between precious metals and collectibles/jewelry, ask a tax professional with self-directed IRA experience). You also can't own any real estate assets that you or any of your relatives plan to live in.
Tax benefits of a self-directed IRA
Self-directed IRAs have the same general tax benefits of traditional or Roth IRAs, but they’re worth discussing here in case you aren’t familiar.
In a nutshell, money you contribute to a self-directed IRA may be deductible on your tax return, depending on your income and whether you or your spouse have a retirement plan from your employer. Investments grow on a tax-deferred basis (meaning no capital gains or dividend taxes each year), and when money is eventually withdrawn from the account, it's considered taxable income.
With a Roth self-directed IRA, contributions aren't tax-deductible. However, investments grow tax-deferred and qualifying withdrawals are 100% tax-free.