Most individual investors saving for retirement are well aware of the tax advantages and benefits of maintaining Individual Retirement Accounts (IRAs) as part of their strategy. These accounts offer a variety of standard investment opportunities in stocks, bonds, and mutual funds that grow tax-free and, depending upon the type of account established, may be tax-free upon withdrawal as well.
In recent years, however, the instability of the market and uncertainty about investment choices have lead some investors to explore other ways to grow wealth for retirement. The self-directed IRA (SDIRA) is one financial vehicle gaining traction.
The SDIRA has been available to investors since the 1970s, but only in recent years have they emerged as a powerful alternative to traditional retirement investment assets. They offer a way for investors to build their retirement portfolio with the advantages of a traditional IRA, but with the opportunity to invest a wider range of assets. The rules for managing an SDIRA are complex and establishing an account may require a little more work, but the advantages can far exceed any initial hurdles. There are, however, a few things to learn and consider about an SDIRA to determine if they fit into your retirement portfolio.
SDIRAs provide avenues for diversification
Standard IRA accounts offer a range of stocks, bonds, and other publically available investments. These assets are combined to create a portfolio that offers the appropriate mix of growth potential and risk management. However, with a SDIRA, an investor can move beyond stocks and bonds to invest in a wide-range of assets. For example, many people use their SDIRAs to own commercial/residential real estate, tax liens, precious metals, or businesses. Investors with local knowledge of real estate or business can use their expertise to build a retirement portfolio that outperforms more standard approaches.
Understand all rules and regulations
While SDIRAs offer many opportunities for wealth growth, the accounts are governed by more complex rules. These rules, established by the Internal Revenue Service, regulate the transactions with the SDIRA and have much to do with self-dealing. For example, if you own property in your SDIRA, you cannot live in, rent, or use the property. This prohibition also extends to family members, including your spouse, parents, and grandparents, as well as children and grandchildren and their respective spouses.
Failure to comply with any of the rules of the SDIRA results in strict penalties. If you engage in a prohibited transaction, the initial tax is 15% of the amount involved. Any delay in remedying the situation results in an additional tax of 100%. Investors wanting to use an SDIRA must be conversant with the rules and regulations of the account; the retirement nest egg is at risk if a person fails to operate legally.
Brokers, fees, and risk
Establishing a SDIRA is more complicated than a standard retirement account. Most well-known banks and brokers do not offer opportunities for SDIRA. Interested investors have to seek out custodians for their accounts that may only specialize in SDIRAs. These firms, because of the specialty, may have higher account opening and annual maintenance fees. Investors need to weigh these costs against the assets they hold and their expected rate of return on those assets.
SDIRAs have also been susceptible to fraud. However, like all investments, the important step is to do the due diligence to ensure the custodian is legitimate. You want to limit the risks you take to just the investment assets and not the broker you select.
The SDIRA offers the well-informed investor an opportunity to diversify their portfolio, invest in assets that they best understand, and to super-charge their retirement savings. Like all investment tools, the key is to understand and manage the risks involved. The first step is to do the research and determine if an SDIRA is right for you and your family.
This article was written by Tim Stevenson. Tim is a wealth of knowledge that enjoys sharing his financial expertise through blogs.