Debunking The Myths About Self-Directed IRAs

Self-directed IRAs have been around almost as long as the traditional IRA of the 1970s but have gained more widespread popularity and general awareness in the last few decades as investors have experienced the ups and downs of the stock market. Despite how long they’ve been available, there are some prevailing misconceptions about self-directed IRAs.

Myth #1: A self-directed IRA is its own type of retirement account.

Fact:

Self-directed IRAs are the same as other IRAs that you would find at a brokerage—they include traditional IRAs and Roth IRAs, along with SEPs, SIMPLEs, Solo 401ks and other qualified retirement accounts. Anyone can open one to save for retirement. “Self-directed” is simply the term that describes the strategy used to invest with them and the types of investments they allow. You may not know it, but you can even “self-direct” an Education Savings Account (ESA) or a Health Savings Account (HSA).

Self-direction enables investors to include a broader array of assets within their retirement plans that typical IRAs (opened and managed at banks, credit unions and brokerages) do not. These are known as alternative assets, or assets that are not publicly traded. Much like typical IRAs, self-directed IRAs come with the same contribution limits, distribution rules and tax advantages.

You may be able to find accounts that are “self-directed” at your typical brokerage house; however, it is important to note that these brokerages cannot hold alternative assets. If you’re looking to invest in non-publicly traded assets, such as real estate or private stock, you’ll need a custodian that specializes in holding these types of assets.

Myth #2: These retirement plans carry a high risk.

Fact:

All investments carry risk. Self-directed IRAs build a hedge against stock market volatility and inflation and enable investors to diversify their retirement portfolios with non-publicly traded assets—most of which are meant as long-term investments (such as real estate, precious metals, private equity, cryptocurrency and more).

Self-directed investors have greater control over their investment returns since they make all of their own investment decisions based on assets they already know and understand. They conduct their due diligence and research before making the investment and can take advantage of wider investment opportunities. The more you know about a specific asset class that can be held in a self-directed IRA, the more successful you can be with managing it.

Many custodians and administrators offer complementary education as a part of their services. They should be able to guide you on what you can and cannot do with your account, but they cannot recommend investment products or provide investment advice.

Myth #3: There are too many IRS rules and regulations about self-directed IRAs.

Fact:

Most people also assume that these restrictions are at the hands of the custodian when it’s actually the IRS that imposes them. The IRS guidelines regarding self-directed investments are in place to protect the account owner. Self-directed IRAs—as with your typical IRAs—are designed for long-term benefits to use in retirement. They’re not get-rich-quick schemes.

The IRS regulations state that the account owner may not self-deal (incur personal gain from an investment), make a transaction with a disqualified person or invest in art, collectibles or life insurance. Additionally, for those investors who plan to include alternative assets within their account, the IRA must be opened and administered by a registered firm that specializes in these retirement plans. The more you know and understand these rules, the easier it will be for you to make informed investment decisions.

Per our guidance on the last myth, your custodian/administrator should be able to provide you with free education on the topic of self-directed IRAs, including what you can and cannot do with your account. It would be wise to absorb as much of that information as possible and ask questions as they arise so you can be sure that you will use your account according to IRS guidelines.

Myth #4: Self-directed IRAs are only for the wealthy.

Fact:

This misconception likely arose from a few well-known examples of wealthy individuals making significant gains using self-directed IRAs.

These exceptions aside, self-directed IRAs are available to all investors of any income level. Remember, these are essentially the same as regular IRAs. You can open a self-directed IRA with any amount and build from there. You can even transfer funds from other IRAs you have or roll over an old 401k into a self-directed IRA to get started. There are a plethora of investment options available to you that don’t require hundreds of thousands of dollars as an investment minimum. In most cases, you don’t even have to be accredited.

Myth #5: Self-directed IRAs are complicated to set up.

Fact:

When you establish a self-directed IRA with the right custodian/administrator, it should be as easy as following their step-by-step guidelines. Be sure your custodian/administrator provides you with a checklist of all the documents you need to submit, instructions to follow for funding your account and instructions for properly executing transactions. As with any financial relationship, working with the right partner makes all the difference.

Even the savviest investor will have questions about the types of alternative investments these plans allow or how an investment or distribution may affect one’s tax situation. It’s important to work with trusted advisors when guidance is needed. An effective, experienced self-directed IRA custodian/administrator should be available to answer your questions when it comes to alternative assets and the IRS rules concerning these retirement plans.

In all, there are a lot of powers at play, but the beauty of self-direction is that your future is in your hands—and if you have the will, there is a way. Sometimes it’s all about perspective and having the facts (and ample access to educational resources) that will empower you to make informed decisions regarding your financial future.

This article was written by Jaime Raskulinecz from Forbes and was legally licensed through the Industry Dive Content Marketplace. Please direct all licensing questions to legal@industrydive.com.