Employer-matched 401(k), Roth IRA and/or traditional IRAs are widely used retirement savings accounts. Why? They provide tax benefits, drive lucrative results over the long term and, well, because they are the ones we all know about. But once these traditional options are maxed out, what is the next move?
An often-overlooked option is the self-directed IRA (SDIRA), which is like other IRAs in that they allow you to save for retirement while leveraging tax benefits. The key difference is what you can invest in. While most retirement accounts only allow you to invest in stocks, bonds, and cash, a self-directed IRA allows investments in alternative assets.
What is a Self-directed IRA?
The SDIRA is a retirement account available to investors in the US. Similar to the standard accounts mentioned above, an SDIRA is an account that is specifically designed to help you save for retirement. As with standard IRAs, an SDIRA can either be opened as a traditional or Roth, either providing tax-free deposits or tax-free growth, respectively.
If you want to open a self-directed IRA, you will need to hire a qualified custodian that offers whatever range of investments you are interested in. Most investment advisors will not offer (or even recommend) a self-directed IRA because they do not earn commissions on the funds held in these accounts.
Investors in 2021 can contribute a maximum of $6,000 to the account annually. This number rises to $7,000 if you are over the age of 50. Funds cannot be withdrawn before the age of 59.5 without having to pay a penalty. Roll-over funds from a traditional 401k or IRA may also be redirected into your SDIRA account.
As mentioned, the difference between the other retirement accounts and SDIRAs lies in what assets you can invest in. An SDIRA opens that account holder up to a wider range of possibilities, including alternative assets like:
● Real Estate
● Precious Metals
● Private Placements
● Limited Partnerships
● And more
Advantages of SDIRAs
In terms of tax advantages, all retirement accounts are superior to brokerage accounts. But self-directed IRAs provide even more benefits than their typical retirement counterparts, including:
● Diversification – As you know, we believe diversification is the most important investment strategy. Self-directed IRAs allow investors with retirement account savings to invest in alternative assets outside the stock and bond market.
● Higher potential returns – With more choices comes more opportunities for gains. Allowing investors to choose from the multitude of alternative investments provides the opportunity to select investments that can appreciate quickly and are not beholden to wild swings in the market.
● Invest in what you know – If real estate is your asset of choice, an SDIRA allows you to add properties to your portfolio. If you also have an affinity for art, use your SDIRA to invest in that as well.
SDIRA Restrictions & Risks
As the name would imply, SDIRAs are self-directed. Your custodian is not permitted to give financial advice, so all research falls on you. If you need help selecting or managing your investments, you may need to hire a financial advisor as well.
There are some additional restrictions to be aware of. Self-directed IRAs will incur maintenance fees and must adhere to certain reporting requirements. Additionally, the IRS prohibits some transactions. (Investors cannot hold life insurance policies, S Corporation stocks, and collectibles in their SDIRA). While they cannot tell you want to invest in, the custodian of your self-directed IRA account will help you to stay compliant with the rules.
Why Invest in Alternative Assets?
Alternative assets offer a great way for investors to diversify, generate above-average returns, and protect their money against market volatility. Real estate is a common alternative asset class that SDIRA holders invest in. Real estate provides:
● Significant tax breaks
● Cash flow generated from rent
● Appreciation of the property’s value
● Hedging against inflation
Although there are many benefits to alternative assets, they tend to be more complex than investing in stocks or bonds. As long as you are aware of the technicalities and details, these assets are a savvy way to diversify and expand your retirement portfolio.
Should You Open a Self-Directed IRA?
The SDIRA is a great choice for investors who want to enjoy a comfortable retirement. For now, there appears to be more and more investors interested in the opportunity to use retirement funds for alternative assets through self-directed IRAs.
However, there is some uncertainty about what Congress may do with self-directed IRAs and other types of retirement accounts in the future. There are some tax proposals out that could hurt this strategy. Time will tell whether negotiations ultimately curtail this powerful tool or preserve it.