What are self-directed IRAs, and should I consider one?

A self-directed individual retirement account might sound like the ultimate empowerment tool for your nest egg, but it’s a bit more complex than that.

Self-directed IRAs, sometimes known as SDIRAs, are trusts that allow holders to place alternative assets into a retirement account—things that aren’t allowed in a regular pretax IRA or an after-tax Roth IRA.

Unlike the traditional world of Securities and Exchange Commission–regulated custodians and investments, self-directed IRAs can hold anything from gold and other precious metals to cryptocurrencies or real estate and even business interests.

There can be benefits for investors who want to diversify their tax-advantaged holdings, but self-directed IRAs can be complex vehicles, and they come with specific rules to follow. Also, because many of these investments are outside the scope of securities regulators, unscrupulous promoters have been known to hawk self-directed IRAs. So do your homework before you invest.

What is a self-directed IRA?

A self-directed IRA is a tax-advantaged account that allows you to own investments that are not allowed in standard retirement accounts. A trust custodian will need to administer the IRA, but you directly manage the investments, hence the name self-directed.

Self-directed IRAs operate similarly to regular IRAs in several ways, according to Kevin Dodson, CEO of New Direction Trust Company, a trust custodian with a 20-plus year track record. For example, self-directed IRAs:

• Can be traditional or Roth
• Are subject to income limits for Roth IRAs
• Have contribution limits of $7,000 annually for people younger than 50; those over age 50 can contribute an extra $1,000 for $8,000 in total (in 2024)
• If you make withdrawals before age 59 1/2, you will pay income taxes and a 10% penalty in a traditional IRA
• Required minimum distribution (RMD) rules apply

However, self-directed IRAs hold a much wider range of investments than regular IRA accounts. Dodson says he’s seen self-directed IRAs hold anything from Hawaiian koa trees to shares of small businesses. Popular holdings in self-directed IRAs include:

• Gold and precious metal bullion (coins and bars)
• Private debt, such as peer-to-peer lending, distressed debt, and mezzanine debt
• Rental property

Not everything is allowed in a self-directed IRA; the Internal Revenue Service imposes some specific restrictions. Sorry—no Beanie Babies, no DeLorean DMC-12, nor anything else that the U.S. Treasury considers a collectible. Specific prohibited items include:

• Works of art
• Rugs or antiques
• Gemstones or metals (except certain precious metals)
• Stamps or coins (except specific precious metal coins)
• Alcoholic beverages
• Life insurance
• Stock in a subchapter S corporation

Do some careful, self-directed research

Owning a self-directed IRA requires a lot more research from you because you manage the account directly. You need to conduct due diligence on the asset(s) you want to invest in as well as the custodian you’ll choose to administer the IRA before opening an account.

Find a custodian who specializes in self-directed IRAs. Dodson says trust custodians are regulated by each state and are approved by the IRS; however, they are not fiduciaries, so they cannot give advice.

Custodians can:

• Help you open an account
• Keep deposits in a tax-advantaged account and make distributions to you
• Prepare statements and reporting for the IRS

Custodians cannot:

• Evaluate if an investment is suitable, complies with tax laws, or is free from fraud
• Verify the accuracy of any information on an asset

Just as with any other IRA, you can fund a self-directed IRA by contributing money, transferring money from other IRAs, or rolling over money from a 401(k) or similar account. Once the account is funded, you direct the custodian to buy the asset you’ve chosen. They will estimate its value for tax purposes.

Depending on the complexity of the asset, you may have to pay several levels of fees—and follow specific steps—to set up the account properly.

SDIRA example: Buying precious metals in a retirement account

Let’s consider the steps you’d need to take to open a precious metals self-directed IRA, one of the most popular types:

• Open an account with a custodian and fund it
• Work with a precious metals dealer to select IRS-approved bullion
• Have the custodian buy the bullion from the dealer
• Arrange for the custodian to ship the bullion to an IRS-approved depository

All these steps will incur individual costs, plus annual fees for the custodian to maintain the account and the depository to hold and insure the metal. You must pay premiums to the metals dealer to buy the bullion and shipping costs to securely send it to the depository.

To stay compliant with IRS rules, ensure your dealer selects bullion coins and bars. The IRS lays out specific purity conditions:

• Gold, 99.5% pure
• Silver, 99.9% pure
• Platinum, 99.95% pure
• Palladium, 99.95% pure

American Eagle gold bullion coins are the only exception to the IRS purity rules; they are allowed in IRAs even though they are only 92% gold. Some foreign sovereign coins are also acceptable, including Canadian Maple Leaf and British Britannia coins.

Beware of prohibited transactions

The IRS has strict rules around your involvement in a self-directed IRA under U.S. code Title 26, Section 4975. These rules regard “self-dealing,” and they can be easy to violate.

Assets held in a self-directed IRA are purchased by the custodian so there’s a degree of separation between you and the asset. You cannot borrow money from the asset and invest it elsewhere.

“You are not your IRA. You are the No. 1 benefactory of an IRA, and an IRA is a different entity in the eyes of the government,” Dodson says.

For example, if you own rental property:

• You need to hire a property manager.
• You cannot put “sweat equity” into fixing it up.
• Neither you nor your family may stay in the property.

Similarly, if you are the majority owner in a small brewery, you can’t get free beer. And if you already own American Eagle gold coins, you cannot put those specific coins in an IRA.

If you break the rules, it means the asset doesn’t meet the requirements of a tax-advantaged account. If the IRS tells the trust custodian there’s a prohibited transaction, or the custodian discovers a prohibited transaction, the total IRA will be prematurely distributed to you. That will generate a “taxable event,” which means you’ll owe taxes, and you may be subject to a 10% early withdrawal penalty.

Avoiding fraud in SDIRAs

Self-directed IRAs and custodians are not regulated by the SEC, and there are numerous cases of fraud surrounding these investment vehicles. The SEC, the North American Securities Administrators Association (NASAA), and the Financial Industry Regulatory Authority (FINRA) have jointly issued investor alerts about how to protect yourself.

The regulators say unscrupulous promoters of self-directed IRAs may be fake custodians, or they may misrepresent their custodial duties, the tax benefits, or the type of assets allowed in IRAs. Others have been known to overhype the potential return on your investment, and they may overcharge for services. Avoid unsolicited investment offers.

The bottom line

Self-directed IRAs can introduce a level of diversification to your retirement portfolio. But they require deep research and due diligence. If you’re being pitched on a SDIRA, or if you heard about it on the radio, stop. Do some homework and talk to a financial advisor (and perhaps a tax professional) before you invest.

Remember: This is your retirement money—your nest egg. It’s money that needs to be there during your golden years. Understand the risks.