The Step-by-Step Guide to Setting up a Self-Directed IRA

It’s a great time to be investing in your own future. The self-directed IRA, SDRIA, has become an increasingly popular investment choice for investors of all ages, including retirees. But like everything else, there are many options to consider and different ways to go about setting up an individual retirement account.

In this comprehensive step-by-step guide, you’ll be guided through the steps of setting up a self-directed IRA. A self-directed IRA allows you to invest your retirement funds in whatever manner you want by using your own professional judgment. This means that it’s important to make sure that you choose investment options that align with your financial goals and risk tolerance.

How do self-directed IRAs work?

A self-directed IRA follows the same template as a standard IRA but with one crucial difference: you can buy anything, from gold bars to cryptocurrency. With regular IRAs, your custodian—usually a bank or broker—limits investment options to approved securities like stocks, bonds, and exchange-traded funds (ETFs). But some investors want to diversify their portfolios using non-traditional asset classes for the purpose of diversification or potentially higher returns in the future.

The contribution limit for every year remains the same: $6,000 ($7,000 for those aged 50 and over) in 2021 and 2022. You can choose to open a self-directed IRA as a traditional IRA or a Roth IRA, with the same pre-tax and post-tax contribution rules.

What is a Self-Directed IRA?

A self-directed IRA is a type of IRA that allows the account holder more control over his/her retirement funds from the convenience of a local bank. It also allows the account holder to use the IRA funds to invest in non-traditional investments like precious metals, tax liens, real estate, gold coins, limited liability companies, and private stock offerings tax-free!

Self-directed IRAs are not the same as traditional IRAs. With a traditional IRA, your investments are managed by an outside company like a bank or insurance company. The broker handles your investments in exchange for a fee. With self-directed IRAs, you manage all of your investment transactions yourself.

Self-directed IRAs are great for investors who want maximum flexibility, especially if they’re looking to make long-term investments rather than trading stocks or bonds.

Types of Self-Directed IRAs

Self-directed IRAs can be categorized into the following three types:

  1. Financial Institution Self-Directed IRAThis is the most popular self-directed IRA account because it is generally offered by the biggest financial institutions in America, like Vanguard, Wells Fargo, Fidelity, and Bank of America. This self-directed IRA limits the account holder’s investment scope to the options that are offered by the financial institution, which typically include stocks, bonds, ETFs, and mutual funds.
  2. Custodian Controlled Self-Directed IRAA custodian-controlled self-directed IRA offers more investment options compared to a financial institution. An FDIC-Insured IRA administrator serves as the custodian of this account. The custodian holds all the funds and generates fees by setting up and managing the IRA accounts. With this self-directed IRA, the control always remains in the hands of the custodian, so every time the account holder wants to make an IRA transaction, it can happen only through the custodian, who, at the direction of the IRA holder, will then make investments or pay expenses.
  3. Self-Directed Checkbook IRA With a checkbook IRA, the account holder has complete control over the IRA funds and the freedom to make investments without relying on a custodian’s approval. With a self-directed checkbook IRA, all the investments can be made simply by writing a check or wiring the funds straight from the self-directed IRA’s LLC. It eliminates all the delays and hassles associated with an IRA custodian so you can act immediately when a profitable investment opportunity is presented to you.The benefits of a self-directed checkbook IRA include the freedom to write checks without seeking the consent of a custodian, instant access to IRA funds, the flexibility to invest in non-traditional assets, and lower fees because you will not be paying the custodian any fees for transactions and account valuation.

    Also, with a self-directed checkbook IRA, all your assets that are held outside your LLC remain protected from claims. In addition, your checkbook IRA will remain safe for up to $1 million from creditor attacks in case of bankruptcy.

Should you save for retirement with a self-directed IRA?

A self-directed IRA might be the ticket if you want to invest your money in unconventional ways. But even if you fit the description, consider this: You can make a mistake with a self-directed IRA, and some tax traps are waiting for you. If you’re serious about getting one—or just want to do it right—speak with a financial advisor or tax professional before diving headfirst into this investment opportunity.

Remember: No experts recommend investing all of your retirement funds in alternative investments; most people have found it better to hold no more than 10% of their money in these riskier bets.

Difference between SDIRA and other retirement accounts

The main difference is flexibility. A typical retirement account will only allow you to invest in assets offered by that particular custodian, while a self-directed IRA company allows you to leverage practically any type of asset as an investment vehicle – including real estate, precious metals, private equity, and many other alternative investments. This is the most common reason investors choose an SDIRA.

Advantages of Self-Directed IRAs

The self-directed IRA offers a number of advantages:

Control. With an SDRIA, you can choose the investments you want to make and how much you choose to contribute. You can also decide whether you want to be invested in stocks or bonds. There’s no minimum amount required to open an account — as long as there’s at least $1,000 in your account, you’re good to go!

Customize Your Investments. With an SDRIA, there are no restrictions on what types of investments you can hold within it — as long as they meet IRS requirements, they are good to go. This flexibility allows investors to have more control over their investment decisions and potentially earn more interest on their investments than they would with traditional IRAs.

Control fees and expenses. With a self-directed IRA, you are responsible for managing the investments within your account rather than having someone else do it for you. This gives investors the opportunity to cut costs associated with managed investments by eliminating third parties.

Understanding the rules around SDIRAs

The rules around self-directed IRAs are not much different from other retirement accounts, but it is important to familiarize yourself with SDRIA rules and regulations.

When you are investing in SDIRAs, four major self-directed ira rules should be kept in mind:

1. IRA contribution limits

Every self-directed IRA has a maximum dollar amount investment limit that you can contribute to it every year. The IRS provides these limits, and exceeding them wouldn’t be possible.

2. Prohibited Transactions

Even though SDIRA has a lot of investment options for people, there are certain transactions that are prohibited. Therefore you must ensure that you aren’t investing in something prohibited while starting with SDIRA.

3. Fair Market Value Reporting

You must perform a valuation of your assets on an annual basis or when there is a distribution.

4. Distribution Rules

IRA distributions, or cash or an asset withdrawal, can be made at any time. However, a few criteria will determine whether tax and penalties are associated with any distribution.

How to Start a Self-Directed IRA Account

To enjoy the benefits of a self-directed checkbook IRA, you need to follow these 4 simple steps:

  1. Find a Trustee to Administer Your IRATo operate your self-directed checkbook IRA, you need to find a trustee who will oversee your account, purchase your alternative investments, and hold them in your account. The trustee may also offer other services like storing your gold coins and managing your real estate.
  2. Transfer the Funds from Your Existing IRA to Your Self-Directed IRAA self-directed IRA needs to be funded first before you can purchase investments. Your custodian can initiate a fund transfer from your existing IRA or 410(k) plans without any tax ramifications.
  3. Understand all the Fees Associated with Opening a Self-Directed Individual Retirement Account A self-directed IRA has much higher fees compared to a bank or a brokerage IRA account which typically runs for a year at an administrative cost of about $20. The fees associated with a self-directed checkbook IRA can range anywhere from $200 to $2,000, depending on your chosen investment types and the services offered.
  4. Get Yourself Acquainted with the Prohibited InvestmentsThe IRS prohibits the IRA account holder from owning collectibles like artwork, antiques, certain coins, and stamps in an IRA. The account holder is also prohibited from investing in real estate that is being used as a vacation home or is being rented by the account holder for most of the time.

Choosing a self-directed IRA provider

The first step in choosing a self-directed IRA provider is to determine whether you have the ability to choose your own investment options. Some providers can only offer mutual funds or exchange-traded funds (ETFs) and may not be able to provide you with other types of investments like stocks or bonds.

If this is the case, then there’s not much point in looking for a self-directed IRA provider because it will restrict your options. However, if you can choose your own investments, then you should look for a provider that provides access to a wide range of investment options.

Key Takeaways

Individuals with a high net worth that exceeds $1 million can enjoy considerable benefits by setting up a Self-Directed checkbook IRA. That is because they are better equipped with a buffer in case of loss from a bad investment decision.

Younger people can also make the most of a self-directed retirement account as they have the luxury of time to their advantage, unlike those who are nearing retirement and cannot give their investments adequate time to grow.

See some of our other tax-free retirement solutions here.