If there’s anything simple in retirement investing, a Traditional IRA is about as simple as it gets. Self-directed IRAs, however, are far from simple.

How do these two IRAs differ, and is a self-directed IRA right for you?

Basics of the Traditional IRA

An individual retirement account (IRA) allows you to invest money earmarked for retirement. The advantage—unlike a regular investment or brokerage account—is that you don’t pay taxes on the proceeds you earn at the time you earn them, which allows those gains to grow much larger over time.

The basics of an IRA look like this: The maximum you can invest in an IRA is $5,500 unless you’re 50 or older, when your limit is $6,500. You can’t withdraw your gains until you’re at least 59½ without a penalty, and the brokerages managing your IRA (known as custodians) will probably limit you to stocks, bonds, ETFs, and other traditional or common investments.

The IRS allows for other types of investments, but most custodians don’t want to deal with non-traditional investments. All of this is true of both Roth and Traditional IRAs.

Self-Directed IRAs

Hold on to your hat because as simple as your run-of-the-mill, plain Jane, Traditional IRA is, the self-directed variety is the absolute opposite.

Any time you see the term “self-directed,” it means that you’re on your own. Nobody is watching your back—other than maybe the IRS and anyone else who wants their cut of the loot. You know those TV survival shows where it’s just the person and vast expanses of unoccupied land? That’s you when you start a self-directed IRA. It’s risky—and it’s not for the person with a low risk tolerance. Now that you’ve been warned, let’s dive in.

A self-directed IRA allows for all of the traditional investments—stocks, bonds, mutual funds, ETFs and more—but it also opens up a new realm of possibilities, including real estate, precious metals like gold, and investments in private companies, energy sources and even your best friend’s new business venture.

You still aren’t allowed to invest in collectibles like art or stamps, life insurance, and tangible personal property. Investments involving most family members and yourself are definite no-no’s as well.

Finally, to set up a self-directed IRA, you often have to deal with companies that aren’t well known.

This type of IRA is normally attractive to people with a lot of investing knowledge, often in a certain niche. A seasoned real estate investor, for example, or somebody with experience investing in startups could find a self-directed IRA very attractive. It’s definitely not for the do-it-yourselfer who wants to dabble in precious metals.

A Major Caveat

Because nobody is watching out for you, you leave yourself vulnerable to potential fraud. In 2011 the U.S. Securities and Exchange Commission (SEC) warned that these accounts are a perfect tool for scammers.

Unlike stocks and other traditional investment vehicles that have a significant amount of regulatory oversight, there’s no such protection over self-directed opportunities. This, again, provides ample opportunity for con artists to run off with your hard-earned money. Do not enter into self-directed investments unless you have expert knowledge or you know somebody with industry experience.

The LLC Angle

Still onboard? Let’s go deeper. Many self-directed IRA owners create a limited liability company (LLC) that is controlled by the IRA. More accurately, the trustee of the IRA makes all of the decisions on behalf of the IRA, which controls the LLC. This may give the client more control over how he or she invests the funds and also provides some of the legal protections that come from investing under an LLC (as opposed to as an individual). Is your mind blown yet? Many IRA trustees who allow this type of action require the use of a tax attorney to remain in compliance with IRS regulations.

Clearly, self-directed IRAs aren’t for everyone. In fact, they’re probably for the minority—the real estate investor with decades of success, the independently wealthy angel investor or the ex–Wall Street financial advisor who knows the investing world inside and out. If that describes you, it is still wise to do your research and talk to a lot of customers before picking a custodian and diving into these more dangerous—but potentially more profitable—waters.


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