A Self-directed IRA is designed for investors who are interested in using more than just stocks, bonds, mutual funds or cash to build their retirement nest egg. Like traditional and Roth IRAs, the annual contribution limit for self-directed IRAs is set at $5,500 for 2017. The limit increases to $6,500 for savers who are 50 or older.
With self-directed IRA limits so much lower than the annual contribution limit for 401(k)s and similar workplace plans, the question for investors is just how much can you really save in one of these accounts? Surprisingly, the answer may be more than you think.
The $100 Million Self-Directed IRA
In 2012, the Wall Street Journal ran a story detailing the value of presidential candidate Mitt Romney’s self-directed IRA. The article put the estimated value of his account at just over $100 million. That may seem like an impossible amount of savings to have in one of these accounts, but a 2014 report from the Government Accountability Office (GAO) suggests that he may not be alone in his multimillion-dollar IRA wealth.
According to the report, there were at least 314 Americans with more than $25 million in their IRAs. The GAO estimated that the average account balance for each of these 314 individuals was $25.8 million. But how did these investors accumulate such substantial assets in their IRAs?
The report suggests that one driver of these higher balances was the use of alternative investments to generate growth beyond what stocks or other traditional investments offer. Those alternatives included stock in private companies and partnership interests, both of which fall under the umbrella of investments that may be used in a self-directed IRA. Self-directed IRAs can also be used to invest in things like real estate, tax lien certificates and precious metals.
Ultimately, building a $100 million balance in a self-directed IRA depends on your time frame for investing and the returns your investments generate. If you were to start saving at age 20 and contribute $5,500 annually, earning a 20% rate of return until age 65, you could hypothetically crack the $120 million mark. That may not be realistic for every investor, however. Still, it is a possibility if you have a longer horizon and you’re targeting investments that outperform stocks.
Investing in a Self-Directed IRA
With its broader range of investment choices, a self-directed IRA affords an opportunity to grow your portfolio but it may not be the right option for every investor. There are, for example, certain rules that you must observe when investing with a self-directed IRA.
First, the assets in your account must be held by a qualified trustee or custodian. While you guide your investment choices, the custodian is responsible for holding your assets, executing the purchase or sale of assets, keeping accurate records of those transactions and reporting them to the Internal Revenue Service.
Second, the IRS places limits on what you can invest in, and prohibits certain types of transactions. Banned transactions include:
- buying or selling property directly from yourself
- lending or borrowing money from plan assets
- investing in a company you own or control
- selling, exchanging or leasing property from the IRA to a disqualified person
- furnishing goods, services or facilities to a disqualified person using plan assets
A disqualified person includes yourself, your family members and any company that you claim an ownership stake in, in excess of 50 percent. Breaking any of these rules could lead to a tax penalty. The associated investments could also lose their tax-advantaged status.
Something else to consider is the volatility of the underlying investments in a self-directed IRA. While things like gold and real estate can be hedges against inflation and offer higher returns, they could also entail a higher degree of risk. Understanding how alternative investments react to fluctuations in the market is vital as you create your investment strategy with a self-directed IRA.
If a $100 million retirement is your goal, a self-directed IRA could get you closer to the target. These accounts offer both tax advantages and flexibility in choosing a portfolio of alternative investments that suit your objectives and risk tolerance. The challenge is making sure you’re observing the IRS rules for self-directed IRAs to avoid a penalty that could diminish your returns over the long term.