A self-directed IRA is a tax-deferred retirement account that allows you to directly manage your investments and buy alternative assets that aren’t available in traditional IRAs. An account with a self-directed IRA service costs more to set up and maintain but allows you to invest in things like real estate, private companies, and precious metals.
How a Self-Directed IRA Works
If you want to invest in broader assets—things other than stocks, bonds, mutual funds, and target-date funds—you usually need to use a self-directed IRA. Self-directed IRA rules and restrictions are very similar to those of traditional IRAs and have the same contribution limits. The big difference is that to set up a self-directed account, you use a custodian that specializes in alternative assets.
The typical differences between a self-directed IRA and traditional IRA include:
- Investment Options – Self-directed accounts allow you to hold things like real estate, privately held companies, or gold and other precious metals.
- Costs – The fees for setting up and maintaining a self-directed IRA are typically higher than they are for traditional accounts.
- Rules – Because investors have more investment flexibility in a self-directed account, they have to be more cognizant not to engage in prohibited transactions.
When you set up an IRA with a custodian or trustee, that company holds the assets in your account on your behalf. As an account holder, you get to choose what to invest in, but you’re restricted to the investments made available by your provider. This is why accounts with a mutual fund company can only invest in that company’s funds, while accounts with online providers can only trade securities available on that provider’s platform.
“Investing in alternative assets in self-directed IRAs is often more time-intensive than investing in traditional assets like publicly-traded stocks, bonds and mutual funds. Investors should also understand that it is their responsibility to investigate and evaluate their investment choices and then instruct their custodian to make purchases. Self-directed custodians do not perform due diligence on investment options and do not provide investment, legal or tax advice. Individuals who are interested in making an investment in a self-directed IRA should contact an investment, legal or tax adviser if they deem it necessary.” – Tom Anderson, President, Retirement Industry Trust Association
Self-Directed IRA Checkbook Control
Self-directed IRAs open up investors to new alternative investments, but some self-directed IRA services offer checkbook control that goes even further. In a checkbook IRA, account holders aren’t restricted to the alternative assets typical of self-directed providers. Instead, with a checkbook IRA, you can invest in almost anything simply by check or wire transfer.
Checkbook control is only available with some self-directed IRA custodians. To establish a checkbook IRA, you need to work with a provider to form an LLC that’s owned by your IRA, and then create a bank account in the name of that LLC. Once you’ve established a checking account, you can invest in almost anything just by writing a check.
An IRA LLC makes it easier to invest in some things, including:
- Closely-Held Equity – Small or informal companies that are still being developed or just getting started
- Private Loans – Small loans to friends or family, private mortgages, and other notes
- Equipment – Equipment for your business or to rent, with the rental income staying in your IRA
- Real Estate – If you fix and flip houses or buy rental properties, you can enjoy great tax advantages with a Self-Directed IRA for Real Estate
Self-Directed IRA Costs
Self-directed IRAs come with special advantages for investors, but they also have unique costs. The extra work required for self-directed IRA services means that fees are typically higher than traditional IRAs. Investors should expect to pay $50 – $150 to set up a self-directed account ($1,000 or more for an IRA LLC) plus 2 percent per year in various fees.
The costs of a self-directed IRA typically include:
- Setup Costs: $0 – $2,500 flat fee – Most self-directed account providers have a fee for establishing an account that covers a lot of the upfront cost
- Custodian Fee: $20 – $100 per year – Some providers charge annual custodian fees for holding assets in an account, but you can typically minimize these with a checkbook IRA
- Administration Fee: 0% – 2% per year – A few providers charge annual administration fees for handling recordkeeping and other items related to your self-directed IRA
- Trading Costs: $0 – $1,000 per trade – Not all providers charge transaction fees for self-directed IRAs—especially those with checkbook control; however, some providers with transaction-based pricing models (handling certain asset classes) charge fees that can be substantial
“Each RITA member sets its own fees based on services provided for particular assets. For example, real estate may require more work by the directed custodian due to origination, titling, recording, and other manual processes such as taxes, insurance, homeowner fees, and maintenance. Similarly, other alternative assets like private equity, tax liens, and promissory notes also require manual processing. Self-directed custodians generally charge more to cover such costs. In contrast, trades in publicly-traded stocks, bonds, and mutual funds are executed electronically without the costs of manual processing. Not all trust companies or directed custodians handle the full array of IRS-allowable investments, so IRA owners should shop and compare fees for specific assets among various providers.” – Mary Mohr, Executive Director, Retirement Industry Trust Association
Who a Self-Directed IRA Is Right For
A self-directed IRA may be right for you if you are a more knowledgeable investor who understands alternative assets and has the time to administer your account. Self-directed accounts are typically riskier than more traditional investment accounts because they allow you to invest in riskier assets.
Self-directed IRAs can also be riskier because most providers are smaller, lesser-known companies. This has even led the SEC to warn investors of increased risk of fraud. Because self-directed accounts are riskier and also require a more hands-on approach to investing, they aren’t right for everyone.
A self-directed account is particularly good for:
- Serial Entrepreneurs – People who frequently invest in new ventures and projects and want to keep any profits tax-free if the company takes off
- Professional Investors – If you’re a sophisticated investor in real estate or private equity, a self-directed account may offer you more flexibility
- Inventors – A self-directed account can be used to develop intellectual property or invest in a patent
- Angel Investors – Early-stage companies often seek funding from outside investors, and it can be very difficult to invest through a more traditional IRA or 401(k)
Top Self-Directed IRA Services
If you want to set up a self-directed IRA, one of the first things to do is identify a provider that is right for you. Choosing a self-directed IRA custodian that meets your needs is one of the most important steps to setting up an account. If you want a checkbook IRA, be sure to select a provider that offers this feature.
|Entrust Group||Established, cost-effective, and self-directed IRA company for investing in certain alternative assets.|
|Equity Trust||Investors who want access to the largest network of personal advisors for individual guidance.|
|MySolo401k*||Investors who want maximum investment flexibility through checkbook control.|
|Broad Financial*||A good alternative self-directed IRA checkbook control provider.|
|uDirect Services*||Best self-directed real estate IRA if you want to invest in your own property deals.|
*Provider offers checkbook control
Some of the top self-directed providers include:
Entrust is one of the more cost-effective, self-directed IRA custodians. They facilitate investment in assets including real estate, precious metals, and oil and natural gas.
Entrust charges a $50 setup fee (unless you’re investing in precious metals) and an annual administration fee that varies depending on the size of your account, number of investments, and the billing structure you select. Entrust also charges transaction fees for buying or selling invests in your account; the fees vary with the type of investment.
Entrust does not market an IRA LLC as an option, but does educate investors on what is necessary to achieve checkbook control for investing in things like private placements. For that reason, it is a very good provider if you want a self-directed IRA to invest in certain alternative assets but do not want a checkbook IRA for even more flexibility.
Equity Trust is a Cleveland-based firm that holds more than $12 billion in assets. Like Entrust, Equity Trust is a self-directed IRA custodian that allows you to invest in a number of alternative assets, including real estate, promissory notes, oil and gas, and private businesses. However, they also do not offer checkbook control as an added feature, which can limit your investment flexibility.
Equity Trust is also a cost-effective provider. They charge a one-time $50 setup fee and annual fees that range from $205 – $2,150, depending on the size of your account. There are no transaction or distribution fees. One of the biggest advantages for Equity Trust is that they have more than 400 representatives around the country who can provide one-on-one guidance as needed.
MySolo401k is provider of self-directed accounts, including self-directed IRAs and Solo 401(k)s. The flexibility they offer investors makes them one of our Best Solo 401(k) Providers. The upfront charges of MySolo401k are relatively high—they charge $1,100 to set up a self-directed IRA. However, the structure they use as a self-directed IRA service minimizes ongoing administrative and custodian fees.
Historically, one of the biggest advantages of MySolo401k is the ability to use retirement assets to fund a new or growing business with a ROBS. However, their self-directed IRA offering can also be advantageous for investors who want ultimate flexibility. Using MySolo401k, you can invest in almost anything.
Broad Financial is another great provider of self-directed checkbook IRAs, although they’re more expensive than MySolo401k. Broad Financial’s projected first-year charges are similar to MySolo401k, at about $1,256. However, their setup fee is only $50. The biggest cost is transactional, with each asset purchase costing $960.
This difference in fee structure means that, while the initial costs are similar for Broad Financial and MySolo401k, the ongoing costs of a self-directed checkbook IRA with Broad can continue to be higher each year, while they’re typically much lower with MySolo401k. However, if you don’t plan to have many transactions after the year you open an account, then Broad Financial may be a good alternative for you.
UDirect is one of best self-directed account providers for real estate investing. For more information on their unique advantages in this area, be sure to check out our ultimate guide to Self-Directed IRAs for Real Estate. UDirect charges a one-time setup fee of $50 and annual fees of $275.
Although uDirect offers additional investments through self-directed IRAs, including private placements and oil and gas, they have developed a specialty in helping investors use a real estate IRA. If you plan to use your account to invest in real estate and don’t anticipate lots of account activity that could involve additional fees, uDirect is a self-directed IRA service to consider.
“If you’re thinking about using a self-directed IRA, you really need to keep an eye out for potential fraud. The SEC has previously taken action against Ponzi scheme operators—some of whom have encouraged people to open self-directed IRAs as part of operating their Ponzi scheme. If you’re going to open a self-directed IRA, make sure you’re working with a legitimate, approved institution. As with any other investment firm, if you’re working with a self-directed IRA provider and someone is making recommendations to you about specific investments, you should always check them out. Use BrokerCheck to see whether that person is properly licensed. If not, probe into that further. In some cases—real estate brokers, for instance—they don’t need to be licensed as investment advisors. But if they say that they’re licensed as an advisor, confirm that they are.” – Gerri Walsh, Senior Vice President for Investor Education, FINRA
Self-Directed IRA Contribution Limits 2019
The contribution limits for self-directed accounts vary by the type of IRA you set up. Most self-directed IRAs are set up as traditional IRAs and have contribution limits of $6,000 per year. In these accounts, you’re allowed to contribute an extra $1,000 if you’re over age 50.
Contribution limits for IRAs, whether or not they’re self-directed, include:
- Self-Directed Traditional IRA: $6,000
- Self-Directed SEP IRA: $56,000
- Self-Directed SIMPLE IRA: $26,000
Self-Directed IRA Deadlines
There are two primary deadlines to be aware of for self-directed IRAs. The first deadline is when accounts need to be established, and the second is for contributions. There are some additional deadlines for certain types of self-directed accounts like SEPs and SIMPLEs, but these are usually the same as normal SEP and SIMPLE IRA Rules.
The deadlines for self-directed traditional IRAs include:
1. Account Setup Due Date: April 15th of Next Year
In order to take advantage of tax-deferred contributions to a self-directed IRA, accounts need to be set up on time. Self-directed traditional IRA accounts must be established prior to your individual tax-filing deadline for a given year. This means that, for example, if you want to establish an account and make contributions for 2019, then your account needs to be set up prior to April 15, 2020.
2. Contribution Deadlines: April 15th of Next Year
The contribution deadline for self-directed traditional IRAs is also your individual tax filing deadline. You are allowed to make tax-deferred contributions for a given year up until your tax-filing deadline for that year (again, for 2019, April 15, 2020).
Self-Directed IRA Rules
Using a self-directed IRA requires that you follow certain rules set by the IRS. These rules will vary depending on the type of IRA that you set up (traditional, SEP or SIMPLE). The rules for self-directed accounts are mostly the same as the underlying IRAs, except that self-directed IRAs do have some prohibited transactions to avoid.
The self-directed IRA rules include:
1. Follow Proper Self-Directed IRA Setup Process
When you’ve decided to set up a self-directed account, it’s important to identify a provider and work through the correct process to setup and use an account. Depending on the type of IRA you’re establishing, this may include completing additional IRS forms, including:
2. Avoid Prohibited Transactions
There are certain transactions that aren’t allowed by self-directed IRA rules. Most of these are transactions involving so-called “disqualified persons,” including you, your spouse, and any IRA beneficiaries. You can’t have any transactions in a self-directed account that involve a disqualified person. There are also some things that you can’t invest in within a self-directed IRA account.
Some self-directed IRA prohibited transactions include:
- Art – Paintings, sculptures, and rugs aren’t allowed in a self-directed account
- Stamps – You can’t use a self-directed IRA to buy collectible or other stamps
- Antiques – Self-directed accounts can’t own old furniture or other items
- Metals or Coins – You can’t invest through a self-directed account in metals or coins unless they’re precious metals like gold or silver
- S-Corps – Investors can’t own shares in an S-Corp through a self-directed account
- General Partnerships – You can’t invest in a general partnership using funds from a self-directed account
- Private Companies that You Control – The IRS prohibits self-dealing in IRAs, which includes lending money to companies that you or your spouse control or work in
3. Follow Financing Standards
If you have a real estate IRA or are financing other investments, the IRS has special self-directed IRA rules for how loans need to be structured. For instance, an account holder is not allowed to personally guarantee loans made to a self-directed account. If you’re going to make investments that require financing, make sure you understand the rules. Work through your self-directed IRA service to put financing in place. Failure to do so can cause you to incur taxes and penalties.
4. Implement a Compliant Matching Program
If you’re setting up a self-directed SIMPLE IRA that involves employees, you need to implement a matching program that meets IRS requirements. This means matching employee contributions up to three percent. You can drop your match to as little as one percent, but can’t match less than three percent more than two years in a five-year period. You can read more in our article on SIMPLE IRA Rules, Providers, Contribution Limits & Deadlines.
If you’re setting up a self-directed SEP, you need to understand your obligations as an employer to fund employee contributions proportional to your own. You can read more about these and other requirements in our article on SEP IRA Rules, Contribution Limits, & Deadlines.
5. Enroll Eligible Employees
This is another rule that’s only necessary if you’re setting up a self-directed SEP or SIMPLE IRA—not for traditional IRAs. In order to set up a self-directed SEP or SIMPLE IRA, you need to enroll all employees who are eligible based on your plan documents. As new employees become eligible, they need to be provided with disclosures and enrolled (if they choose to participate).
6. Immediately Vest All Contributions
Vesting also isn’t a concern for self-directed traditional IRAs, but for those plans that involve employees (such as SEP and SIMPLE IRAs), all employer contributions need to be made on time and vested immediately with employees. Unlike 401(k)s and some other retirement plans, employer contributions in employee IRA accounts can’t be subject to vesting schedules.
How to Set Up a Self-Directed IRA in 4 Steps
There are four major steps to set up a self-directed IRA to invest in alternative assets like real estate. The first and most important step is to choose the right self-directed IRA provider. After you’ve picked a provider, you may need to execute a plan agreement and prepare a notice to employees, depending on the type of IRA.
The four steps to set up a self-directed IRA include:
1. Choose a Self-Directed IRA Service
When you’ve decided to establish a self-directed IRA, the first step is to choose and contact the provider that’s best for you. This step is critical because if you don’t choose the right provider, you won’t be able to achieve your investment objectives or will end up paying higher costs than you should. If you want a checkbook IRA, be sure to choose a self-directed IRA service that offers this feature. Your provider will walk you through the rest of the steps depending on your particular situation.
2. Execute a Plan Agreement
For traditional self-directed accounts, you only need to complete typical provider applications. However, if you’re setting up a self-directed SIMPLE or SEP, you may also need to structure a plan agreement. These forms include IRS Form 5305-SEP or 5305-SIMPLE, which outline the respective rights and obligations of employers and employees.
3. Provide Annual Notice to Eligible Employees
If you’re setting up a self-directed retirement plan that involves employees (a SEP or SIMPLE, for example) you’ll need to prepare proper employee disclosures. These disclosures are required by the IRS and include information on your plan and the advantages of tax-free saving.
4. Set Up Account & Contribute
The last step of setting up a self-directed IRA is to use it and maintain it. This means preparing the account application and other forms required by your provider. Once your account is established, make sure to contribute regularly, choose investments consistent with your investment objectives, and take the steps necessary to make sure your account is properly maintained and investments are periodically reviewed.
Alternatives to a Self-Directed IRA
Self-directed IRAs are specialized products designed to help you invest in certain alternative assets. They are often used to invest in real estate as well as precious metals and other niche investments. While self-directed accounts are different from other types of IRAs, there are also different kinds of self-directed IRAs that vary widely.
Alternatives to SIMPLE IRAs include:
1. Traditional IRA
You have many more investment options in a self-directed account than a traditional IRA. However, in many other respects, these two types of accounts are very similar. You can only contribute $6,000 per year to either a self-directed or a traditional IRA ($7,000 if you’re over 50). Contributions are pre-tax but there is no matching, and you can make contributions any time prior to your tax-filing deadline for a given year.
2. Solo 401(k)
Solo 401(k) contribution limits are much higher than most self-directed IRAs. However, depending on your Solo 401(k) provider, you can get a lot of the same flexibility. You can read more in our article on the Best Solo 401(k) Providers.
You can also borrow against a Solo 401(k), which isn’t allowed in an IRA—even a self-directed IRA. Nevertheless, self-directed IRAs can be cheaper than a Solo 401(k), especially if you have checkbook control and work with a cost-efficient provider for your investing style.
3. SEP IRA
SEP IRA contribution limits are much higher than self-directed accounts. In a SEP, there’s more paperwork and you’re required to fund contributions for all employees proportional to your own contributions. However, it’s possible to have a self-directed SEP IRA, which can be the best of both worlds. A self-directed SEP offers high contribution limits but still requires that you contribute for all full-time employees whenever you contribute to your own account.
4. SIMPLE IRA
SIMPLE IRAs are designed for businesses with employees. SIMPLEs have contribution limits of $26,000, which are higher than traditional self-directed IRAs—but still not as high as SEPs or Solo 401(k)s. However, SIMPLE IRAs require employers to match employee salary deferrals up to three percent. There’s also additional IRS paperwork.
Compared to self-directed traditional IRAs, SIMPLE IRAs are a great way to encourage employee participation in a retirement plan. What’s more, it’s possible to establish a self-directed SIMPLE IRA, which can be a good balance for certain small company owners who want to encourage employee saving and give themselves the flexibility to invest in alternative assets.
Frequently Asked Questions (FAQs)
1. How much money can you put in a self-directed IRA?
There are different types of self-directed IRAs, so it depends on what type of IRA you set up. For traditional IRAs—which are the easiest to set up—you can contribute up to $6,000 per year ($7,000 if you’re over 50).
2. Can I borrow money from my self-directed IRA?
No, it’s not possible for an account owner to borrow money from a self-directed IRA because they’re considered a “disqualified person.”
3. What’s a self-directed IRA for real estate?
A real estate IRA is a self-directed account that’s set up specifically to invest in property. If you’re thinking about setting up a self-directed account specifically for this purpose, be sure to check out our article on the Ultimate Guide to the Self-Directed IRA for Real Estate Investing.
4. Can a self-directed IRA invest in an LLC?
Yes, a self-directed account can absolutely invest in an LLC. In fact, investing in private companies like LLCs is one of the biggest uses for self-directed IRAs. Setting up a checkbook IRA actually involves setting up an LLC that’s wholly owned by your IRA.
A self-directed IRA is a great tool for investing in alternative assets, including real estate, oil and gas, precious metals, or small private companies. However, the increased risk involved in these investments means that self-directed IRAs provide the most benefits for sophisticated investors who want to actively monitor their investments and administer their own accounts.