Self-Directed IRA vs. Traditional IRA: What’s the Difference?
There are a few different options to choose from regarding retirement planning. One of the most popular is the IRA, which comes in both self-directed and traditional varieties; this includes precious metals, bitcoin, and many more. So, what’s the difference? In this blog post, we’ll discuss the critical differences between self-directed and traditional IRAs, so you can decide which is right for you.
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TRADITIONAL IRAs
An IRA is a retirement account that people use to save money, unlike other retirement accounts. This account lets people put in a set amount of money every year and get a tax deduction. The money in the account can grow without being taxed, but people have to pay taxes when they take the money out since there’s no way to get a tax-deferred retirement account.
People usually establish an account with a broker, bank, or mutual fund. Then they can only invest in the stocks, bonds, or exchange-traded funds that the broker, bank, or mutual fund offers. It’s best to consult a financial advisor to make sure you’re investing correctly and get helpful investment advice.
SELF-DIRECTED IRAs AND ADVANTAGES
A self-directed IRA is like a regular IRA but with more investment options. You can only invest in approved stocks, bonds, mutual funds, and CDs with a self-directed traditional IRA. But with a self-directed IRA, you can also invest in real estate, precious metals, tax liens, limited liability companies, franchises, and more. This makes you less likely to lose money if one market sector goes down. Precious metals IRA is one of the most common types of investment, wherein you’re allowed to purchase gold and silver as an investment. You have to look for the ideal gold group to invest your money in.
There are about 2.5 million self-directed IRA accounts in the United States. The number of these accounts has grown significantly in the last few years. This is because the stock market has done poorly, the real estate market has grown, and it has been hard to get small business loans. The advantages of self-directed IRAs can be summarized as follows:
Tax Advantages:
A Self-directed IRA is like a regular IRA but with more tax advantages. You can put your IRA funds into any investment you want with a self-directed IRA. This includes assets that usually wouldn’t be allowed in regular IRAs. This way, you can keep more of your money and let it grow tax-free. The tax is paid later when you take the money out of your IRA financials instead of when you earn it. You don’t have to pay taxes on the money while it’s growing.
Investment Options:
By using a self-directed IRA, you can invest in nearly any type of investment. This includes real estate, private business entities, tax lien certificates, precious metals, and commercial paper. All of these investments are tax-free.
Diversification:
A self-directed IRA lets you invest in many different things, like real estate. This can help you to protect your retirement money from stock market crashes and other problems.
INVESTMENTS MADE BY SELF-DIRECTED IRAs
The IRS allows an account holder of self-directed IRAs to invest in various alternative investments that are not available from banks or brokerage firms. This includes stocks and bonds, but also a wide range of other options like:
- Residential or commercial real estate
- Domestic or Foreign real estate
- Raw land
- Foreclosure property
- Mortgages
- Mortgage pools
- Deeds
- Private loans
- Private equity
- Tax liens
- Private businesses
- Franchises
- Limited Liability Companies
- Limited Liability Partnerships
- Private placements
- Precious metals such as American gold or Silver eagles and certain coins that meet specific purity standards)
- Stocks, bonds, mutual funds
- Foreign currencies
A Self-directed IRA cannot invest in a few types of investments. These include:
- Collectibles (art, stamps, jewelry, rugs, baseball cards, etc.)
- Life insurance contracts
- The stock of an S corporation
There are various gold IRA guides you can view to help you purchase gold and platinum and other prescribed precious metals.
TYPES OF IRAs THAT MAY BE SELF-DIRECTED
Traditional IRA
A traditional IRA can be self-directed by opening an account with a Custodian who offers self-directed accounts.
Roth IRA
You can establish a self-directed Roth IRA by opening an account with a Custodian. This is not the same with traditional IRA, where your contributions are not tax-deductible. However, all earnings and principal in the Roth IRA are tax-free if you follow IRS rules.
With a traditional IRA, both the principal and earnings are taxable when you take money out. With a Roth IRA, you don’t get a tax deduction when you put the money in, but you can take the money out without paying taxes on it. This depends on your age, how much money you make, and what the tax rates are.
A SEP IRA is a kind of traditional IRA that is for self-employed people or small business owners. This kind of IRA has a lot of tax benefits, one of which is that you can contribute more money to it each year than you can with a traditional or Roth IRA. The limit for 2016 is the lesser of 25% of your income or $53,000. You can also direct where your money goes in this kind of IRA if you want to. You need to open a self-directed account with a company that offers self-directed IRAs to do this.
The following may open and contribute to a SEP. Anyone who:
- is a sole proprietor
- has a business partnership
- is a business account owner
- has self-employment income earned by providing a service
- is an employee of someone who establishes a SEP IRA for his/her employees
Simple IRAs
The Retirement Savings Incentive Match Plan for Employees IRA (SIMPLE-IRA) is an IRA set up by a small employer for employees. This IRA allows employees to make matching contributions and also elective contributions. Self-employed individuals may use these contributions, and they are attractive because you can make larger annual contributions than in a traditional IRA.
STEPS FOR ESTABLISHING A SELF-DIRECTED IRA
According to the law, almost all Self-directed IRAs are opened with a self-directed IRA custodian who provides Self-directed IRAs. If you don’t have an account with such a custodian, there are only two easy actions to take:
- Select the appropriate custodian.
There is a lot of variation among self-directed IRA custodians as to how much experience they have, how much they charge for holding your investments, and the quality of service they provide. To open an account with most custodians, you must sign an application, provide a copy of your driver’s license, and choose a payment method.
- Fund the Account.
There are three methods to put money into your self-directed IRA:
Contributions
You can make annual contributions to a self-directed IRA. The annual contribution amount depends on several factors, including how much you get paid and what type of IRA you have. Most people who establish a self-directed IRA will not rely on contributions to fund it. Instead, they will transfer money from an existing retirement plan into their new self-directed IRA.
Rollover
When you take money out of your IRA or other qualified retirement plans, this is called a rollover. You can ask for the money to be paid directly to the company that will hold your IRA, or you can get the money and then put it into the IRA yourself.
There are a few disadvantages to getting the money yourself. You have 60 days to put the money into an IRA, or else it becomes taxable. The 60 day period starts the day after you get the money. Usually, there are no exceptions to this rule, but taxes may be taken out of the distribution, so you might not have as much money to put into your IRA.
Transfer
An IRA transfer is when you move your money from one company that manages IRA accounts to another company. This is done by telling the first company to send the money to the second company. The receiving company will take care of it from there.
In most cases, you can’t just take your money out of a retirement plan that your employer set up for you. This includes 401k, 403b, and profit-sharing plans. Usually, in order to move the money into a Self-directed IRA, something has to happen that makes it possible.
Generally, a plan-triggering event is based on what is allowed by your employer’s plan documents. Most plan documents allow a rollover under the following circumstances:
- When the plan ends.
- When the participant reaches age 591/2.
- When the participant leaves the employer.
To see if you can rollover retirement funds from your employer’s plan, you should consult the plan documents or administrator.
For more information about individual retirement accounts, click here.
Frequently Asked Questions about Self-Directed IRA vs. Traditional IRA
A self-directed IRA is a form of traditional or Roth IRA. You save for retirement on a tax-advantaged basis, and the contribution limits are the same. The only difference between self-directed and other IRAs is what kind of assets you own in the account.
The self-directed IRA may be your solution if you have an investment plan that a traditional IRA account doesn’t support. But be aware of the responsibility that comes with it. It’s your job to vet your opportunities, make informed investment decisions, and avoid prohibited transactions.
Fees and charges for self-directed IRAs vary. At IRAR, the flat yearly fee is $199 for one asset and $274 for two assets. Other SDIRA custodians can charge anywhere from $199-$2,000.
An individual retirement account (IRA) allows you to put money into the account before paying taxes. The money can then grow without being taxed. You will have to pay taxes when you take the money out of the account, but your current tax rate will still apply.
Your retirement tax professional will help you set up a new Self-Directed IRA account with a new FDIC and IRS-approved IRA custodian. The new custodian will then request the transfer of your IRA assets from your current IRA custodian. This transfer will be tax-free and penalty-free.
You will need a custodian or trustee who offers a self-directed IRA. Pick the investments you want to make. Find a broker to purchase the asset. Ask the custodian to complete the transaction.
People who have a self-directed IRA can choose to invest in LLCs. But the directed IRA LLC must follow the IRS’s rules. This is especially true of rules about disqualified parties or prohibited transactions. It is also essential to know that LLCs might generate income that could create a tax liability for the IRA. Knowing the LLC membership interest is also important to help you gauge whether you’re earning or not.
The money you contribute to a self-directed IRA may be deductible on your tax return like a traditional IRA. The money in the account will grow without being taxed, and when you take the money out of the account, it will be taxed as income.
If you’re an investor, you might want to roll over some (or all) of your pre-existing self-directed retirement account into a new Self-Directed IRA. In this way, you can keep your 401(k) with your current employer. This will give you more control over where and how your money is invested.
