Self-directed IRAs enable you to invest retirement savings in assets not typically offered by brokerage companies, such as real estate, private company stock or promissory notes – often offering higher rates of return than traditional stocks, exchange-traded funds and mutual funds.
However, these investments can be harder to verify and pose greater risk for fraud. You should carefully review and verify all information provided on your account statements.
Taxes
Self-directed IRAs allow retirement savers to invest in alternative assets like real estate or private equity, which may offer higher returns than traditional investments. Unfortunately, this account comes with higher fees and more complicated recordkeeping responsibilities; additionally it may be challenging to locate an approved custodian willing to handle specific asset classes.
An IRA owner should perform extensive research before investing. Red flags to look out for include new companies claiming unrealistically high levels of return, no third-party oversight and promoters using an IRA to market their own investment opportunities.
Unrelated business income tax, or UBTI, applies to profits associated with non-traditional investments such as real estate. When an IRA invests in such companies they incur an unrelated business income tax that applies only when their trade or business falls outside the “specified service trade or business” definition imposed by law.
Fees
Self-directed IRAs may provide more investment options than traditional retirement accounts; however, their increased fees and complexity can sometimes come at the cost of increased complexity. For instance, investing in alternative assets typically requires additional documentation, while adhering to IRS rules could incur extra taxes and penalties if violations occur.
As alternative assets can be difficult to value, it’s vital that account holders carefully verify all information in their statements regarding prices and asset valuation, according to Merryman.
Equity Trust and uDirect provide low or no transaction or maintenance fees. Pacific Premier Trust and Rocket Dollar also have low fees for both IRAs and 401(k) plans. Despite having lower transaction or maintenance fees than traditional IRAs due to their more complex nature (real estate for instance might incur annual mortgage interest, depreciation, repairs and insurance fees that wouldn’t exist otherwise). However, this doesn’t reduce operating costs significantly for self-directed IRAs, with annual mortgage interest costs, depreciation, repairs costs as well as insurance costs not present in more traditional IRAs compared to traditional ones despite any savings due to lower transaction or maintenance fees being collected by custodians like Equity Trust or Rocket Dollar offering competitive fees at very competitive prices for their clients’ 401(k).
Investing
Self-directed IRAs may offer greater investment flexibility, but they come with their own set of risks that traditional IRAs don’t. For instance, investments such as real estate or precious metals may require special knowledge about regulations associated with them and may take longer to sell when needed. Furthermore, some assets may be less liquid which increases liquidity risk significantly when selling quickly when needed.
Some investors may be tempted to forgo due diligence out of convenience or overconfidence, leaving themselves vulnerable to fraud. SDIRAs should be protected with strong passwords and two-factor authentication whenever possible; safe digital document storage solutions also help safeguard against theft or unauthorised access of IRA paperwork, contracts and communications.
Self-directed IRAs may offer smart investors higher returns and greater diversification, outweighing any additional risk they present. But for investors with limited time and income who are looking for safety in retirement savings goals, traditional IRAs might be better.
Risks
Self-directed IRAs may provide greater potential returns than traditional IRA assets; however, they also carry greater risks. Investors must adhere to IRS regulations regarding prohibited transactions and guidelines — for instance making sure a disqualified person doesn’t reap benefits from an SDIRA-owned asset.
Lacking regulatory oversight, alternative investments can often be less transparent than publicly traded securities, making it harder for IRA owners to verify financial information on these investments accurately and verifying financial details, with some also having limited liquidity due to longer holding periods, restricted redemptions or no market on which to trade them.
Individuals interested in opening a self-directed IRA should first consult an impartial financial professional before making any major investment decisions. Signs of fraud to watch out for include new investment companies with unreasonably high claims of return and no third-party audit or review by a recognized accounting firm.
