Self-directed IRAs give investors maximum investment freedom and expand your options beyond what’s possible with traditional IRAs, yet this freedom comes with considerable responsibility: finding and vetting investment opportunities while avoiding prohibited transactions are your sole responsibility.
If you break any IRS regulations, penalties and taxes could ensue; certain investments such as life insurance or collectibles that do not meet purity standards could even be prohibited entirely.
1. They come with higher fees
Self-directed IRAs may provide greater investment options than traditional retirement accounts offered through brokerage firms; however, investors should carefully evaluate the higher fees associated with these kinds of accounts and consult an impartial financial expert regarding risks and rewards involved when investing in alternative assets that may experience greater market volatility or inflation risk.
These investments may also not be as liquid as stocks and mutual funds; for example, real estate purchases and sales may take months; investors should also keep in mind the possibility that they might not be able to sell their property at a profit in an emergency situation.
Importantly, keep in mind that the IRS has stringent regulations regarding how your retirement account funds should be spent and can impose significant penalties if any rules are broken. Red flags for compliance violations include brand new investment companies promising unreasonable levels of return as well as investments bought or sold with disqualified people such as friends or relatives.
2. They have a lot of rules to follow
Self-directed IRAs offer many advantages to those willing to assume greater responsibilities, including greater investment choices and flexibility when selecting investments, alternative assets for higher returns and diversifying beyond traditional stock market investments. But these perks come at the price of potentially higher risks and additional fees.
SDIRA investors who wish to comply with IRS rules must conduct extensive due diligence on themselves and vet investments prior to investing, in addition to avoiding prohibited transactions. This requires performing extensive due diligence when investing in alternative assets which don’t provide as much transparency – for instance when purchasing precious metals bars or cryptocurrency such as Bitcoin – making sure it satisfies purity standards and isn’t being sold on untrustworthy exchanges.
But that can be problematic, because it is far too easy to run afoul of the IRS with even one bad move. In fact, they will void an entire account if they suspect any violation of its rules governing which assets can be included in an IRA and how those assets should be utilized – leading to either a large tax bill or losing future tax benefits on savings. It would be prudent to consult an expert prior to investing in any self-directed IRA so you know all its risks and rules fully.
3. They often deal with high-risk investments
Self-directed IRAs allow for greater variety in investments, but some are high risk. According to the Securities and Exchange Commission, criminals often target those with self-directed IRAs and sell fraudulent investments that come with unrealistically high levels of return and no third-party verification. Be wary when purchasing such an account! Red flags include brand new investment companies claiming unrealistically high levels of return as well as lack of third-party verification of returns promised.
Investors must also exercise extreme caution when investing in non-traditional assets like physical gold and real estate, which are typically purchased on specialized exchanges without offering the same level of transparency as stocks, ETFs and mutual funds. Selling them when needed may take more time and yield less return than originally paid for the asset in the first place.
Investment in alternative assets can offer diversification and leverage your industry knowledge, but it’s crucial that you work with a professional advisor in order to make sound choices. And remember: any violation or prohibited transaction with an IRA could lead to costly tax bills and penalties; prohibited transactions include investing in life insurance policies, collectibles or properties you reside in (such as rental properties) while you cannot use your IRA to buy/sell cryptocurrencies like Bitcoin.