Money Girl

What is a Self-Directed IRA (SDIRA)?

Episode Summary

Find out how a self-directed IRA differs from a regular one, who can benefit from using one, and other types of self-directed accounts you might consider.

Episode Notes

Find out how a self-directed IRA differs from a regular one, who can benefit from using one, and other types of self-directed accounts you might consider.

Money Girl is hosted by Laura Adams. A transcript is available at Simplecast

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Episode Transcription

If you're considering opening a retirement account or have already been shopping for one, you've probably seen the option to open a self-directed IRA or SDIRA. This show will review what a self-directed IRA is, how it differs from a regular IRA, who might benefit from having one, and other types of self-directed retirement and medical spending accounts.

Hi, everyone, and thanks for joining me this week! I'm Laura Adams, a personal finance expert hosting the Money Girl Podcast since 2008, with over 42 million downloads. I'm the founder of The Money Stack, a weekly newsletter helping you build your bank account and live rich on your terms. I also work with select brands doing on-camera and writing work as a financial spokesperson and female money speaker.

As always, you can reach me using my contact page at That's also where you can learn more about my newsletter, books, and money courses. Got a money question or idea for a show topic? Call 302-364-0308 and leave me a message.

What is a self-directed IRA (SDIRA)?

A self-directed IRA is a type of IRA where you choose investments instead of the account custodian. While there's typically a custodian to oversee rules and administration, account owners can make almost any investment they choose. 

For instance, you could own precious metals, commodities, business partnerships, cryptocurrency, private equity, real estate, or tax liens in a self-directed retirement account. That's different from a regular retirement account, which prohibits alternative investments and limits you to a conventional menu of stocks, bonds, mutual or exchange-traded funds, and CDs.

However, the IRS does forbid certain investments in self-directed retirement accounts, including life insurance, collectibles, and transactions with a disqualified person (including yourself). That means you can't use SDIRA funds to buy antiques, art, or coins. 

Nor can you invest in anything considered "self-dealing," which means doing business with yourself. For instance, you can't lend money to yourself from the account, take income from it, or benefit from an asset in a self-directed retirement account in any way.

In other words, you can't buy a property using SDIRA funds and use it as a vacation home for part of the year–or offer the property to your relatives. But you can own rental property inside a self-directed account and rent it to the public. You just have to put all income the property makes back into the account. 

You're also not allowed to contribute sweat equity to property in your self-directed retirement account, like doing maintenance and repairs. So, even if you're a plumber, it's technically against the rules to fix a dripping faucet on a property you bought with self-directed retirement funds. Saving money by doing handiwork yourself isn't allowed because it's an indirect benefit.

Another rule prohibits owning a business inside a self-directed retirement account if a close relative, like your spouse, sibling, or child, owns more than 50% of it. You also can't invest in any entity where you're an officer, director, highly compensated employee, or a 10% or more shareholder.

If you violate the self-dealing rules of a self-directed retirement account, you can lose its tax status. That means you'd owe taxes on the entire value plus a 10% early withdrawal penalty if you're under age 59.5.

So, before making any questionable investments with self-directed funds check with a financial or tax advisor to ensure you don't inadvertently violate the account rules.

What are SDIRA contribution and withdrawal rules?

You can have a traditional self-directed retirement account, which allows tax-deductible contributions and tax-deferred growth, or a Roth, with after-tax contributions and tax-free growth. A self-directed retirement account has the same tax advantages as the regular equivalent.

For 2024, you can contribute up to $7,000 or $8,000 if you're over 50 to a traditional or Roth self-directed IRA. There are also income limits for participating in a Roth self-directed IRA, just like a regular one. If you're self-employed, you qualify for a self-directed retirement plan with much higher contribution limits that I'll cover in a moment.

When you reach age 73 (or 75 starting in 2033), you must take the required minimum distributions (RMDs) from a traditional self-directed or regular IRA and pay income taxes. The withdrawal amounts change annually based on your account balance and a life expectancy table published by the IRS. 

However, there are no RMDs for a Roth self-directed or regular IRA. If you take distributions before age 59.5 from a traditional or Roth account that weren't previously taxed, you must pay income taxes plus a 10% penalty. Those same rules apply to self-directed accounts.

READ ALSO: Think you’re too rich for a Roth? Think again

What are the pros and cons of an SDIRA?

While SDIRAs have many advantages, be sure you understand their cons. The main pros include:

The downsides of an SDIRA include strict investing rules that could be easy to violate accidentally. As I mentioned, that could jeopardize the precious tax status of your account, making you responsible for income taxes plus a 10% penalty if you’re younger than 59.5. Another cons is typically paying higher account fees compared to a regular IRA, which cuts into your earnings.

However, the most significant drawback of a self-directed retirement account is that many investments you might hold are not liquid. For example, you can sell a stock or exchange-traded fund immediately if you need income in retirement or need to take an RMD. 

But if you own a business, rental home, or apartment building inside your retirement account, they could take years to sell, depending on the market. And the penalty for failing to take a timely RMD is a hefty 25% of the amount you were required to take but didn’t. However, there is an exception that reduces the RMD penalty to 10% if you correct a shortfall within two years. 

The bottom line is that when you have a self-directed retirement account with alternative investments not easily liquidated, you must create a careful strategy to sell them so you comply with RMDs that begin after age 73. 

RELATED: Can you contribute to a 401(k) and an IRA in the same year?

Other types of self-directed retirement accounts

In addition to SDIRAs, there are self-directed accounts for the self-employed that are governed by the same IRS rules as for regular accounts. They include a self-directed solo 401(k) for small business owners with no full-time employees other than a spouse. You can also choose a self-directed SEP IRA, which is a retirement plan for small businesses with or without employees.

For 2024, the combined employer and employee contribution limits are $69,000 for a self-directed solo 401(k) or SEP-IRA. There is an additional $7,500 catchup contribution allowed for solo 401(k) participants over age 50, bringing their total to $76,500.

Many people don't realize you can also have a self-directed health savings account (HSA) that works like a regular HSA, helping you cut health care expenses–if you have an HSA-qualified health plan. Your contributions and earnings are tax-free if used for qualified expenses, like medical, dental, vision, hearing, and alternative care costs.

READ ALSO: 4 common HSA mistakes and how to correct them

How do you open a self-directed retirement account?

You can open a self-directed IRA or other retirement plan with many banks, credit unions, or other financial institutions. Some may specialize in offering accounts for specific alternative assets, such as cryptocurrency or precious metals. They'll have a custodian who administers the account, holding your investments for safekeeping and ensuring you comply with IRS rules.

Once your self-directed retirement account is open, you can roll over funds from an existing retirement account or make a new contribution. Then, you can purchase any asset that isn't prohibited.  

For instance, if you transferred $250,000 from a regular Roth IRA to a Roth SDIRA, you could use the money to buy a $200,000 rental property and list it on Airbnb. The expenses to repair and maintain the property would have to come from the SDIRA, and you'd have to deposit all profits back into it. Remember that you couldn't benefit personally from the rental property in any way, or you'd violate the account rules.

Let's say you keep the rental property in your Roth SDIRA for 20 years before selling it and retiring. If its value appreciated from $200,000 to $500,000, your $300,000 gain would be entirely tax-free. 

Neither an SDIRA institution nor a custodian can offer investment advice to account holders, so do your own research carefully.

SDIRAs can be an excellent choice for savvy investors who deeply understand alternative investments and want more diversification, responsibility, and control than conventional financial products. However, SDIRAs may be too advanced for novice investors who can earn sufficient growth from a regular IRA with mainstream investments like index funds. 

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That's all for now. I'll talk to you next week. Until then, here's to living a richer life.

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