Should You Create a Self Directed IRA?: Part 2

Previously, we discussed some of the basics of self-directed IRAs, and what sets these retirement accounts apart from other plans, such as Roth IRAs or 401ks. For the second piece of this two-part post, we’ll cover some of the more specific details about self-directed IRAs, including their unique advantages and disadvantages. With this information, you can weigh the pros and cons - and ultimately decide if this type of retirement account is right for you.

Benefits of a Self-Directed IRA

Self-directed IRAs come with a host of benefits, the most important of which is the wide range of assets you can add to them. As we discussed in Part 1, investors can add much more than just stocks and bonds to this type of IRA account; real estate, private equity, partnerships, and even precious metals can all be contributed. Other advantages include:

• Being able to invest in what you know about, and having total control over it.
• Not limited to the offerings of an IRA custodian.
• Ability to truly diversify your retirement portfolio, rather than relying on the stocks, and mutual funds that the average investor uses.
• Ability to partner with friends, family, or trusted colleagues for even bigger savings.
• The use of commodities to better protect yourself from a fluctuating economy.

Disadvantages of a Self-Directed IRA

While self-directed IRAs come with a strong set of benefits that appeal to many investors, we can’t ignore the account’s inherent disadvantages. They are:

• Self-directed IRAs usually involve just one asset class, which can significantly increase risk.
• Like other types of retirement accounts, self-directed IRAs don’t always have the liquidity you need. There are caps to how much new money can be contributed ($5,500 or $6,500 depending on your age), and if something goes awry (say, your rental property needs a new roof), you may not have the reserve cash to repair your asset.
• Required minimum distributions are present in many types of retirement accounts, but RMDs can be especially hazardous with the illiquid self-directed IRA. If your asset isn’t generating enough income to pay the distribution, you may be forced to sell some or all of it just to meet the RMD deadline.
• The IRS has a pretty lengthy list of prohibited transactions where self-directed IRAs are concerned. Some of these include not being able to lend or borrow from the account, not being able to buy property directly from you (the individual), and not being able to do business with a company you own (for instance, if you own a roofing company, you can’t hire your own company to fix the roof on your asset).

Is a Self-Directed IRA Right for You?

Now that you know some of the pros and cons associated with self-directed IRAs, it’s time to think about whether this retirement account will work for you. Obviously, the decision to place investments in a self-directed IRA is entirely up to you - you know your situation the best, after all - but remember this: these types of accounts are not usually recommended for the casual or novice investor. There are a lot of nuances and subtleties to familiarize yourself with, not to mention the risk that can be present. However, if you’re wanting to really diversify your retirement portfolio and you have the knowledge and experience to confidently manage your own assets, then a self-directed IRA might be an avenue you wish to explore.