6 Myths Debunked: What You Should Know About Self-Directed IRAs
Uncertainty around retirement is at an all-time high, and you’ve likely felt it yourself. Concerns about the future of our Social Security system, rising inflation, and the increasing cost of living have left many of us wondering anxiously how we’ll fund our later years. And in a volatile market, the traditional investment options available in retirement accounts can feel especially limiting, with few alternatives.
More than ever, investors are looking for ways to take better control of their financial future.
Self-directed Individual Retirement Accounts (SDIRAs) can be an exciting avenue for opportunity: They offer greater flexibility and control over retirement investments, and the ability to diversify into alternative investments beyond traditional stocks and bonds.
However, misinformation often holds investors back from taking the leap into SDIRAs. There are widespread misconceptions about what these accounts allow, how they’re regulated, and who can benefit from them.
By clearing up some of the biggest myths about SDIRAs, you can make more informed decisions about your investment strategy and work toward your financial goals.
Myth #1: Self-Directed IRAs Aren’t a Legal Retirement Strategy
Some investors may assume that self-directed IRAs operate in a legal gray area: a financial loophole that exists only until the IRS decides to shut it down. It’s an understandable assumption; after all, SDIRAs allow investments in assets that traditional IRAs don’t include, such as real estate, private equity, and startups.
But does that mean that SDIRAs are legally questionable?
Absolutely not.
SDIRAs have been legal since IRAs were introduced in 1974 with the Employee Retirement Security Act (ERISA). They’re governed by the same regulations as traditional IRAs but allow for a broader range of investment options. SDIRAs aren’t limited to stocks, bonds, and mutual funds, as they are with traditional IRAs; through an SDIRA, you can invest in alternative assets.
With that flexibility, however, comes greater responsibility; it’s important to follow IRS rules carefully to avoid any penalties.
Myth #2: Self-Directed Retirement Planning Is Only for the Wealthy
A common misconception is that self-directed IRAs are an exclusive tool only for the ultra-wealthy—those who have the time, capital, and expertise to navigate alternative investments.
If you don’t have millions in assets to invest, is an SDIRA even worth considering?
The answer is yes.
Any investor can open and benefit from an SDIRA. While higher net-worth individuals often leverage SDIRAs for tax-efficient wealth building, these accounts are just as accessible to those with more modest retirement savings. The IRS doesn’t require a minimum balance to open an SDIRA, and contribution limits are the same as traditional IRAs.
Investors at all levels can use SDIRAs to diversify their portfolios, whether through investing in rental properties, private businesses, or other alternative asset classes. If you’re already invested in real estate, venture capital, or private lending, an SDIRA simply offers you a tax-advantaged way to keep doing what you’re already doing.
Myth #3: You Can Do Whatever You Want In a Self-Directed IRA
Total investment freedom: It’s an appealing idea, and some investors mistakenly believe that an SDIRA gives them unrestricted access and use of their retirement funds.
Can you use an SDIRA to buy a vacation home? Loan money to your small business? Invest in a relative’s startup?
No; the IRS has clear prohibited transaction rules to prevent self-dealing, or using your funds to benefit yourself. These rules exist to ensure that retirement funds are used for investment purposes and not personal gain, and breaking them can result in severe tax consequences.
The key prohibitive rules include:
Transactions with Disqualified Persons: You cannot engage in any direct or indirect transactions with disqualified persons, including yourself, your spouse, your children, your grandchildren, or your parents. This includes any entities owned 50% or more by a disqualified person.
Personal Use of Assets: You cannot use your SDIRA for personal benefit. For example, if your SDIRA owns a rental property, you and your family are prohibited from staying there. Income (such as from your SDIRA rental properties) cannot be deposited into personal accounts, but must instead be put back into your SDIRA.
Investing in Disallowed Assets: You cannot use your SDIRA to invest in assets that are classified as disallowed by the IRS. This rule applies to all IRAs, including SDIRAs. Disallowed assets include collectibles such as artwork or antiques, and any type of life insurance.
Myth #4: Self-Directed IRA Tax Rules Differ From Other IRAs
Another common misconception is that self-directed IRAs come with different or additional tax advantages. If an SDIRA allows alternative investments, does that mean it comes with unique tax breaks?
No, there aren’t any special tax advantages. SDIRAs follow the same tax rules as traditional and Roth IRAs.
Traditional SDIRAs offer tax-deferred growth, meaning you don’t pay taxes on any gains until you take distributions. Roth SDIRAs are funded with after-tax dollars, allowing for tax-free withdrawals in retirement.
Myth #5: Self-Directed Retirement Planning Is Too Risky
We all know that investing always carries risk. But are SDIRAs inherently more dangerous than traditional IRAs?
Not necessarily; the level of risk in your SDIRA depends on how you invest.
If you make speculative, high-risk investments, your SDIRA could lose value. But if you diversify and perform careful due diligence, an SDIRA can be less volatile than a traditional stock-heavy portfolio.
Investors often use SDIRAs to invest in real estate, private equity, or private lending—assets that can potentially provide more stability than public markets. The key is to do your homework, assess risk carefully, and consult with professionals when needed.
Myth #6: Self-Directed IRAs Are Too Complicated to Set Up
Many investors assume that setting up an SDIRA is a significant logistical challenge, requiring constant oversight and endless paperwork. If traditional IRAs are set-and-forget, do SDIRAs require continuous handling?
Not at all. Opening and maintaining an SDIRA is simpler than most think. The process typically involves choosing a reputable SDIRA administrator; funding the account through a rollover, transfer, or contributions; and selecting and directing your investments, with your SDIRA custodian ensuring compliance.
While SDIRAs do require more decision-making than traditional IRAs, they don’t have to be overwhelming. A well-structured investment strategy with the right professional support can make managing an SDIRA straightforward and rewarding.
Build the Retirement You Want with Self-Directed IRAs
Self-directed IRAs are a powerful tool for investors looking to diversify their retirement investment strategy. They’re legal, accessible, and tax-advantaged, but they require thorough due diligence and discipline. With the right approach, SDIRAs can help you build long-term wealth while staying aligned with your financial goals.
Ready to explore your options? At Chicago Trust Administration Services, we have the industry know-how to help you navigate self-directed retirement planning. We provide the necessary regulatory guidance for your SDIRA transactions, so you can invest with confidence and take control of your financial future.
To see how we can help, we invite you to schedule a complimentary meeting with us by calling 312-869-9394 or emailing steve@ctasira.com.
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*The content and opinions in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
**CTAS professionals are not financial advisors and cannot provide advice or recommendations regarding specific investment decisions.