Learn How a Self-Directed IRA Can Help You Craft a Diversified Retirement Portfolio

Economists have been predicting an impending recession for the last few years – and while it may not be impacting your retirement account today, the bull market will eventually turn into a bear market. 

But even during tumultuous times, not all markets are impacted equally. This is actually great news for you. During the 2008 housing crisis, real estate and banking were heavily impacted. Other markets, like consumer staples, did not see the same negative trends. During the COVID pandemic, airlines, food services, and retail were dramatically affected. At the same time, healthcare boomed. Having investments in a variety of sectors means you’re able to grow your investments steadily and protect against inevitable economic waves. A diversified retirement portfolio allows you to withstand the ups and downs of the economy.

What makes a diversified portfolio? 

A diversified portfolio includes a variety of investments. You may be familiar with this idea specifically when it comes to your stock portfolio. This method is spreading your investments across big industries like tech stocks, energy stocks, and healthcare stocks — while also mixing them up among large-cap stocks, small-cap stocks, growth stocks, and dividend stocks. Your portfolio doesn’t necessarily need to include every sector — but a broad variety of stocks, both in industry and stock type, is what makes a good diversified portfolio. 

Beyond your stock portfolio, adding other types of investments to your retirement holdings can help you diversify even more. Being pigeonholed into traditional investments may mean you’re missing out on greater returns and big tax savings. Self-directed IRA investments are a powerful financial tool you can add to your retirement portfolio. These accounts allow you to put your money into less traditional investments, like real estate or private equity, while taking advantage of tax benefits and potentially higher returns. 

How Is a Self-Directed IRA Different from Conventional Investments?

Conventional investments are what come to mind for most people when they think of a “retirement account.” For most people, their retirement plan is a well-funded 401(k) account, vested in stocks, bonds, and mutual funds. This method has been preached as the tried-and-true way to build wealth and retire comfortably. However, given current market trends and inflation rates, it may not be the ideal retirement solution it once was. 

Self-directed IRA accounts offer more personal control and freedom in what type of investments you can make. By using these types of accounts you get access to the tax advantages of traditional investments, without the restriction of Wall Street-only commodities. You may also find these less conventional investments offer higher returns than the stock market. Common assets people like to include in their self-directed IRAs are things like real estate, personal loans, precious metals, private equity, and more. 

What is a Self Directed IRA?

A self-directed IRA is an alternative investment account used to invest in non-traditional assets while benefiting from the available tax advantages. You get the flexibility to choose what to invest in and this account can include a wider variety of assets than conventional options. If you are looking to diversify your retirement portfolio and step into more creative investments, a self-directed IRA may be an optimal solution for you.

A self-directed IRA allows for the same tax advantages as other IRA accounts. Per the IRS, ”For 2023, the total contributions you make each year to all of your traditional IRAs and Roth IRAs can't be more than $6,500 ($7,500 if you're age 50 or older)” This yearly contribution limit includes all your IRA accounts whether they are traditional, Roth, simple, self-directed, etc. 

This type of account offers options to invest in assets outside the stock market like real estate and private equity. These investments may offer higher returns and be less susceptible to shifting market conditions. If you are already investing in precious metals, real estate, or similar assets without using a self-directed IRA, you may be missing out on tax benefits. 

Traditional IRA vs Self-Directed IRA

A traditional IRA is funded with pre-tax dollars, deferring your taxes until withdrawal. When you take out the money with qualified withdrawals, it’s taxed as income. Traditional IRAs are offered by many banks and brokerages. You can easily open an account online in a few short minutes. You can invest in conventional assets like stocks, bonds, mutual funds, and ETFs.

These third-party companies are account custodians and have IRS compliance built into their infrastructure. They keep track of your gains and losses, automatically reporting your account contributions. With them acting as a watchdog, there is less room for mistakes.

Self-directed IRAs operate similarly to traditional IRAs when it comes to tax benefits. The big difference between the two is the type of investments you can have and the custodian responsibilities. With a self-directed IRA, you can invest in non-traditional assets like precious metals, private equity, and real estate (and more!). 

These accounts also require a custodian specifically for self-directed IRA accounts. Custodians are only responsible for holding and administering the assets. They are not in charge of verifying the validity of the investments. Self-directed IRAs also have complex IRS rules which means you as the investor need to be educated on the process to avoid prohibited transactions. 

Advantages of self-directed IRAs

The biggest benefit of a self-directed IRA is the flexibility to invest outside of traditional markets. You may already be investing in private equity or real estate. But if you’re not using an IRA as the vehicle for the investments, you could be losing out on tax benefits. 

Another advantage is that self-directed IRAs can be either traditional or Roth IRA accounts. This means you get to choose whether you want the tax benefits before you put your retirement funds in or after when it’s time for withdrawal. Regardless of which account you choose, make sure you stay within the contribution limits. 

Disadvantages of self-directed IRAs

With complex IRS rules and regulations surrounding self-directed IRAs, investors who want to be hands-off may not enjoy the work and education needed for the upkeep of this type of account. As previously mentioned, your custodian isn’t responsible for checking the soundness of your investments. You are in charge of verifying these investments are valid. 

If you like liquid assets, a self-directed IRA may not be your first choice. A downside of these non-traditional assets is they don’t often have the same liquidity as conventional investments. For example, if your funds are invested into real estate as a rental property – that asset will take time to sell. Even in a hot seller's market and the quickest closing possible, you are still looking at a minimum of two weeks. These types of assets don’t allow you to reallocate your funds as quickly as if you were selling off stocks from your 401(k) account – which only takes a couple of days to settle.

Traditional vs. Roth Self-Directed IRA

Both traditional and Roth IRAs can be self-directed. The biggest difference between these two accounts is whether you want to get your tax break upfront or on your withdrawals. There are benefits to both. The IRS contributions limit applies to all your IRA accounts regardless of their type. It is possible to have multiple IRA accounts, including self-directed, but you cannot go over the contribution limits in any given year.

A traditional IRA gives you the tax benefits upfront. You put money in tax-free and let it grow. Upon withdrawal, assuming you are doing so after age 59 ½ – the money you take out is taxed at your current income tax rate. This includes any money that has been accumulated as capital gains or net positive returns.

Roth IRAs give you the tax benefit on the back end. The money you put in has already been taxed at your current tax rate. While inside the account the money can grow and grow. When you make qualified withdrawals, that money is not taxed — including any gains on your investments. 

How Can I Invest My Self-Directed IRA?

There are a variety of ways to invest your retirement funds using your self-directed IRA. This freedom is what investors are seeking with this account. However, the IRS focuses more on prohibited transactions than investment opportunities. 

Let’s go over some common types of assets used with a self-directed IRA:

  • Real estate: With your SDIRA, you can purchase undeveloped land, single-family homes, multi-family residential properties, commercial or industrial properties. You can buy and sell properties within the account. 

  • Precious metals: Investing in gold, silver, palladium, and platinum is regarded as a great way to mitigate risk. They’ve historically increased in value decade after decade. When purchasing them with your SDIRA, your custodian will buy them on your behalf and they will need to be stored at a secure facility, per IRS regulations. 

Tax Implications of a Self-Directed IRA

Being “self-directed” means the account owner alone is responsible for the education and understanding of the risk of each investment. While your account custodian is responsible for holding and administering the assets — they are not liable for making sure the investment is good.

There is a complex set of tax rules and a list of prohibited transactions with self-directed IRAs. If you complete just one prohibited transaction, per the rules, that account is no longer an IRA and will be subject to taxes at the account’s fair market value. Because the rules are complex and specific, it’s best to seek out professional help to manage your self-directed IRA assets and transactions. 

How Chicago Trust Administration Services Can Help

A good custodian will make adding a self-directed IRA to your portfolio easy. You can roll over an existing 401(k) account into a new self-directed IRA. A quality self-directed IRA administrator will guide you throughout the process, protect your investments, and keep your account IRS compliant. If you’re ready to explore more creative options for your diversified retirement portfolio, the professionals at Chicago Trust Administration Services can help guide you through diversifying your investments with a self-directed IRA.  

A self-directed IRA is a great option for investors who want to be more involved in creating the retirement of their dreams. We have been helping investors like you for over seventeen years. 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.

Steven Miszkowicz