So, What is a Self-Directed IRA Anyway?

1 Jan 2020

So, What is a Self-Directed IRA Anyway?
Breaking Down the Answer to a Very Loaded Question

What is a self-directed IRA? Believe it or not, that is actually a very loaded question.

In order to really begin to define the concept of a self-directed IRA, we must define three terms:

1. IRA: a type of financial account that gives you tax breaks in exchange for saving and investing for retirement.

2. Self-Directed IRA: a type of IRA that permits you nearly unlimited freedom in how you invest your retirement savings.

3. Captive IRA: a type of IRA that imposes limits on the asset types that can be purchased within the IRA (other than those imposed by the IRS).

As you can see, there are two clear categories of IRA: self-directed and captive. In almost every way, those two categories are identical. The tax benefits are the same. The contribution limits are the same. Nearly everything is the same when comparing self-directed and captive IRAs.

However, in one very substantial way they are absolutely the opposite of each other. That difference is all about the amount of control that you, the investor, have over your own investments.

A self-directed IRA permits you nearly limitless investment options, including:

-- Real estate
-- Privately held companies
-- Precious metals
-- Cryptocurrencies
-- Private loans
-- Nearly anything else

The Two Prohibited Asset Classes for Self-Directed IRAs

1. Life Insurance
2. Collectibles

On the other hand, a captive IRA is limited not by the relatively few regulations governing investments imposed by the IRS but by the financial institutions offering the account to investors.

Why would they do that?

Simple. Most financial institutions who offer IRAs do so as a way to compel their customers to purchase that institution's investment products. If a stock brokerage offers an IRA, they are probably going to restrict you to investing in stocks. If a mutual fund company offers an IRA, they are probably going to restrict you to investing in mutual funds. In this way, the IRA owner is "captive" to the restrictions placed on their account by the IRA provider, but these restrictions are not imposed by the law.

At its core, a self-directed IRA is just a way for you to build your retirement savings by investing in assets that you actually know and understand.

On the other hand, a captive IRA is limited not by the relatively few regulations governing investments imposed by the IRS but by the financial institutions offering the account to investors.

Why would they do that?

Simple. Most financial institutions who offer IRAs do so as a way to compel their customers to purchase that institution's investment products. If a stock brokerage offers an IRA, they are probably going to restrict you to investing in stocks. If a mutual fund company offers an IRA, they are probably going to restrict you to investing in mutual funds. In this way, the IRA owner is "captive" to the restrictions placed on their account by the IRA provider, but these restrictions are not imposed by the law.

Setting aside technical definitions, you should think of your self-directed IRA as a means to an end. It's a tool for you to use to the best of your abilities. As a self-directed investor, it is your responsibility to leverage those abilities when you can and know when to leverage someone else's abilities instead of your own. That is the responsibility that comes with self-directing your retirement account.

If you are a skilled real estate investor, for example, then it makes all the sense in the world for you to focus some of your retirement investments into real estate. On the other hand, if you are a whiz at identifying potential in pre-IPO companies or spotting opportunities in patents and copyrights, then you will want to focus some of your assets there. If you thrive in the cryptocurrency environment, then it only makes sense to put some of your retirement capital there.

You get the idea: You should have the opportunity to invest your retirement savings into the best asset classes for you because those are the assets in which you are most likely to experience the kind of results you need to make your retirement years as grand and glorious as you have always hoped they would be.

The choice is really quite simple: Allow Wall Street and the conventional financial world to decide for you how you should invest your hard-earned retirement savings or decide for yourself how you will invest that capital. If you choose the former, then using a captive IRA will be the right choice for you. If the latter, then you will need a self-directed IRA.

Of course, not everyone should use a self-directed IRA. Not everyone has the ability or the inclination to direct their own retirement. Those people will be better off using a captive IRA because they need someone else to direct their retirement so it does not sit and stagnate.

However, if you are reading this magazine, the odds are pretty good that things like real control, autonomy in investing, the ability to make your own decisions rather than having limits forced on you, creativity, and flexibility in investing matter to you. In that case, a self-directed IRA will be an extraordinary thing for you because it fits the bill exactly.

A self-directed IRA is a tool that allows you to save and invest for retirement for who you are, using your best knowledge and experience, and reflecting your values and preferences rather than those of Wall Street!

by Bryan Ellis

Access Bryan Ellis's entire "Self-Directed IRA Fundamentals" course online at SDIMagazine.com/academy. Bryan Ellis is the founder of Self-Directed Investor Society, host of the popular podcast SDI Talk, and publisher of Self-Directed Investor magazine.

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