The self-directed IRA is a retirement account vehicle that allows investors to use retirement funds to buy alternative assets, such as real estate.
A self-directed IRA is not a term of art and you will not find it anywhere in the Internal Revenue Code.
A self-directed IRA simply refers to an IRA account which is permitted to be invested in traditional assets, such as stocks, but also alternative assets, such as real estate, precious metals and tax liens. In the last several years, the number of self-directed IRA accounts has grown significantly.
The Internal Revenue Code does not describe what a self-directed IRA can invest in, only what it cannot invest in. Code Sections 408 & 4975 prohibits Disqualified Persons from engaging in certain types of transactions.
In general, as long as the self-directed IRA does not purchase life insurance, collectibles, or engage in a prohibited transaction outlined in Code Section 4975, then the investment can be made.
There are essentially three types of self-directed IRAs:
- Financial Institution Offered Self-Directed IRA
The most popular self-directed IRA account offered is the financial institution self-directed IRA. The reason that this type of self-directed IRA is so popular is because it is generally offered by most banks and major financial institutions.
With this type of self-directed IRA, the IRA holder is able to only make IRA investments offered by the financial institution, which typically include financial related investments, such as stocks, mutual funds, and ETFs.
A financial institution self-directed IRA is popular with retirement investors interested in investing in traditional assets.
- Custodian Controlled Self-Directed IRA
A custodian controlled self-directed IRA offers an IRA investor more investment options than a financial institution self-directed IRA. With a custodian controlled self-directed IRA, a special IRA custodian will serve as the custodian of the IRA.
Unlike a typical financial institution, most IRA custodians generate fees simply by opening and maintaining IRA accounts and do not offer any financial investment products or platforms.
With a custodian controlled self-directed IRA, the IRA funds are generally held with the IRA custodian and at the IRA holder’s sole direction, the IRA custodian will then invest the IRA funds into traditional or alternative asset investments.
A custodian controlled self-directed IRA is popular with retirement investors looking to invest in alternative assets which do not involve a high frequency of transactions, such as the purchase of raw land or private fund investments.
- “Checkbook Control” Self-Directed IRA LLC
The self-directed IRA LLC with “checkbook control” is increasing in popularity as a vehicle for investors looking to make alternative assets investments, such as rental properties, that require a high frequency of transactions.
Under the Checkbook IRA format, a limited liability company (“LLC”) is created, which is funded and owned by the IRA and managed by the IRA holder.
The “checkbook control” self-directed IRA allows one to eliminate certain costs and delays often associated with using a full -service IRA custodian.
The Checkbook IRA LLC structure allows the investor to act quickly when the right investment opportunity presents itself cost effectively and without delay.
A “checkbook control” self-directed IRA LLC is popular with retirement investors seeking to invest in alternative assets, such as rental properties, fix and flips, tax liens, or cryptocurrencies that require a high frequency of transactions.
Using a self-directed IRA to make investments with your retirement funds can prove to be a great way to better diversify ones retirement portfolio, as well as gain the opportunity to invest in hard assets you know and understand. However, one should consult with his or her investment adviser or tax professional for more specific information on this subject.
