What is a Self-Directed IRA & How It Works?

Kevin Mercadante is professional personal finance blogger, and the owner of his own personal finance blog, OutOfYourRut.com. He has backgrounds in both accounting and the mortgage industry. He and his wife are "empty nesters" living in New Hampshire.

Did know you can invest in assets like precious metals, crypto, and fine art inside your retirement account? Well, a self-directed IRA provides you with these opportunities.

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Self-directed IRAs offer investors a way to manage assets outside of the paper assets common to most retirement accounts. However, there are some factors to consider for these accounts, including asset choice, associated fees, and liability. 

Most folks are familiar with the traditional and Roth IRA and these accounts’ ability to provide tax benefits for retirement funds. However, these accounts don’t allow for every asset an investor might want to use to build up their retirement fund.

As of 2016, roughly half a million investors use self-directed IRAs to increase their asset diversity for retirement. But, how do these accounts allow for alternative assets and how can they be used well?

Let’s look at what makes these rare IRA accounts work. 

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What is a Self-Directed IRA (SDIRA)?

A self-directed IRA is an individual retirement account (IRA) that holds investments not normally seen in normal IRAs. These investments, for one reason or another, are not allowed in normal IRAs, forcing investors to opt into these self-directed accounts. 

How Self-Directed IRAs Work

Self-directed IRAs allow individuals to hold assets not allowed in standard IRAs in a tax-advantaged account. Regular IRAs allow for assets like bonds, stocks, certificates of deposit, mutual funds, and exchange-traded funds (ETFs).

However, SDIRAs allow for more options, including precious metals, commodities, crypto, limited partnerships, and real estate. 

SDIRAs can be established as either a traditional or Roth IRA variant, following the same rules as standard IRAs. As is the case for regular Roth IRAs, you can contribute up to the annual maximum based on your age so long as your income isn’t above a certain value. 

Despite their name, you don’t have to manage a self-directed IRA on your own. Regulations require that SDIRAs are partly managed by a third party, including custodians or trustees, to ensure that investors follow the rules and regulations to maintain their tax-advantaged status.

How to Open an SDIRA

The first step you’ll have to take is to find a custodian or trustee to help manage the account. The IRS maintains a list of trusted entities as part of its oversight of SDIRAs, following the guidelines and rules set by legislation. 

Not all custodians will offer all alternative investments as part of their services. So, if you have assets in mind that you want to fill an SDIRA with, you will need to double-check with the custodian to see what asset they will manage. 

Once you have a custodian in mind, the next few steps will look something like this: 

  1. Work with your custodian to determine what assets will go into the SDIRA.
  2. Carry out your due diligence with each asset to ensure it is something you want in your portfolio.
  3. Locate a broker to buy the investment from.
  4. Ask the custodian of the account to carry out the transaction and place the assets into your account.

Because of the custodian’s role in managing the account, they are not allowed to give financial advice to account holders. This is why self-directed IRAs have their name, as it will be up to the investor alone to decide what they want to add to their account.

Advantages of SDIRA

There are several reasons why you might want to look into opening a self-directed IRA.


With SDIRAs, you can hold a greater range of assets than you otherwise could with standard IRAs. With access to a greater range of assets, you’ll be able to pick and choose the assets you want to hold for your retirement or financial stability. 

This fact is important in making investing appealing to a wider range of people. Investing is partly how many folks can retire comfortably as their assets grow over time.

Allowing folks to invest in other asset classes in a tax-advantaged account goes a long way to getting more folks invested in the markets.

Tax breaks

Taxes on investments held over the long term have more forgiving tax rates than what the standard federal income tax would cost across all income brackets.

That alone should be enough to entice investors, as that was why these tax brackets on long-term assets came about originally.

When you add the fact that Roth versions of the SDIRA exist to the equation, long-term investing can save money over time.

Invest with your expertise

Not many people recognize that they work with investing assets every day. Whether it's the real estate we live in, the commodities we see in stores, or the stocks representing ownership of the companies we work at, investing opportunities are everywhere. 

With SDIRAs, investors can choose which categories of assets they want to invest in, including ones related to their expertise or passion. The stronger your relation to your investments, the more likely you are to do your due diligence and pick assets that will do well.

Diversity of assets

It’s no secret that having a diversity of investments in your asset allocation is important for financial success. Regular IRAs are great for diversifying paper assets like stocks and bonds but do not allow for more niche assets. 

Using an SDIRA to have a little money off to the side in alternative assets gives you a way to use some of your money for potentially big returns, all while keeping most of your investments in safer bets.

Access to higher growth potential

As mentioned above, most of the alternative assets you would put into an SDIRA are assets that have a higher chance for growth over time.

Commodities, cryptocurrencies, and similar volatile investments could experience rapid growth in the future, making them good choices for folks looking at a growth strategy for their retirement accounts.

Creative investing strategies

SDIRAs work with some creative investing strategies, much like their standard counterparts. These strategies require a lot of investing know-how for the asset class you want to work with, but you can achieve substantial returns with some calculated plays. 

Kirk Chisholm, a renowned wealth manager for Innovative Advisory Group, had a story about someone using an SDIRA to invest in real estate and then selling the contract for a higher price to other investors.

The pocketed difference could then be used to invest in more properties.  It is not a recommended strategy for the average person, but the story shows the creativity in these strategies. 

Risks of Self-Directed IRAs

There are some downsides to opening up a self-directed IRA. Here are what those risks are and some more information about them.

Due diligence

When you work with an SDIRA, you make all the decisions about what goes into the account. Your custodian manages the entry and exit of assets for your account and nothing else.

They cannot give you any financial advice or make any assessments about investments for you.  So, it will be up to you to decide what goes into the account.

This freedom can be liberating for some, but if you prefer to rely on other expert advice, SDIRAs may not be the right call for you. 

Prohibited transactions

While self-directed IRAs have a range of asset classes they accept, you can’t add every kind of investment into these accounts. There are prohibited investments, a term that refers to investments that cannot go into an SDIRA. 

For example, things like collectibles and life insurance can’t go into these accounts. Adding these investments into an IRA puts you on the hook for not just the taxes associated with those investments, but also any penalty fees that the IRS hits you with. 


There are several fees associated with opening and maintaining an SDIRA. In addition to the one-time creation fee, you can expect first-year fees, an annual renewal fee with the custodian, and miscellaneous fees to cover things like paying investment bills. 

If your income or asset growth can’t keep up with these fees, then the whole point of the account is moot. Even if your assets do well, sometimes these fees eat into your return, potentially making the account less viable than a standard IRA.

Lack of liquidity

Most assets going into an SDIRA are physical assets like real estate, gold bullion, or commodities.  While these are great investments for growth and cash flow, they are not liquid like paper assets such as stocks and bonds. 

These paper assets sell faster on the open market than most physical assets.  If you have to take distributions or sell off portions of the account, you will have to scramble to find buyers for the assets. 


Part of the danger of having an SDIRA is how you go about creating it. The IRS defines custodians or trustees of these accounts as trusted third parties that cannot offer any service outside of account management. 

So, third parties that give advice or push certain types of asset classes on their clients would be committing fraud.  If you open an account with a custodian committing fraud, there is a chance your assets will be lost or reduced in some way.

This issue is why research into a proper custodian is critical. 

Lack of transparency

Another concern with promoters of SDIRA services is they sometimes present things in too positive a light.  These providers will give purchase prices for offered assets or include expected growths alongside purchase prices to over-inflate an asset's worth, all while failing to mention that the figures assume best-case scenarios. 

Overall, investors looking to get into SDIRAs will want to look at their custodians and the services they offer to see how transparent they are.

Your custodian should be offering reliable services, not selling you on assets. 

Concentrated portfolios

A self-directed IRA can be a great way to diversify your entire portfolio, but it is susceptible to lacking diversity like other IRAs. Using an SDIRA to invest in non-traditional assets as your sole investment account means you can see losses if that asset performs poorly. 

So, the best way to use these accounts seems to be housing non-traditional assets rather than using them as a way to go crazy on growth strategies outside the stock market.

Should I Invest in a Self-Directed IRA?

A self-directed individual retirement account is an investment account that can hold assets not allowed in standard IRAs.

These assets can be used as part of growth strategies involving physical assets, to implement creative investing strategies, or to express a passion for a particular asset or market. 

There are pros and cons to opening these accounts, but the main consideration for an investor thinking about these accounts is if they have alternative assets they want to associate for retirement.

There are risks, fees, and extra legwork required to keep up with these accounts, which isn’t something every investor wants to handle. 

We recommend that you check out some trusted SDIRA custodians and see what they have to offer. You can use these service providers to get a feel for what SDIRAs are like and if their offerings are something you want to add to your portfolio.

Alto IRA

With a self-directed IRA from Alto IRA, you can invest your retirement dollars in alternative assets like crypto, real estate, and fine art.

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Here are answers to some of the common questions out there about self-directed IRAs.

Are self-directed IRAs a good idea?

If you have alternative assets you want to have managed for retirement, then an SDIRA can be a good choice. It will require extra money, time, and effort to maintain one of these accounts though, making it a hassle for anyone outside of a dedicated investor.

How much money can you put in a self-directed IRA?

Much like regular IRAs, self-directed IRAs have an annual contribution limit of $6,000. For folks over the age of 50, this increases to $7,000 per year.

These values only apply to the Roth SDIRAs, however. 

What is the difference between a traditional and Roth SDIRA?

A traditional SDIRA has no limit to the contributions you can make in a year but requires the investor to start taking distributions at age 72.

However, a Roth SDIRA has an annual contribution limit and no required distributions based on age. 

How are SDIRAs taxed?

For the most part, there are no taxes on SDIRAs themselves. You have to file a valuation form for your SDIRAs every year with your federal taxes, at which point things like Unrelated Business Taxable Income (UBTI) come into effect.

Kevin Mercadante is professional personal finance blogger, and the owner of his own personal finance blog, OutOfYourRut.com. He has backgrounds in both accounting and the mortgage industry. He and his wife are "empty nesters" living in New Hampshire.

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