When it comes to planning for retirement, many consumers are eager to know more. However, while there is a range of retirement accounts available to help them plan their retirement finances, there is one account that many are not taking advantage of – self-directed IRAs. Estimates from the Securities Exchange Commission say only 2 percent of IRAs were self-directed IRAs in 2012. Yet, while investment in alternative asset class investments has grown impressively in recent years, self-directed IRAs continue to be underused and under maximized. As you round up their end-of-year financial checklists and move forward with the financial goals for the new and retirement, here is what you need to know about a self-directed IRA and what it can bring to your financial planning for retirement.
What Is A Self-Directed IRA?
Simply put, a self-directed IRA is a retirement account that allows you to hold a broader range of assets, instead of the traditional stocks and bonds that come with other retirement accounts. The main benefit of self-directed IRAs is the flexibility and freedom it provides the holder when it comes to crafting their retirement portfolio. For you, this can mean greater diversification and spread of risk, a key strategy often recommended by retirement experts. In reality, this also means you can explore investments in alternative assets such as cryptocurrency, limited liability partnerships, real estate, and precious metals (the list goes on). At the same time, you can still enjoy the tax advantages of an IRA including tax deferrals or tax-free withdrawals. Holders of An SDIRA can also enjoy protection from the Bankruptcy Abuse Prevention and Consumer Protection Act. If you experience bankruptcy, the Act entitles you to an exemption of up to $1 million of your funds in your SDIRA account.
Drawbacks Of A Self Directed IRA
However, it does come with its own set of rules and fees. For 2021, the limit on SDIRA was $6,000 (or $7,000 if you are entitled to catch-up contributions). Yet, the rules are regularly being updated so it is worth checking before you invest. The IRS recently announced changes to retirement plans including raising the contribution limit for 401(k) to $20,500. A final note: one of the often missed disadvantages of an SDIRA is that the alternative investment assets tend to carry higher risk. One of the attractions of a self-directed IRA is that it enables investment in higher return investments. However, the flipside of this is that they often come with higher risks. Remember, higher returns often equal higher risks.
Investing In Alternative Assets With Your Self Directed IRA
The increased diversification of an SDIRA means investors can opt for assets like real estate, start-ups, and the recently popular cryptocurrency. However, each alternative class of asset comes with pros and cons to be considered carefully. For instance, investing in private real estate equity with your SDIRA comes with the promise of good long-term returns. Based on past research and claims, adding real estate investments can strengthen your retirement portfolio. Real estate equity investment also comes with low volatility. On the other hand, investing in real estate can come with high costs. For instance, the closing costs of a home can average up to 6 percent of its value. Similarly, investing in a promissory corporate note with your SDIRA can help you invest in corporations looking to raise capital. However, they come with a higher default risk than bonds. If you want to invest in cryptocurrency with your SDIRA like Bitcoin or Etherum, you should also familiarize yourself with how different the rules are from other investments to avoid penalties. Those that wish to hold cryptocurrency in their retirement account are required to do so through a limited liability company (LLC). It is also important that you take the time to conduct your research before investing in higher-risk assets like cryptocurrency.