What are the advantages/disadvantages of a self-directed IRA?

Question

I recently learned of self-directed IRAs.

Here is how it works:

1. I open a self-directed IRA account with a company that acts as a custodian of my account (here is a short list of such companies).
2. I transfer or deposit funds to my self-directed IRA account.
3. I direct the custodian to make purchases from my account.

One of the advantages of a self-directed IRA is the variety of investments that can be made. The following can be purchased from a self-directed IRA account:

1. Real-estate. Actual homes, condos, or commercial real estate. My relatives and I cannot, however, use any of the real estate that is purchased from the IRA.
2. Foreign real estate.
3. Ownership in a business. If I was interested in buying into a business I could do it with funds from my self-directed IRA.
4. Precious metals (gold, silver, and platinum). This is what piqued my interest in self-directed IRAs. I cannot take delivery of the metals. The metals must be stored by some other party. If I purchase coins they can only be US metal coins. One idea I had was to purchase bullion bars from the Perth Mint.

The custodian charges an initial fee (around $50) to setup the account and an annual fee (around $250 - $300) to maintain the account. Seems like it would take a fairly large (above $200K) IRA to justify the annual fee. The custodian usually charges a fee for every transaction (around $50) - definitely don't want to be making a lot of moves in this account.

Does anyone have experience with self-directed IRAs?

What are other advantages/disadvantages to self-directed IRAs?

Answer 1

There is nothing wrong with self directed IRA's the problem is that most of the assets they specialize in are better done in other ways.

1. Real estate is already extremely tax advantaged in the US. Buying inside a Traditional IRA would turn longterm capital gains (currently 15%) into ordinary income taxed at your tax rate when you withdraw this may be a plus or minus, but it is more likely than not that your ordinary income tax rate is higher. You also can't do the live in each house for 2 years before selling plan to eliminate capital gains taxes (250k individual 500k married couple). The final problem is that you are going to have problems getting a mortgage (it won't be a conforming loan) and will likely have to pay cash for any real estate purchased inside your IRA.

2. Foreign real estate is similar to above except you have additional tax complexities.

3. The key to the ownership in a business is that there are limits on who can control the business (you and maybe your family can't control the business). If you are experienced doing angel investing this might be a viable option (assuming you have a really big IRA you want to gamble with).

4. If you want to speculate on precious metals you will probably be better offer using ETF's in a more traditional brokerage account (lower transactions costs more liquidity).

Answer 2

Our company does a lot of research on the self-directed IRA industry. We also provide financial advice in this area. In short, we have seen a lot in this industry.

You mentioned custodian fees. This can be a sore spot for many investors. However, not all custodians are expensive, you should do your research before choosing the best one. Here is a list of custodians to help with your research

Here are some of the more common pros and cons that we see.

Pros:

1) You can invest in virtually anything that is considered an investment. This is great if your expertise is in an area that cannot be easily invested in with traditional securities, such as horses, private company stock, tax liens and more.

2) Control- you have greater control over your investments. If you invest in GE, it is likely that you will not have much say in the running of their business. However, if you invest in a rental property, you will have a lot of control over how the investment should operate.

3) Invest in what you know. Peter lynch was fond of saying this phrase. Not everyone wants to invest in the stock market. Many people won't touch it because they are not familiar with it. Self-directed IRAs allow you to invest in assets like real estate that you know well.

Cons:

1) many alternative investments are illiquid. This can present a problem if you need to access your capital for withdrawals.

2) Prohibited transactions- This is a new area for many investors who are unfamiliar with how self-directed IRAs work

3) Higher fees- in many cases, the fees associated with self-directed IRA custodians and administrators can be higher.

4) questionable investment sponsors tend to target self-directed IRA owners for fraudulent investments. The SEC put out a good PDF about the risks of fraud with self-directed IRAs.

Self Directed IRAs are not the right solution for everyone, but they can help certain investors focus on the areas they know well.

Answer 3

This type of account will sell you just enough rope to hang yourself.

Gold is at $1400 or so. Were you around when it first hit $800 in '79/'80? I was. No one was saying "sell" only forecasts of $2000. If you bought and held, you've still not broken even to inflation let alone simple market returns.

Answer 4

The main advantage and disadvantage I can see in a scenario like this are - how savvy and good an investor are you? It's a good way to create below-market average returns if you're not that good at investing and returns way above market average if you are...