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Self-Directed IRAs Guide

written by: Dave Guilford•edited by: Rebecca Scudder•updated: 2/16/2009

The first of a two-part article on Self-Directed IRAs, this article covers the basics of what a Self-Directed IRA is, what it does, and how to open a Self-Directed IRA account and deposit money into it. Looking to use a self directed IRA for real estate purchase, or traditional investments? Read on.

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    The Nuts & Bolts of Self-Directed IRAs

    With an ever-expanding array of investment alternatives, the overall investing market is becoming more sophisticated each year. The heaviest concentration of individual investment dollars in the U.S. is found in retirement accounts of one form or another. The most common retirement accounts are employer-sponsored plans like 401(k) and 403(b) plans. Running a close second are the various types of Individual Retirement Accounts (IRAs). Each of these retirement vehicles offers the advantage of preferential tax treatment.

    In the case of an employer-sponsored retirement plan, contributions are added to the account before taxes, and any capital gains and income generated within the account are tax deferred until distribution. While traditional IRAs are funded with after-tax dollars, they are allowed a line-item deduction on the individual's tax return and any capital gains and income generated within the account enjoy the same tax deferral as an employer-sponsored account. The tax deductible contribution to a traditional IRA may be phased out depending upon income.

    Mutual fund shares make up the bulk of the assets held within U.S. retirement accounts. They are favored by most investors for their inherent diversification and professional management. Many IRA investors also invest in individual stocks to take advantage of the greater potential gains.

    But what about more advanced investment vehicles? Is it possible to buy stock options in an IRA? How about real estate? What about using a self-directed IRA to invest in a private business or buying private mortgages? Can that be done, too? The answer is yes.

    A type of IRA that was created in the late 1990s and has gained in popularity each subsequent year is the Self-Directed IRA. As the name implies, the definition of a self-director IRA is one that allows investment into almost anything the IRA account holder chooses. There are prohibitions against investing in certain things like most collectibles including baseball cards, and account holders can't use the proceeds of their account to benefit themselves or their immediate family members directly. Beyond that, there aren't too many limits on the approved investments in a Self-Directed IRA.

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    How-To Open A Self-Directed IRA Account

    The first step in establishing a Self-Directed IRA is to find a custodian. A search will reveal dozens of Self-Directed IRA custodians, but they are not all alike. Research is key in determining the right custodian for the job. For example, some custodians allow real estate investments but not stock options. Others disallow investments in private companies. Finally, the fees charged by one custodian may be higher or lower than others. Be sure to find the custodian that best meets your investment needs and objectives with an affordable fee schedule.

    The next step is to fund the account. This can be done by cash deposit up to the annual IRA contribution limit. More common in the case of Self-Directed IRAs, however, will be an IRA rollover or transfer. This is when an account holder rolls over an old 401(k) account or transfers all or part of the funds in an existing IRA to establish the account. Once the account is open, you're ready to begin investing!

    In Part 2, we'll discuss some of the possible investments available in a Self-Directed IRA.

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    List of Brokerages Offering Self-Directed IRA Accounts

    This is a partial list of some online brokerages that offer self-directed IRA custodian services:

    • Vanguard
    • TIAA-CREF
    • Entrust Group
    • T. Rowe Price
    • PENSCO Trust Company