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.