The Difference between Conventional and Self-Directed IRAs

Estimated reading time: 3 minutes(Last Updated On: April 13, 2021)

An IRA is one of the most effective tools that you have in your quest to secure a financially comfortable retirement. In addition to offering compounding returns over your lifetime, it also offers several tax advantages. Typically, a bank or other financial institution will control your IRA investments. However, with a self-directed account, you decide how to save for retirement.

Self-Directed Accounts Allow You to Be the Trustee

As the name implies, a self-directed account allows you to decide where your contributions go. This means that you can invest in startup businesses, real estate, or anything else that you think will earn a return on your investment. At the same time, you get the same tax advantages as you would with any other IRA. 

Who Can Have a Self-Directed Account?

Those who have self-employment income can have such an account. The good news is that anyone can have self-employment income without quitting their day job. If you babysit for your neighbor’s kids, walk dogs, or write articles for money, that may be enough to qualify. If you are curious as to whether you have self-employment income in a given year, don’t be afraid to ask a tax professional before opening an account.

Are There Limits to How Much I Can Contribute?

The same contribution limits apply regardless of what type of account that you have. For 2017, you can contribute up to $6,000, and catch-up provisions allow those over the age of 50 to contribute another $1,000 in a year. If you make less than $6,000 in self-employment income in a given year, you can contribute that amount instead. Contributions to your self-directed IRA will also be reduced by any contributions made to other accounts. 

Withdrawal Rules are Also the Same

If you decide to take money out your account before the age of 59 ½, you may be subject to early withdrawal penalties. You will also lose the ability for that money to compound until retirement age. Furthermore, income taxes will need to be paid on any cash withdrawn prior to age 59 ½, and the withdrawal may bump you to a higher tax bracket.

Conventional IRA Accounts Limit Investment Opportunities

A typical IRA will allow you to invest in stocks and bonds. In some cases, you will be allowed to invest in gold or other precious metals. This can be extremely limiting if you don’t understand how the stock market works or don’t want to deal with low bond yields. Depending on where you have your IRA, you may be paying management fees for trading decisions that you likely could make on your own. 

If you are looking for a way to take control of your retirement, a self-directed IRA may be the best option for you. The freedom to invest in what you know and love can make it easier to get higher returns without necessarily increasing your risk. Earning higher returns may make it easier to retire sooner because you will have the financial security to do so. 

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