Self-Directed IRA vs Traditional IRA

Opening a retirement investment account is an excellent way to create a cushion for after you stop working. However, numerous retirement accounts are available to investors, and you may be unsure of the right type for your needs.

Self-directed IRAs and traditional IRAs are two types of individual retirement accounts that you can use to grow your savings. However, these accounts offer different advantages and disadvantages. Understanding the differences between these two accounts can help you choose the right IRA account for your retirement plan.

Read on to learn the differences between a self-directed IRA and a traditional IRA.

What Is an IRA?

Before you can understand the differences between a self-directed and traditional IRA, you should know what an IRA is.

An individual retirement account (IRA) is a tax-deferred retirement account. Typically, investors make their own contributions to their IRAs. However, employers can also contribute to these accounts for their employees as part of their company-sponsored retirement plans.

Tax-deferred IRA funds are invested in stock market products like stocks, bonds, and mutual funds. Once the account holder reaches a certain age, they can withdraw the funds in their account to use toward retirement expenses.

What Is a Traditional IRA?

black alarm clock on pile of dollars

A traditional IRA is an investment account overseen by a broker, investment advisor, or financial institution. This account contains traditional investments, such as stocks, bonds, and mutual funds.

Traditional or conventional IRAs are in contrast to Roth IRAs. While you can contribute pre-tax dollars to a traditional IRA, contributions in Roth IRAs are post-tax.

Technically, a self-directed IRA is also a type of traditional IRA. However, in this article, we will use the term “traditional” or “conventional” to distinguish these IRAs from self-directed ones.

What Is a Self-Directed IRA?

A self-directed IRA (SDIRA) is a special type of IRA that allows account holders to carry alternative investments in their accounts.

While traditional IRAs contain funds invested in traditional assets like stocks, bonds, and mutual funds, you can invest your self-directed IRA funds in a wide range of products, such as:

  • Real estate
  • Gold and other precious metals
  • Private equity
  • Limited liability companies (LLCs)
  • Private placements
  • Cryptocurrency
  • Other investments

Self-directed IRAs give account holders more control over their investments. These accounts allow investors to choose exactly where they will invest their retirement funds. They also give investors access to a broader array of assets.

What Are the Similarities and Differences Between SDIRA and Traditional IRAs?

SDIRAs and traditional IRAs are both IRAs that allow you to invest pre-tax money. This means you can put pre-tax income into these accounts, reducing your annual taxable income. However, you will need to pay taxes on your contributions when you withdraw IRA funds.

Additionally, both types of IRAs must follow IRS rules for the annual contribution limit. As of 2022, the contribution limits are $6,000 per year. You must also take your first required minimum distributions once you reach age 72.

However, these accounts have many differences as well. For example, in a conventional IRA, a brokerage firm typically oversees the account. Meanwhile, custodians oversee self-directed IRAs — for instance, a gold custodian can help you set up and manage a self-directed IRA investing in gold.

Working with a custodian instead of a brokerage firm may allow you to save money on fees. However, self-directed IRAs can sometimes be riskier than traditional ones, as you need to plan your investments yourself.

Self-Directed IRAs and Traditional IRAs: Advantages and Disadvantages

two bags with a green check and red x mark

Self-directed IRAs and traditional IRAs both have advantages and disadvantages. Understanding these factors can help you make more informed investment choices and determine the best IRA type for your needs.

Pros and Cons of Traditional IRAs

Pro: Less Work

Traditional IRAs offer a more hands-off approach to retirement investing than self-directed ones. For example, you can trust a brokerage firm or financial institution to make investment decisions for you rather than needing to choose your investments yourself.

Con: Less Control

However, traditional IRAs offer less control over your investments. You cannot choose the stocks, bonds, or other products within the stock market that your broker invests in. As a result, you may disagree with some of their investment decisions.

Pro: Easier to Set Up

Traditional IRAs are relatively easy to set up. You just need to choose the institution, select the account type, and begin making contributions. This simplicity makes regular IRAs suitable for people without much investment knowledge.

Con: Steeper Fees

While traditional IRAs are more hands-off than self-directed ones, they also come with steeper fees. As the account owner, you will need to pay for the time and work your broker puts into managing your retirement investments.

Pros and Cons of Self-Directed IRAs

Pro: More Flexibility

The most significant advantage of a self-directed IRA over a conventional IRA is flexibility. You can have total control over the alternative investments within your retirement plans. If you want to invest in certain assets, such as precious metals or real estate, you can.

Con: More Work

However, with great power comes great responsibility. Because self-directed IRAs typically do not use brokerage firms, you’ll need to put more effort into managing your account. You should stay up to date on market trends and carefully research the assets you plan on holding in your account.

Additionally, you’ll need to be aware of IRS rules about self-directed IRAs. For example, certain transactions are prohibited within these accounts.

Pro: Greater Diversification

Diversifying your investment portfolio is an excellent way to lower your volatility. The more diverse products you have in an investment portfolio, the lower your risk of losing everything in a market crash. When you invest in gold, real estate, or other alternative assets, you add diversity to a portfolio with more traditional products.

Con: More Challenging to Set Up

However, you’ll need to spend a little more time setting up a self-directed IRA than a traditional one. For example, you’ll first need to identify a custodian that offers the alternative investments you’d like in your account. You may also need to transfer retirement funds from an existing IRA into your new one.

Can I Have Both a Traditional IRA and a Self-Directed IRA?

merged chess pawn on chessboard

Remember that a self-directed IRA is a type of traditional IRA. Because there are no limits to the number of traditional IRAs you can establish, you can have both a traditional and self-directed IRA at the same time.

However, the contribution limits for IRAs still stand, regardless of the number of IRAs you have. In 2022, you cannot contribute more than $6,000 to your IRAs in total.

There are a few exceptions to this rule. For example, if your spouse or certain family members have no or little income, you may be able to contribute to an IRA on their behalf.

Additionally, you’ll need to pay fees for every IRA you open. These fees can average between $50 and $100 per year, depending on the type of IRA you open and the manager you use.

What Is the Best IRA for Precious Metals Investing?

If you’re looking to invest in precious metal products through an individual retirement account, you’ll need to open a self-directed IRA rather than a traditional one.

Traditional IRAs can only hold standard investment options like stocks. As a result, you cannot invest in precious metals through these accounts.

Opening a self-directed IRA through a custodian specializing in gold and silver IRAs is the best way to add these alternative assets to your retirement funds. Your custodian can help you add money to your account, choose the precious metal products to add to your investment, and store them for you.

Final Thoughts

If you’re deciding between a regular IRA and a self-directed IRA, the biggest question to ask is how you would like to invest the money in your account.

Both of these accounts have IRS tax advantages compared to other IRAs, such as a Roth IRA. They also both have maximum contributions and required minimum distributions.

If you’d like to invest in gold, real estate, or other assets, a self-directed IRA may be the right choice. First, however, you’ll want to choose a reliable custodian who can make the process of investing seamless and stress-free.

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