Understanding the Difference Between Self-Directed IRA and Traditional IRA

Self-Directed IRA and Traditional IRA

With an individual retirement account (IRA), you get to save money for the future while enjoying several tax advantages. If you are a self-employed individual who does not have access to any workplace retirement accounts, such as 401(k), you should open an IRA to save for retirement on a tax-deferred basis.

With limited knowledge of the IRA options, choosing the right one can be challenging. You should think of hiring an experienced retirement custodian only when you have determined the type of IRA you want. Since most investors are confused between self-directed IRAs and traditional ones, let us discuss which one is right for you.

Major Differences Between Self-Directed IRAs and Traditional IRAs

It is important to understand that self-directed IRAs (SDIRA) are also traditional IRAs where the account holder has control over their retirement funds and investment decisions. However, we will use the term “traditional IRA” to refer to other conventional IRAs in this article to avoid confusion.

Primarily, there are two major differences between self-directed IRAs and traditional IRAs.

  • Control over the account’s funds and investment decisions: When it comes to traditional IRAs, you do not have direct control over your funds and investment decisions. The plan administrator managing the account makes the decisions for you once you give them your permission.

For SDIRAs, you get the freedom to make investment decisions. These IRAs give you the flexibility to invest in traditional assets (stocks, bonds, and mutual funds) of your choice. This helps you have a better understanding of your investments and offers better chances of building wealth on your own terms.

You can direct the SDIRA investment decisions through a custodian or broker, but they are not involved in the investment transactions.

  • Option to Invest in Alternative Assets: When you choose a traditional IRA, your investment portfolio is limited to traditional assets such as conventional stocks, bonds, and mutual funds. You cannot invest in alternative assets through such an account. Thus, the portfolios in traditional IRAs are less diversified.

Self-directed IRAs, on the other hand, give you the option to invest in alternative assets like private equity, real estate, private lending, gold, and more. This not only helps you diversify your portfolio but also increases your chances of generating faster income within your comfort zone.

Since the stock market can be volatile, your investment value may go down at times. With alternative assets like real estate, you can mitigate the risks as they are more stable.

Self-Directed IRA Investment Options

As mentioned above, you get access to alternative investments with SDIRA, which is certainly one of its biggest advantages over traditional IRAs. While you can invest in a wide range of assets with SDIRA, here are some of the popular options that are not available in a traditional IRA.

  • Digital currency and blockchain technology
  • Private lending (mortgages and notes)
  • Residential real estate (duplexes, mobile homes, rentals, etc.)
  • Commercial real estate (office space, multifamily condos, retail space, etc.)
  • Venture capital (investments in startups)
  • Lands

While you get the option to invest in a wide variety of assets with an SDIRA, you do require advanced knowledge of these investment options. If you do not have expertise in these asset classes, it is better to choose a traditional IRA and let the investment manager take care of the trades.

Choosing the Right IRA Plan for You

The above comparison makes it very clear that self-directed IRAs have several advantages over other traditional IRAs. However, an SDIRA may still not be ideal for you. To determine which type of IRA is best for you, ask yourself the following questions:

  • Do you need more control over your investment decisions?
  • Do you want to explore alternative investment options with your IRA?
  • Do you have the time to study all the investment options and make the decisions yourself?

If all your answers were “Yes,” you may consider opening an SDIRA. Otherwise, it is better to trust the expertise of an investment manager or plan administrator and go for a traditional IRA.

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The views expressed in this article are those of the authors and do not necessarily reflect the views or policies of The World Financial Review.