Traditional IRA vs. Self-Directed IRA: What Are the Differences?

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Written By Mark

Mark is the co-owner of and has many years of experience in financial markets. 

There are differences between traditional IRAs and Self-Directed IRAs (SDIRAs). These differences may be more significant than you think.

Individual Retirement Accounts (IRAs) are tax-deferred retirement accounts that allow individuals to put aside money for retirement savings every year. Earnings in the IRA are tax-deferred until the owner of the account makes qualified withdrawals starting at age 59-1/2.

Invest for retirement in your IRA plans. Contribute the maximum annual amount to your IRA and then allow the magic of tax-deferred asset growth and reinvestment to increase your capital.

Avoid early withdrawals from your retirement account. You’ll pay significant penalties if you withdraw money before age 59-1/2.

Traditional IRAs vs. Self-Directed IRAs

Traditional IRA accounts are typically managed by a financial advisor or broker. Funds within the traditional IRA are limited to certain asset types, e.g. mutual funds, stocks, and bonds.

A self-directed IRA account also permits you to acquire traditional assets like stocks but, if you’re so inclined, you can get other assets like real estate, precious metals, cryptos, or even hard-money loans.

Hard money loans are a specific type of asset-based lending through which a borrower obtains money secured by their real property.

Before you decide to open a self-directed IRA, do your research. While SDIRAs allow you to invest in a wide range of assets, e.g. real estate, bitcoin/cryptos, precious metals like gold (refer to our guide on the best gold IRA companies for more details), or tax liens without the consent of a custodian, it’s important to know yourself.

What’s your risk tolerance profile? Should you invest money for retirement in these alternative assets?

If you’re a new investor or uncertain about directing your own investments, traditional IRAs are a good choice.

Traditional IRAs Favor Traditional Liquid Asset Classes

In a traditional IRA, you can put retirement assets in qualified mutual funds, equity, and bonds offered by your custodian.

In a self-directed IRA, your custodian’s role is considered passive. That is, your passive custodian doesn’t provide investment advice or approve the investments. You make the investment decisions.

Since you’re in charge of most of the decisions in your Self-Directed IRA, recognize that a certain amount of dedication is required.

Self-Directed IRAs Allow You to Invest in a Broader Selection of Assets

A self-directed IRA permits you to hold so-called alternative investments within a retirement account.

In contrast to traditional or Roth IRAs, which primarily consist of equity and bond investments, self-directed IRAs give a much wider selection of choices. It’s up to you, the SDIRA owner, to manage the assets. Be aware of the potential risks associated with certain types of assets.

Your risk tolerance profile is an important first decision. If you can’t tolerate the higher risks associated with alternative investments, stick with a traditional IRA for now. Long-term investing requires patience and a careful-self assessment.

If you have more control of your retirement assets and the broad market sells off, are you likely to stay calm or acquire more quality at lower amounts? Do you have the discipline is maintain portfolio percentages? Will you rebalance the portfolio of assets on a regular basis to maintain the positive benefits of diversification?

What Is a SDIRA?

Self-directed IRA accounts are like traditional or Roth IRA accounts in some ways. A self-directed IRA also brings tax advantages, and owners of these accounts must follow the same contribution limits and requirements.

In 2022 the maximum contribution to a self-directed IRA is $6,000 ($7,000 for those 50 years or older).

Take qualified distributions from the SDIRA at age 59-1/2. Unless you have no other choice, leave your IRA assets in place to benefit from reinvestment, compounding, and time.


Let’s say you have a traditional IRA or a Roth IRA account. In either type of retirement account, you might invest in mutual funds or safe fixed-interest investments, e.g. certificates of deposit (CDs).

In contrast, your SDIRA allows you to invest in a broader range of investment choices, including real estate, water rights, tax lien certificates, oil and gas/mineral rights, undeveloped/raw land, promissory notes, livestock, precious metals (e.g. gold, silver, platinum, etc.), cryptocurrencies, or LLC membership interests.

If you’re interested in a self-directed retirement plan, find an experienced financial advisor first. Although you won’t need a custodian’s permission to invest in or sell certain assets in your SDIRA, you might not want to manage retirement assets alone.

Advantages of SDIRAs for Retirement

SDIRAs provide a variety of perks. Some of the primary advantages of an SDIRA include:

• Investment flexibility (you have more asset options in the SDIRA)

• Tax-deferred growth on your investment earnings

• Opportunities to invest in assets that align with your experience, knowledge, and passions. For instance, if you’re an experienced real estate investor, it’s possible to invest in this asset class for retirement.

• Opportunities to diversify your retirement funds: maintain both SDIRA plus other retirement accounts and/or traditional investment portfolios funded with after-tax money

• Select assets that may possess higher capital appreciation potential

Disadvantages of SDIRAs

The stakes can be high when you invest in alternative assets. Remember, you’re saving money for retirement. Depending on your investment life cycle stage, retirement may seem quite a long way off.

Here are some of the disadvantages of investing in a self-directed IRA:

• Higher risk-reward opportunities are plentiful. You can lose money in your self-directed IRA.

• Account maintenance fees and other related costs can be high.

• Tax reporting and record-keeping requirements can be time-consuming and complicated

• You’ll owe taxes and penalties if you don’t follow IRS guidelines concerning these plans

Traditional IRA vs. Roth Self-Directed IRA

You can elect to set up a self-directed IRA or Roth IRA. Both accounts present a variety of tax advantages with several key differences.

Traditional self-directed IRAs may allow you to deduct account contributions on your taxes. However, when you withdraw funds from the account in retirement, these withdrawals will likely be taxed as ordinary income.

If you choose a Roth self-directed IRA, you contribute after-tax funds to the account. These contributions aren’t deductible from your current taxes. However, when you take withdrawals from the Roth IRA in retirement, your distributions will be entirely tax-free.

Should I Choose a Self-Directed IRA for Retirement?

The answer to this question is important. Because you direct the investment decisions in an SDIRA, you must be prepared to manage transactions, paperwork, and communicate instructions related to the account.

Self-directed IRAs may be appropriate for investors with aggressive risk-return parameters or investors with specific insights and expertise. For instance, if you’re a real estate professional, adding real estate to your SDIRA may be the ideal fit.

Before deciding on whether a self-directed IRA is the best choice for your retirement dollars, consider your investment strategy and risk tolerance. Never take on more risk than you must.

Again, just because you can obtain alternative assets in your SDIRA doesn’t mean you should. Build a financial plan for retirement and stick to it.

IRAs Are Tax-Deferred Savings Accounts for Retirement

Saving for retirement is very important. Any gains, income, and interest earned in your traditional or self-directed IRA allows capital to grow faster.

Your IRA is intended to provide income for retirement:

• You make contributions to a traditional IRA

• Your employer can make contributions to a SEP-IRA

• A custodian bank holds your traditional IRA plan assets and invests them in the most liquid asset classes, e.g. shares, mutual funds, and bonds.

Self-directed IRAs, either traditional IRA or Roth IRA plans, allow you the account owner to select assets and make investment decisions.

Other Differences between Self-Directed IRA and Traditional IRA Retirement Accounts

When you invest funds in a non-self-directed or traditional IRA, you can direct your financial advisor and make investment decisions about the account.

However, unless your money manager or advisor has discretionary trading authority, you must give your permission for them to make transactions in the account.

In a self-directed IRA, your investment decisions must pass through the passive custodian or broker-dealer. As the account owner, you’ve got much more flexibility in making investment choices.

If self-directed IRAs interest you, evaluate your account costs. Transaction fees or annual account fees can reduce both short-term and long-term results. Self-directed IRAs can require a little more time to establish than traditional IRA accounts.

Generally speaking, traditional IRAs and SDIRAs differ because of the investment types you may hold in them. A traditional IRA is limited to highly liquid securities, e.g. stocks, CDs, exchange-traded funds (ETFs), or bonds.

As the owner of an SDIRA, you may select from a broader array of asset classes, including alternative investments. Not all SDIRA custodians offer the same assets. If you’d like to invest in gold bullion, for instance, look for a custodian that provides this asset.

Since SDIRA plans are self-directed, remember:

• Passive custodians cannot give financial advice. For this reason, many financial institutions don’t present SDIRAs to their clients.

• SDIRAs require more homework.

• Work with a financial advisor if you need help in selecting or managing suitable assets for your retirement.

Alternative Assets for Self-Directed IRA Retirement Plans

SDIRAs are subject to IRS restrictions. Funds in your self-directed IRA may be invested in assets beyond stocks, bonds, and cash equivalents.

You may invest in precious metals, private placements, tax liens, private placements, and more.

You cannot invest in collectibles or insurance instruments in your SDIRA. Collectibles, e.g. jewelry, rare coins, art, baseball cards, antiques, alcoholic beverages, stamps, and other memorabilia aren’t approved assets for your SDIRA.

However, it’s possible to get investment exposure to some of these assets in an SDIRA. For instance, if you want to invest in physical gold, do so when your custodian provides gold bullion as a choice. You won’t have the option to invest in rare collectible gold coins, though.

Real estate investments are also a popular asset choice for self-directed IRAs. Your SDIRA funds may be used to acquire foreclosed properties, for instance.

These assets will be held in your IRA custodian’s name. Self-dealing restrictions are in place, so you’re prohibited from living in the property held in your SDIRA.

IRS-Prohibited Transactions in Your Retirement Accounts

The IRS establishes rules for your retirement accounts. All types of IRA plans can’t participate in some transactions, including:

You can’t make a personal loan from your IRA against funds or take part in self-dealing, e.g. any business transaction in which you or members of your family are involved.

Traditional IRAs. vs. Self-Directed IRAs: What’s the Right Choice for You?

The choice between traditional and self-directed IRAs isn’t “self-limitation” and “total freedom of choice.”

Investing money regularly into your IRA account is a sound financial practice. It can lower your current taxable income and build your net worth over time.

Know yourself. If you invest in individual stocks, how likely are you to check value quotations or worry about short-term performance? Do you need or want advice about how to identify quality assets for your IRA or SDIRA?

Time is on your side. If you’re a new investor or you’re catching up for retirement, use historically proven strategies to invest for long-term capital appreciation, income, and dividends.

Plan for broad market downturns. Diversify your portfolio is multiple asset classes that don’t correlate. Then, if you’re concerned about market sell-offs, create a strategy ahead of time.

For instance, if you like the idea of blue-chip stocks that pay regular dividends, use cash available to lower your average cost basis of these shares in the future.

You don’t need aggressive growth instruments to achieve income retirement goals. If you have decades until retirement, discuss your risk tolerance preferences with an experienced financial advisor.

Build a sound retirement strategy and stick to it. Remember that time in the market and not market timing is the best way to achieve positive returns in your IRA or self-directed IRA retirement plan.

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