What Is a Self-Directed IRA, and How Does it Work?

You may have heard the terms "self-directed retirement account," "alternative IRA," or "real estate IRA," but like most investors, you could probably use some clarity. What exactly is a self-managed retirement account? What benefits does it have? And what possible effects can a Self-Directed IRA have as part of your retirement investment strategy? Get answers from the Self-Directed IRA Specialists at Madison Trust, then get help gaining control of your retirement investments with a Self-Directed IRA.

What is a Self-Directed IRA?

A Self-Directed IRA is just like a standard IRA. It’s a retirement account that you put funds into, and those funds are invested with the goal of helping them to grow. The main difference between Self-Directed retirement accounts and standard IRAs is the types of investments you can choose. With a standard IRA, you will invest in stock market products such as stocks, mutual funds, and bonds. With a self-regulated retirement account, you can invest in alternative assets. Popular Self-Directed IRA assets include real estate and private placements.

Why Have I Never Heard of a Self-Directed IRA?

The concept of a Self-Directed retirement plan is a novel one to many, as the majority of Americans hold their IRAs in large brokerage houses. They automatically assume that IRAs can only be invested in stocks, bonds, and mutual funds since those are the products offered to them. Brokerage houses do not accommodate alternative investments due to the administrative burden involved and loss in commission.

What Are the Benefits of a Self-Directed IRA?

Portfolio Diversification: A Self-Directed IRA allows investors to diversify their retirement portfolios to include assets that are inaccessible in a standard IRA. Self-Directed IRA custodians specialize in privately held investments like real estate, private businesses, promissory notes, cryptocurrencies, and more, all within a tax-advantaged account.

Hands-on Investing: Self-Directed retirement plans encourage individuals to invest in what they are familiar with. They provide investors with the power to put money into investments that make sense for them personally. Different people have different strengths and expertise, and it makes sense that their investments should reflect those differences.

Stability: With a Self-Directed IRA, one can diversify from the volatility of the stock market and invest in products with a steadier and more reliable revenue stream. Popular choices include rental real estate, secured promissory notes, and tax liens.

How Does a Self-Directed IRA Work?

Like its standard counterpart, a Self-Directed IRA is held by a qualified custodian. The custodian will hold your funds, execute transactions, and assist with any necessary tax filings. When you want to make a specific investment, here are the basic steps:

Choose an Asset: This part is fully up to the investor. In most cases, a Self-Directed IRA custodian will not offer specific financial advice. You should choose an asset for which you have a good grasp of its potential profitability as well as one that you have the means to manage.

Submit an Investment Authorization Form: Fill out the form and submit it to the Self-Directed IRA custodian, and the custodian will perform the transaction. Of course, certain assets will have more extensive paperwork associated with their purchase; this is not due to the Self-Directed IRA but rather to the nature of the asset itself. For example, real estate often possesses a more involved process, including title and deed processing.

Are There Different Types of Self-Directed IRAs?

Yes. A Self-Directed IRA investor who wants to invest in alternative assets has a number of different account options.

Self-Directed IRA

This is the classic Self-Directed retirement account where the custodian not only holds the account but also actively performs the transactions.

Checkbook IRA

This is a type of Self-Directed IRA where the account holder can perform transactions on their own. This can be accomplished by establishing an IRA LLC or IRA Trust.

Learn More

How Do You Set Up a Self-Directed IRA

The process to set up a Self-Directed IRA is easy:
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Open a Self-Directed IRA

Open an account by completing an application online. You will be asked some basic questions, like, "What kind of account are you opening?" and "How are you funding your IRA?"  
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Fund Your Account

Fund the account by either transferring an existing IRA or rolling over a former employer's plan like a 401(k) or 403(b).
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Make an Investment

Invest the funds by instructing Madison Trust Company to issue a check or a wire to the investment of your choice.

What can a Self-Directed IRA Invest in?

It's hard to detail a complete asset listing because a Self-Directed IRA can legally invest in almost any type of asset. The only three types of assets that are forbidden are collectibles, S-Corporation Stock, and life insurance settlements. Some of the more popular types of alternative investments include:

Real estate
Private placements like hedge funds, private equity funds, and LLCs
Promissory notes
Precious Metals
And Many More

Self-Directed IRA Pros and Cons

The choice to invest with a standard IRA or a Self-Directed IRA can depend on multiple factors. Investors and their investing goals are unique, so the way to achieve those goals can differ greatly. Here are the differences between a standard IRA and a Self-Directed IRA.

Standard IRA
Self-Directed IRA
Typical stock market products. These can be shares of stock in individual enterprises or aggregated products such as mutual funds.
Nearly any type of asset. Investors can buy real estate, a stake in a private business, or precious metals and immediately transform them into retirement assets. Almost any asset can be purchased except collectibles, S-Corporation Stock, and life insurance settlements.
Asset Security
No guaranteed security. Your IRA's value will go up and down along with the stock market.
No guaranteed security. Certain types of assets tend to hold value better, while others are more volatile.
Fees are usually charged as a percentage of the account's value. The more the account grows, the more the fees will be.
Different Self-Directed IRA companies have different fee structures. Madison Trust charges a flat quarterly fee that is not tied to your account size. There can also be transaction fees for active buying and selling.
IRS Rules
All retirement accounts are subject to the same rules. Since investments are handled through a third party, you won't usually run into legal issues.
A Self-Directed IRA is governed by the same rules as a standard IRA, but since you have more control over the investments, it's important to understand rules like prohibited transactions.
Must be held by a regulated custodian as required by the IRS. Most banks, brokerages, and online trading platforms offer IRAs.
Offered exclusively by regulated custodians who specialize in Self-Directed IRAs.
Standard IRA
Asset Choice
Standard stock market products.
Standard fee schedules are asset-based. That means a defined percentage of the overall account will be assessed as the annual fee.
Account Opening
Depending on the institution chosen, can be done in 15 minutes.
IRS Rules
All retirement accounts are subject to the same rules.
Self Directed IRA
Asset Choice
Diverse asset choice.
Different Self Directed IRA companies have different fee structures. Madison Trust charges a flat annual fee that is not dependent on account value.
Account Opening
Madison’s Self Directed IRA can be opened in 15 minutes. A Checkbook Control Self Directed IRA can take longer to set up due to the establishment of the LLC or Trust.
IRS Rules
A Self Directed IRA has the same rules as a standard IRA.

How Much Does it Cost to Use a Self-Directed IRA?

The cost to set up a Self-Directed IRA with Madison Trust Company is $50; maintenance is $100 per quarter.

What Are the Contribution Limits for a Self-Directed IRA?

IRC Section 4975(a) states that an IRA owner may not take any personal benefit from their plan before the age of retirement. Dealings that violate this clause are known as prohibited transactions. The simple definition of a prohibited transaction is any transaction between a retirement plan asset and a disqualified person.
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Get the Madison Trust Advantage: Start Your Self-Directed IRA Today

Madison Trust is at the forefront of the Self-Directed IRA industry due to our impeccable customer service and sensible fee schedule. When you call Madison Trust, you will be served by a friendly and knowledgeable member of our team. Our staff members undergo CISP training (the most comprehensive IRA training available), allowing them to guide you through complex transactions with care, sensitivity, and precision. Contact us today to get started.
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Madison Trust Company
401 East 8th Street • Suite 200
Sioux Falls, SD 57103
Mailing Address:
Madison Administration Company
One Paragon Drive • Suite 275
Montvale, NJ 07645
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(800) 721-4900
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