Advanta IRA is one of the nation’s leading self-directed account administrators. We often encounter questions from people who want to know about self-directed investing. Below are 15 of the most frequently asked questions about how a self-directed IRA (SDIRA) works with alternative investments, including types of accounts, a list of common assets, and how to fund a new account.
Using alternative investments to build retirement wealth is a smart strategy in today’s economy—especially when combined with an erratic stock market. Alternative investments often have a low correlation with stock market performance and have the potential to produce positive returns even when the stock market is down and when inflation is high. This is why the SDIRA is becoming more popular with savvy retirement savers like you.
Top 15 Frequently Asked Questions about a SDIRA
- What is an SDIRA?
Self-directed IRAs (SDIRAs) and solo 401(k)s work like their conventional counterparts with two powerful exceptions:
- Self-directed plans allow alternative investments that are not available for regular retirement plans housed with mainstream banks and brokerages.
- Plan owners are in complete control of their retirement funds and investing decisions. You decide when to buy and sell assets in your account instead of depending on third-party administrators or workplace plan custodians to make these moves for you.
- What is an alternative investment?
Alternative investments encompass an asset class outside traditional stocks, bonds, and mutual funds. These investments don’t depend on the stock market’s performance to produce returns and create critical diversity in your retirement portfolio. Often, alternative investments, such as real estate, offer less volatility with the potential for higher returns. However, some alternatives, like private equity, present higher risk, less regulation, and low liquidity depending on the asset.
- Can I invest in real estate in an SDIRA?
Yes, you can invest in real estate in a self-directed IRA. Accounts that hold real estate assets are commonly called real estate IRAs. Examples of investments include single and multifamily homes, raw land, unimproved land, timberland, tax liens, commercial real estate, and real estate syndications.
- What other alternative investments are available for an SDIRA?
You can hold a vast pool of alternative investments to the stock market in self-directed plans. A few of the more popular assets include:
- real estate
- syndications
- tax liens
- private mortgages and notes
- precious metals
- private equity
- cryptocurrency
- oil and gas options
- futures and forex trading
- and much more…
- What is a checkbook IRA?
A checkbook IRA gives account owners checkbook control of their retirement funds so they can invest and pay bills directly from IRA funds. This investing strategy involves the IRA opening a single-member LLC in which the IRA is the only member. The IRA owner is appointed manager of the LLC and opens a bank account in the LLC’s name. The bank account is funded with money from the IRA, making investing easy by simply writing a check to purchase the asset. Investment-related bills are paid in the same manner.
- Can I self-direct another plan besides an IRA?
There are several types of self-directed retirement and savings plans you can use.
Plans for individuals:
- Traditional IRAs
- Roth IRAs
Plans for small businesses or self-employed individuals:
- Simple employee pension (SEP) plans
- Savings incentive match plans for employees (SIMPLE)
- Solo 401(k)s (also known as individual-k plans)
Other plans that can be self-directed:
- Health savings accounts (HSAs)
- Education savings accounts (ESAs)
Self-directed accounts have varying requirements for eligibility, annual contributions, and distributions. Understanding the rules for all accounts can help you make the decision that suits your needs.
- What investments are not allowed in my self-directed account?
The only investments the IRS prohibits in these accounts are life insurance contracts and collectibles. Internal Revenue Code 4975 states: collectibles include works of art, rugs, antiques, metals (other than certain approved gold, silver, and palladium bullion), gems, stamps, coins, alcoholic beverages, and other tangible personal property as may be defined by the Secretary of Treasury.
- How do I fund my account?
After you open an account with a self-directed IRA services provider like Advanta IRA, funding your account is easily accomplished in the following ways:
- Make a cash contribution (within the annual contribution limits of your plan)
- Transfer or rollover funds from an existing IRA or old 401(k)
- Can I invest with limited funds?
Yes. Plenty of opportunities don’t require hundreds of thousands of dollars to invest. Tax liens, mobile homes, duplexes and triplexes, private lending, and some private equity and real estate investment syndications are examples of assets you can acquire with limited funds.
- Can my SDIRA partner with others or with myself to invest?
Your IRA can partner funds with your money and other investors and entities to invest. It can even partner with other IRAs to invest. Income and investment-related expenses (if any) are distributed and paid commensurate with each partner’s percentage of ownership.
- Can my IRA borrow money to buy an investment?
Yes, your IRA can take out a non-recourse loan to help finance an investment. These loans are commonly used to invest in real estate and use the investment property as collateral. Non-recourse loans are unique in that neither the IRA nor the IRA owner is responsible in case of default. The only recourse the lender can pursue is the collateral used to protect the loan. The caveat in using a non-recourse loan is your IRA may owe unrelated business income tax (UBIT) on the debt-financed portion of the investment.
- What are UBIT and UDFI?
Your IRA may owe unrelated business income tax (UBIT) when it uses a non-recourse loan to invest. If the asset produces returns, the income attributed to the earnings is considered unrelated debt-financed income (UDFI). UBIT only applies to the percentage of returns produced by the financed portion.
UBIT also comes into play if your IRA owns a business investment and earns unrelated business taxable income (UBTI) from that asset. However, if the business pays taxes as a C-Corp, UBIT does not typically apply.
- What IRS rules for SDIRAs do I need to know?
The same rules that govern typical retirement and savings plans apply to self-directed plans. However, self-directed plan owners must understand prohibited transactions for IRAs and make sure your IRA does not transact with disqualified persons or entities. Whether committed unknowingly or not, prohibited transactions cause your IRA to suffer penalties, taxation, and even disqualification of its tax-sheltered status.
Disqualified persons include:
- The IRA holder and their spouse
- The IRA holder’s lineal ascendants, lineal descendants, and spouses of lineal descendants
- Investment advisors and managers
- Any corporation, partnership, trust, or estate in which the disqualified person maintains control as a president, manager, etc.
- Anyone providing services to the IRA, such as the trustee or custodian
- What are some examples of prohibited transactions for a self-directed plan?
Examples of prohibited transactions include:
- You or a disqualified person vacationing in property owned by your IRA
- Purchasing a property from your own IRA
- Selling an asset you or a disqualified person owns to your IRA
- Lending money from your IRA to yourself or a disqualified person
For more explicit rules regarding prohibited transactions and disqualified persons, read IRC 4975. Consulting with a certified public accountant or other financial professional is advised to ensure your account complies with IRS regulations.
- How do I learn more about self-direction and alternative investments?
Advanta IRA offers weekly webinars at no cost for individuals to learn how to manage their own retirement accounts and build tax-free or tax-deferred wealth for retirement using SDIRAs.
We also host a virtual investor marketplace and networking event called Pitch, Promote, & Prosper. This lively online forum occurs once a month and allows investors to connect and pitch their investment deals and services to each other.
You can check out Advanta IRA’s Alternative Investing Advantage podcast, which features guests who discuss investment strategies for beginner and sophisticated investors.
Contact Advanta IRA if you have questions. We do not sell investments or give advice, but our team enjoys educating people about self-directed strategies and the wealth-building opportunities alternative investments present.