Skip to content

Self-Directed IRA Versus Traditional IRA

Traditional IRA
Self-Directed IRA and Advantages
Investments That Can be Made by Self-Directed IRA
Types of IRAs that may be self-directed
Steps for establishing a self-directed IRA


A traditional Individual Retirement Account (commonly called “IRA”) is a retirement account that allows individuals to set aside a prescribed amount of money each year into the account. The money contributed to the account generally provides a tax deduction. The earnings from investments made by the account are “tax deferred” until the money is withdrawn. The account is generally established with a broker, bank, or mutual fund. The investments that can be made are generally only those offered by the broker, bank or mutual fund and are generally limited to stocks, bonds, or funds offered by the mutual fund or broker.


A self-directed IRA is technically no different than a traditional IRA. A self-directed IRA is unique because of the investment options available. Most traditional IRAs only allow approved stocks, bonds, mutual funds and CDs. A truly self-directed IRA allows these types of investments along with real estate (commercial and residential), precious metals tax liens, limited liability companies, franchises and much more making an investor less susceptible to downturns in once sector of the market.

There are approximately 2.5 million Self-directed IRA accounts in the United States. In the last several years, the number of Self-Directed IRA accounts has grown significantly. The significant increase in the number of Self-Directed IRAs formed can be largely attributed to the poor performance of the stock market, the growth of the real estate market, the lack of liquidity in the small business loan market. The major advantages can be summarized as follows:

Tax Advantages:

    With a Self-directed IRA you have all the tax advantages of traditional IRAs, as well as tax deferral and tax-free gains. All income and gains generated by your IRA investment will flow back to your IRA tax-free. By using a Self-Directed IRA to make investments, the IRA owner is able to defer taxes on any investment returns, thus, allowing the IRA owner to benefit from tax-free growth. Instead of paying tax at the time the income is earned by the Self-Directed IRA, tax is paid only at a later date when a distribution from the IRA is taken, leaving the investment to grow tax-free without interruption.

Investment Options: With a Self-directed IRA, you can invest in almost any type of investment, including real estate, private business entities, tax liens, precious metals and commercial paper tax-free.

Diversification: With a Self-directed IRA, you can invest in almost any type of investment, including real estate, allowing you to diversify and better protect your retirement portfolio. For example having real estate in your IRA protects an investor from stock market downturns and volatility.


IRS rules allow holders of Self-directed IRAs to invest in a broad range of alternative investments not available from banks and brokerage firms. So in addition to stocks and bonds a self-directed IRA account holder can diversify his or her investments in any of the following:

  • Residential or commercial real estate
  • Domestic or Foreign real estate
  • Raw land
  • Foreclosure property
  • Mortgages
  • Mortgage pools
  • Deeds
  • Private loans
  • Tax liens
  • Private businesses
  • Franchises
  • Limited Liability Companies
  • Limited Liability Partnerships
  • Private placements
  • Precious metals such as American gold or Silver eagles and certain coins that meet certain purity standards)
  • Stocks, bonds, mutual funds
  • Foreign currencies

There are only a few types of investments a Self-directed IRA cannot invest and these are:

  • Collectibles (art, stamps, jewelry, rugs, baseball cards, etc.)
  • Life insurance contracts
  • Stock of a S corporation

Note: you may purchase gold and platinum and certain other prescribed precious metals


Traditional IRA. A traditional IRA may be self-directed just by opening an account with a Custodian who offers self-directed accounts.

Roth IRA. A self-directed Roth IRA may be established just by opening an account with a Custodian who offers self –directed IRAs. A Roth IRA differs from a traditional IRA in that contributions to the Roth are not tax deductible, but all earnings and principal are tax-free as long as the IRS rules are followed. In a traditional IRA distributions of both principal and earnings are taxable. So with a Roth IRA, an account holder sacrifices upfront tax deductions for the benefit of tax-free withdraws. The determination of which one is more beneficial depends upon several factors including age, rates of return, and tax rates.

SEP IRAs. A SEP IRA is a type of traditional IRA for self-employed individuals or small business owners. (SEP stands for Simplified Employee Pension.) The main benefit of a SEP is that it allows significantly greater yearly contributions to the account than a traditional or Roth IRA. For 2016 the limit is the lesser of 25% of an account holder’s compensation or $53,000. A self-directed SEP may be established by opening an account with a Custodian who offers self-directed IRAs.

The following may open and contributed to a SEP. Anyone who:

  • is a sole proprietor
  • has a business partnership
  • is a business owner
  • has self-employment income earned by providing a service
  • is an employee of someone who establishes a SEP IRA for his/her employees

Simple IRAs. Savings Incentive Match Plan for Employees IRA (SIMPLE-IRA) is an IRA set up by a small employer for a firm’s employees that allow both matching and elective contributions. These may be used by self-employed individuals (you are treated as employer and employee) and are attractive in that larger annual contributions may be made than in a traditional IRA.


By law almost all Self-directed IRAs are opened with a Custodian who offers Self-directed IRAs. If you do not have an account with such a custodian, there are only two simple steps for opening an account: They are:

  1. Select the appropriate custodian. Custodians differ as to amount of experience, fees charged for holding investments and for each transaction undertaken, and quality of service provided (we can help with this process). To open an account for most accounts, all you’ll need is a signed application, copy of your driver’s license, and method of payment (we can help select a custodian). For a list of some of the custodians who provide self–directed IRA services click here.
  2. Fund the Account. The issue covered here is how to get funds into your self-directed IRA. There are essentially three ways:


    You can make annual contributions to a self-directed IRA and the amount of the annual contributions depends on several factors including your compensation and, the type of IRA. Most individuals establishing a Self-directed IRA will not rely on contributions to fund it but will transfer funds from an existing retirement plan either by way of rollover or transfer to the Custodian of a Self-directed IRA.

Rollover. A Rollover occurs when an individual requests a distribution from an IRA or a Qualified Retirement Plan (such as 401k, 403b or profit sharing plan) and then “rolls” the assets into an IRA. The individual can request that the funds from the distributions be paid directly to the self-directed IRA custodian or received personally and then contributed to the self-directed custodian. There are major disadvantages to receiving the funds personally: the individual has sixty (60) days from receipt of the eligible rollover distribution to roll the funds into an IRA (otherwise the distribution becomes fully taxable). The 60-day period starts the day after the individual receives the distribution. Usually, no exceptions apply to the 60-day time period; ii.taxes may be withheld from the distribution leaving less funds to contribute to the Self-directed IRA.

Transfer. A transfer is a transfer of funds from a traditional IRA custodian to a self-directed IRA custodian. With an IRA transfer, the IRA holder directs the transfer, but does not actually receive the IRA assets. Instead, the transaction is completed by the distributing and receiving financial institutions.

Note: Most employer qualified retirement plans (this includes 401k, 403b, and profit sharing plans) have restrictions on the ability to withdraw funds by way of rollover. In general, in order to rollover funds from qualified retirement plans to a Self-directed IRA there must be a plan-triggering event. A plan-triggering event is typically based on what is allowed under your employer’s plan documents. Most plan documents allow a rollover under the following circumstances: (i) the termination of the plan, (ii) the plan participant reaching the age of 591/2, or (iii) the plan participating leaving the employer. To determine if you can rollover funds from your employer plan you should consult the plan documents or the plan administrator.