Disadvantages of a Self-Directed Individual Requirement Account (SDIRA)

Self-Directed IRAs (source: ramseysolutions.com)

With extensive experience as an electrical/software/coding engineer along with having a diverse financial background, Thomas Wettermann’s areas of interest include Machine Learning (ML), artificial intelligence (AI), and Financial Technology (FinTech). For the past few years, Thomas Wettermann has focused on the underlying technologies that support and promote all phases of cryptocurrency, Web 3.0, and metaverse ecosystems.

What Is an Individual Retirement Account (IRA)?

An Individual Retirement Account (IRA) is a tax-advantaged retirement savings account. It is an account that must be established at a financial institution, like a bank, a brokerage, or a mutual fund company.

A custodian must hold an IRA on behalf of an individual where these retirement investments grow on a tax-free or on a tax-deferred basis. All custodians must be approved by the Internal Revenue Service (IRS).

There are two types of conventional IRAs. There is the traditional IRA where contributions to the account are made with pre-tax dollars. And there is the Roth IRA where contributions to the account are made with after-tax dollars. Both the traditional IRA and the Roth IRA have their own rules and restrictions regarding fund accessibility, tax consequences, and eligibility.

What is a Traditional IRA?

Contributions to a traditional IRA are tax-deductible but there are strict eligibility requirements. These requirements are mandated by the IRS and are based on an investor's income, filing status, and availability of other retirement plans.

Transactions in the account, including interest, dividends, and capital gains, are not subject to tax while the funds remain in the account. However, when funds are withdrawn from the account, withdrawals are subject to federal income tax.

Investors might find traditional IRAs beneficial if their tax rate in retirement might be lower than when contributions are made.

What is a Self-Directed Individual Requirement Account (SDIRA)?

A Self Directed Individual Requirement Account (SDIRA) is an IRA type that must be set up as a conventional IRA, that is, either a traditional IRA or a Roth IRA. Whether you select either a traditional or Roth IRA for your SDIRA, the same limitations and eligibility guidelines apply to SDIRAs as conventional IRAs.

An SDIRA allows the account holder to invest in alternative assets for retirement savings. For example, these alternative assets may be real estate, precious metals (gold and silver), private equity, commodities, or digital assets (such as cryptocurrencies).

Importantly, SDIRAs have the same contribution and income limits as conventional IRAs. All individual retirement accounts including SDIRAs are covered under Internal Revenue Code 408.

What are the Disadvantages of an SDIRA?

Before deciding to open your IRA, you should perform thorough due diligence and carefully consider your investment objectives, level of experience, adversity to risk, volatilities, and fees.

For example, SDIRA custodial fees can get expensive when considering Setup Fees, Annual Account Fees, and Transaction Fees.

If you are close to retirement age, it is important to note that certain types of alternative assets are speculative investments and have experienced extreme periods of volatility. As just one example, cryptocurrencies are not currently regulated and could result in rapid price fluctuations, based on potential regulations or statements made on social media.

And finally, the Federal Deposit Insurance Corporation (FDIC) and Securities Investor Protection Corporation (SIPC) provide investors with insurance for certain deposits and investments. However, be aware that cryptocurrency is not covered by the FDIC or SIPC. In addition, the SEC has warned of the risk of fraud when participating in certain types of SDIRAs, such as crypto SDIRAs.

Most IRA providers do offer some types of insurance, so you should naturally investigate such coverage before you open an SDIRA account. The IRS prohibits various types of transactions and activities for funds held in an SDIRA. If certain complex IRS rules and regulations are not followed, IRS owners may have to pay penalties or taxes.

There are also certain asset types that are forbidden to be kept in an SDIRA that you might be interested in adding to your return funds, such as life insurance, collectibles, or real estate that you or a family member live in.

All opinions expressed on this site are owned by Thomas Wettermann and should never be considered as advice in any form. Thomas Wettermann is not an independent financial advisor.

Any opinions, news, research, analyses, prices, or other information contained on this website is provided as a general market commentary of Thomas Wettermann and does not constitute investment advice.

Thomas Wettermann will not accept liability for any loss or damage, including without limitation to, any loss of profit, which may arise directly or indirectly from the use of or reliance on such information. Trading digital financial assets such as cryptocurrencies can carry a high level of risk, and may not be suitable for all investors.

Before deciding to invest, purchase, and/or trade cryptocurrency you should carefully consider your investment objectives, level of experience, adversity to risk, and volatilities. The possibility exists that you may sustain a loss of some or all of your initial investment; therefore, you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with cryptocurrency trading, and seek advice from a qualified and independent financial advisor.