How To Open a Self-Directed Individual Requirement Account (SDIRA)

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 However, when funds are withdrawn from the account, withdrawals are subject to federal income tax.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. 

How do You Open an SDIRA?

Use the following steps to open your own self-directed IRA: 

1. Find a custodian or trustee for the account. Remember, not all IRA administrators are authorized to custody an SDIRA. 

2. Determine what type of alternative asset you would like your account to hold.

3. As you will be directing the investment activity for this self-directed account, you should initiate a certain amount of due diligence needed for the investment.

4. Find a broker to purchase the investment. If you are purchasing a cryptocurrency, you should select an exchange that sells the type of currency that you are looking to add to your retirement funds.

5. Request that your account be initiated to hold your desired investment.

Conclusion

If you are looking to diversify your retirement funds, adding alternative investments by using an SDIRA to your existing retirement nest egg might be for you. 

However, you might first consider heeding the investment advice of tax professionals suggesting that you limit your alternative investments given their speculative nature. For example, some investment professionals suggest that you limit your exposure to only 5% of your entire retirement funds.

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