In this article, I’d like to discuss some of the core differences between self-directed IRAs and traditional IRAs, and explore some of the ways a self-directed IRA can be used as a powerful investment tool. But before we delve into this topic, let me be clear in saying that self-directed IRAs are not for everyone. Before you consider taking the path of a self-directed IRA, I strongly recommend that you consult with your financial adviser and discuss your intentions for leveraging your retirement savings in this way.
The reason that I chose this topic is that self-directed IRAs have become somewhat of a hot trend lately in the investment arena, and yet I still interact with many folks that are unaware that self-directed IRAs are even an option. I’m not saying a self-directed IRA is the best option for you, but I do think that everyone should at least be aware that this option exists. In the past it seemed as if self-directed IRAs were reserved for and used exclusively by the wealthy elite. But today, they are more commonplace, and many people are discovering smart ways to leverage them to produce attractive investment returns with the same valuable tax advantages as traditional IRAs.
So what is the difference between a traditional IRA and a self-directed IRA?
A traditional IRA is a tax-deferred retirement account made up of various securities, such as stocks, bonds and mutual funds, which are registered with state and federal authorities. A self-directed IRA is still a tax-deferred account, but it comes with added flexibility that allows you to invest in things other than securities. Instead of the usual stocks, bonds and mutual funds, you may choose, for example, to invest in commercial or residential property, a small business, or unregistered securities. Some people are rolling over traditional IRAs into self directed IRAs, while others are opening new self-directed IRA accounts with the intention of using them for a variety of investment purposes.
While there are many types of investments for which self-directed IRAs may be used, the trend I’m seeing the most is people leveraging their retirement savings to purchase real estate and rental properties. If there is a good deal on property, these accounts can provide the cash flow needed to make the investment. Self-directed IRAs also can be used as a down payment for a mortgage on a property, but because cash buyers typically get the best deals, I’m seeing a lot of investors using this tool as a resource for buying real estate in cash. A self-directed IRA can provide capital and an effective channel for investing, and in many cases the return on investment is higher than what you might get from a traditional IRA. However, there are several important things to consider before choosing this financial tactic:
Restrictions. There are many restrictions and tight guidelines that limit the use of self-directed IRAs and the money made off the investments. For example:
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