While self-directed IRAs (SDIRAs) are growing wildly in popularity, they remain a bit of a mystery to many investors. The potential for rewards are great with SDIRAs. Unfortunately, so are the risks. It’s important to separate the truth from the myths so you can make a more informed decision about whether or not a self-directed IRA is a good investment for you.
Self-directed IRA Myths
You’ll hear quite a few things about self-directed IRAs. Some of them are pure fiction, while other myths are actually true. These are a few of the top myths people ask about in relation to SDIRAs.
Myth 1 – Self-directed IRAs are difficult to set up
This is not the case. In fact, most of them are quite simple to establish. Simply contact the financial institution you want to set your account up with and discuss your wishes. Most offer a simple-to-follow plan and will help guide you through the account set-up process, whether you choose to use their services for custodianship or go the truly self-directed route with a self-directed IRA LLC.
Myth 2 – You can’t buy real estate with your IRA
While this is definitely true with traditional and Roth IRAs, it is not the case with a self-directed IRA. You can, in fact, invest in real estate along with a long list of other investment options that are not available to holders of traditional IRAs.
It’s this list of options that doesn’t involve typical investment fare that makes SDIRAs so attractive to many investors. That being said, there are strict rules about real estate purchases with SDIRAs you must follow in order to avoid strong penalties and tax repercussions.
Myth 3 – An LLC is unnecessary for an SDIRA
This one is true – sometimes. Only checkbook control IRAs, known as self-directed IRA LLCs, require an LLC to be set up. Bank or custodian controlled IRAs do not. However, they also do not offer the same benefits regarding privacy and asset protection that the LLC provides.
Myth 4 – An IRA cannot own a business
Just as you can buy real estate with an SDIRA, you can also purchase a business with the IRA. Once again there are strict rules regarding ownership of the business and profit.
Now that we’ve explored the myths, it’s time to pay a little close attention to the risks of investing in SDIRAs. This is not an investment plan that’s great for novice investors in most cases. However, for those who are experienced with the type of investments they’re making and are willing to learn and play by the rules, it can be highly rewarding.
Risk 1 – Fraud
There are many schemes that prey on self-directed IRA investors because they do not always have custodians or utilize the financial advice of others.
Risk 2 – Strong IRS Regulation and Rules for Compliance
Failing to meet the stringent rules the IRS has in place can result in big time penalties, fees, and fines that cost more money than they make. No one wants losses in investments. That’s why it’s important to understand the rule and letter of the law (and to follow both) when investing in SDIRAs.
Risk 3 – Loss of Investment and/or Profits
Investments are risky by nature. The bigger the risks, the larger the potential rewards. Since you’re essentially on your own, as an investor with SDIRAs the risks of loss are greater.
Risk 4 – Absence of Advisors
Even if you choose an account with a custodian, the role of the custodian is not to advise you of the legality, wisdom, or potential for fraud in your investments. This means you have no one acting in the capacity as an advisor to help you grow your investments with an SDIRA.
With the type of freedom investors enjoy with self-directed IRAs, there is a price to pay. The risks are substantial and this is not an investment for the faint of heart. However, the rewards are abundant for those who invest wisely and in accordance with the rules and regulations.