Self-directed IRAs have the option to invest directly in alternative assets or invest indirectly through “liquid alts” such as fund-of-fund mutual funds, Exchange Traded Funds (ETFs), Real Estate Investment Trusts (REITs), or Special Purpose Acquisition Companies (SPACs) that provide daily liquidity.
What is a Self-Directed IRA?
A Self-Directed IRA is comparable to a standard IRA as it is a retirement account where funds are contributed to allow for the growth of retirement funds through investments. However, the main distinction between the two lies in the types of investments each account can hold. While a standard IRA permits investments in publicly traded products such as stocks, bonds, and mutual funds, a Self-Directed IRA offers the flexibility to invest in a wide range of alternative assets. Common choices for investment in a Self-Directed IRA include real estate, precious metals, and private placements.
Are There Different Types of Self-Directed IRAs?
Self-Directed IRA
As the account holder of a Self-Directed IRA, you have the ability to direct the custodian to carry out transactions and invest in alternative assets that go beyond stocks, bonds, and mutual funds.
- Optimized for low-transaction investments, like private placements and precious metals
- Place investments by instructing Madison Trust to send your IRA funds by writing a check or sending a wire directly to your investment.
- Simpler and low-cost setup; setting up an LLC or trust is not required
Self-Directed IRA with Checkbook Control (Checkbook IRA)
By creating an entity, this type of Self-Directed IRA grants you, the account holder, the ability to execute transactions in real-time.
- Optimized for transaction-heavy investments, like real estate rentals and fix-and-flips
- Place investments by simply writing a check or sending a wire from your Checkbook IRA designated checking account
- The company will create the entity (LLC or trust) for you to provide a seamless investment experience
How Does a Self-Directed IRA Work?
Choose an Asset: This part is fully up to the investor. In most cases, a Self-Directed IRA custodian will not offer specific financial advice. You should choose an asset for which you have a good grasp of its potential profitability as well as one that you have the means to manage.
Submit an Investment Authorization Form: Fill out the form and submit it to the Self-Directed IRA custodian, and the custodian will perform the transaction. Of course, certain assets will have more extensive paperwork associated with their purchase; this is not due to the Self-Directed IRA but rather to the nature of the asset itself. For example, real estate often possesses a more involved process, including title and deed processing.
3 Self-Directed IRA Investments Investors Love
Self-directed IRAs offer the opportunity to invest in various alternative assets, such as private equity, venture capital, private debt, hedge funds, real estate, and commodities. Out of these options, three of the most favored choices for investment are discussed below.
Private Equity
Private equity investments involve acquiring or investing in private companies that are not publicly listed on stock exchanges and purchasing public companies. Various styles of private equity investing exist, with the most prevalent ones being:
- Venture Capital – Invest in early-stage companies, including start-ups. These are high risk investments that often fail, which is why returns can be greater than traditional investments.
- Distressed Funding – Invest in troubled companies with underperforming business units or assets to turn them around and sell them for a profit.
- Leveraged Buyouts – As the most popular form of private equity funding, it uses a combination of debt and equity to purchase a company, improve the business, and resell it for a profit or by initial public offering (IPO).
Real Estate
Real estate investments encompass various types, including direct investments in rental properties such as offices or apartment buildings. Additionally, investors can opt for indirect investments through Real Estate Investment Trusts (REITs), Limited Liability Companies (LLCs), and Limited Partnerships (LPs).
By directly investing in or purchasing rental properties, the IRA assumes the role of a landlord, requiring responsibilities such as ensuring mortgage payments, property taxes, and insurance are covered, overseeing maintenance tasks, recruiting tenants, and managing any issues that arise. This approach offers the advantage of enabling investors to generate reliable and sustainable income streams over the long term.
Private Debt
Private debt resembles a business bank loan; however, it lacks the regulatory limitations imposed by banks. Private lenders may offer higher yields due to the relatively lower fees and interest rates associated with bank loans. The scope of private debt encompasses the following things:
- Venture Debt – Private lenders invest in high risk, high return start-up companies.
- Infrastructure Debt – Capital-intensive projects are lent capital in return for higher yields.
- Real Estate Debt – Investors fund real estate developments and acquisitions.
- Private Debt Funds – Investors pool money to fund large-scale projects.
- Private Debt Funds (Mortgage Focus) – Investors primarily invest in the development or purchase of residential and commercial real estate.
Private debt investors have the potential to attain high returns, usually exceeding bank rates by 4 – 6%, along with favorable cash flow from fixed interest and principal payments. Moreover, investors can anticipate enhanced diversification resulting from bond volatility, accompanied by returns comparable to those of equities.
What Are the Benefits of a Self-Directed IRA?
Portfolio Diversification
Investors can expand the range of their retirement portfolios with a Self-Directed IRA, enabling them to include assets that are not available in a regular IRA. Self-Directed IRA custodians focus on overseeing privately held investments such as real estate, private businesses, promissory notes, cryptocurrencies, and others, all within an account that offers tax advantages.
Hands-on Investing
Self-Directed retirement plans promote investment in areas individuals are already knowledgeable about, empowering investors to allocate money towards personally meaningful investments. As people possess various strengths and areas of expertise, it is reasonable for their investments to align with these differences.
Stability
By utilizing a Self-Directed IRA, individuals have the opportunity to expand their investments beyond the unstable stock market and instead opt for more stable and dependable sources of income. Examples of favored options are rental real estate, secured promissory notes, and tax liens.
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