When it comes to saving and investing for retirement, you have many choices and tools to employ. You might have a 401(k) plan at your workplace, for example. That's great, but one downside to it is that the investment options it gives you might be limited to a suite of mutual funds, many unthrilling. Thus, IRAs can be more attractive, because they let you invest in a huge array of mutual funds, plus a wide range of individual stocks, bonds, CDs, and more. There's a way to have an even wider range of investments, if you want, including real estate -- via a self-directed IRA. Just think twice before you opt for one.
The obvious upside of a self-directed IRA, at least for some folks, is the wider range of possible investments that they permit. For example, you can use one to invest in real estate or in a private business. As my colleague Dan Caplinger has explained, this can be a big deal, if you see significantly more growth potential for you in a kind of investment that a conventional IRA doesn't permit. Fledgling businesses can be extra risky, and many ultimately fail -- but when they do succeed, they can create big wealth for the early investors who were able to get in well before the company went public and issued common stock on the open market.
A self-directed IRA can hold all kinds of investments, such as oil and gas, cattle, promissory notes, and actual gold (as opposed to gold funds or stock in gold-related companies). Even racehorses can qualify. There are some limits, though, with investments such as collectibles or insurance disallowed. "Self-dealing," investing in your own company or in a way that benefits certain family members, is prohibited. (Examples might include buying yourself a vacation home or issuing a mortgage to your son so he can buy a home.)
Of course, it's not all upside with self-directed IRAs, and a good case can be made that they should just be avoided. For example, there are a lot of rules regarding them, so you might want to consult a financial or tax pro before proceeding. You may actually need to hire legal or other professional help in proceeding with this kind of investment, and those costs can add up. (Real estate investments might need occasional appraisals, for example.)
And the rules for self-directed IRAs can make things difficult, too. With traditional IRAs, the IRA owner must start taking "required minimum distributions" beginning at age 70 ½ (this isn't the case with a Roth IRA) -- and that can be problematic, if the IRA holds assets from which you can't easily shave off portions annually. Traditional IRAs also levy taxes on withdrawals at your ordinary income rate, and that can be as high as 25% or even almost 40%. (Again, the Roth has much appeal, since its withdrawals can be tax-free.)
Then there are scams. Many con artists out there preying on gullible folks have taken to promoting self-directed IRAs.
The biggest knock against self-directed IRAs, if you ask me, is that they permit you to invest your very valuable retirement money in investments that tend to be riskier than many alternatives. Yes, you might really want a big return on your money, but you may be more likely to earn that via a conventional IRA and index funds or carefully selected individual stocks. That's "self-directed," too, in the sense that you're the one choosing the investments and calling the shots.
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The article Beware of Self-Directed IRAs originally appeared on Fool.com.
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