Self-Directed IRA Vs. Traditional IRA: How They Compare

Individual retirement accounts (IRAs) allow you to invest your money in various assets. These accounts are tax-advantaged, allowing you to reduce your tax liability. Various types of IRAs exist, including traditional IRAs and self-directed IRAs. Both accounts can have advantages, but the best choice depends on your preferences.

How traditional IRAs work

A traditional IRA is a tax-advantaged retirement savings account. These accounts offer tax-deductible contributions and tax-deferred growth. While distributions are taxed as regular income, these accounts are still advantages if you expect to be in a lower tax bracket in retirement.

A traditional IRA is maintained by a custodian, such as a bank or investment firm. While you may have control over your investment selections, your choices are usually limited to traditional investments, such as stocks, bonds and investment funds.

How self-directed IRAs work

A self-directed IRA (SDIRA) gives you broader discretion to select and manage the investments it holds. This opens the possibility of pursuing alternative investments beyond what most traditional IRAs allow.

For instance, an SDIRA enables you to invest in assets such as:

These accounts have the same tax advantages as regular IRAs, including pre-tax contributions and tax-deferred growth.

The reasons for choosing a self-directed IRA include portfolio diversification, greater control over investment selection and the potential for higher returns. However, this can also mean greater risk, as is often the case when choosing alternative investments.

How traditional IRAs compare to self-directed IRAs

While IRAs and SDIRAs share many similarities, they also have a few differences. Here is how the two account types compare:

The main advantage of SDIRAs over traditional IRAs is that they offer more expansive investment options. However, the fees can be higher for SDIRAs. In addition, the risk can be greater if you hold alternative investments in an SDIRA.

What to consider when choosing between a traditional IRA and SDIRA

Traditional IRAs and self-directed IRAs both have advantages, and which one is a better choice depends on the situation. You can also have both. Here’s what to consider.

• Your investment preferences: If you have little interest in alternative investments, a traditional IRA might make more sense. Otherwise, choose an SDIRA.
• Risk tolerance and diversification: Do you have a high risk tolerance and want the greatest possible diversification? If so, an SDIRA is ideal. If your risk tolerance is lower and you prefer traditional investments, a traditional IRA might be better.
• Long-term growth potential and retirement planning: Long-term growth can be higher with an SDIRA due to higher-risk, higher-reward alternative investments. However, due to their high risk, it’s best to invest in them only if you have many years until retirement — preferably decades. If not, a SDIRA may not be the right choice.

When choosing between a traditional IRA and SDIRA, remember not to focus too much on potential returns. Equally important is your situation and long-term financial goals.

Traditional IRA and SDIRA FAQs

• Can you roll a traditional IRA into a SDIRA?
  

  There are generally two ways to move funds from a traditional IRA to a self-directed IRA. The first is using a direct transfer, and the IRS doesn’t limit how often you can conduct these transfers. The second is by using a 60-day rollover, and the IRS lets you conduct one of these per year. Check that your SDIRA custodian accepts rollovers. Also, required minimum distributions or excess contributions cannot be rolled over, according to the IRS.

• Can I have both a SDIRA and IRA?
  

  Yes, you can have more than one IRA. Note, however, that your total contributions across all IRAs for the year can’t exceed the annual contribution limit of $7,000. You couldn’t, for example, contribute $7,000 to your traditional IRA and then another $7,000 to your self-directed IRA, totaling $14,000. You could contribute $3,500 to each, for example.

• What are the penalties for early withdrawals for SDIRAs and IRAs?
  

  Taking funds out of a traditional or self-directed IRA before age 59½ may be subject to a 10 percent early withdrawal penalty. That is, unless you qualify for certain exceptions, such as using the withdrawn funds for a first-time home purchase, qualified education expenses or certain medical costs.

Bottom line

The main difference between traditional IRAs and SDIRAs is that SDIRAs allow you to invest in a broader array of assets, providing access to real estate, precious metals and cryptocurrencies, for example. However, the fees can be higher for SDIRAs and, crucially, so can the risk. It’s important to consider these factors and whether an SDIRA can fit into your retirement strategy before moving forward.

— Bankrate’s Logan Jacoby contributed to an update.

Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.