What is a Self-Directed IRA?
- Erica Elliott
- Nov 20
- 3 min read
Updated: 11 hours ago
In 1974, when Congress passed ERISA into law, the universe of Individual Retirement Accounts (IRAs) was born. There was never anything in this law that required IRAs to be invested in stocks and bonds. The law only lists what you CAN'T do in your IRA, which we will review later.
But the financial services industry jumped on this new market opportunity. In the waning world of employers' pension plans, they successfully persuaded consumers that their role as advisors in the traditional stocks & bonds markets was the most convenient choice. This naturally excluded all other investment types, which we will review below.
The term SELF-DIRECTED IRA (SDIRA) and other SD retirement plans evolved from these events. YOU hire yourself as the SDIRA advisor choosing what types of assets are in your plan. However, you must hire a 3rd party CUSTODIAN to hold its investments. But the custodian is effectively a container. Think of your plan's 3rd-party CUSTODIAN as your safety deposit box at your local bank branch. But you now are free to decide what goes into the box, because you hold the key!
What can you hold in your box?
Beyond stocks, bonds, and mutual funds, there are many more items that CAN be held in retirement. Let's start with some other possibilities.
REAL ESTATE
LOANS
PRECIOUS METALS
PRIVATE EQUITY
CRYPTOCURRENCY
So what CAN'T your IRA do?
NO COLLECTIBLES!
Think artwork, stamps, antique cars, baseball cards, Birkin bags, wine, diamond rings, and Rolex watches.
If you pause, it is logical. Even though they can greatly increase in investment value, they are all items that can be enjoyed PERSONALLY.
They inure personal benefits to you, so they don't belong in an IRA.
SEPARATE SOVEREIGN COUNTRIES
Begin to think about yourself and your retirement plan as two separate sovereign countries. You are the Crown Regent and a sovereign citizen of your country. The same applies to your IRA. You are not citizens of each other's countries. In the world of tax, if you crossed the border into IRA's country, you would be declared DQ, a Disqualified Person.
NO DISQUALIFIED PERSONS!
FAMILY TREE
YOUR LINE
In the tax world, this follows the logic of inheritance rules along ancestral lines UP and DOWN the family tree. So who is a Disqualified Person in the land of YOUR IRA?
Your grandparents, children, and grandchildren are ALL DQ persons just like you! If you legally adopt a child, they are considered grafted into your tree and DQ. Any entity controlled by one of these people are also DQ! When it comes your sovereign IRA, ALL of you are DQ'd and barred from doing business with YOUR retirement plan.
THE GOOD NEWS
YOUR CIRCLE
But guess what? The tax rules do NOT exclude anyone else in your family tree! Your IRA CAN do business with others in YOUR CIRCLE. Your aunts, uncles, siblings, half-siblings, step-siblings, nephews, nieces, cousins, or step-children that were not legally adopted. And if we extend further into your community, your IRA can do business with your friends, neighbors, roommates, classmates and co-workers. As well as any businesses or entities created by your circle. YOUR CIRCLE IS GOOD, YOUR LINE IS DQ'D.
WHAT ARE PROHIBITED TRANSACTIONS?
PERSONAL BENEFIT RULE
Your IRA can transact with your CIRCLE, but NOT your LINE. Your transaction can benefit YOUR LINE. All of those previously identified DQs can't do business with your IRA. If one of you did a business deal with your IRA, that would be a big NO-NO and identified as a Prohibited Transaction. It creates a taxable event and can even blow up your IRA. Think nuclear bomb.
Transactions are good within your CIRCLE, but are strictly prohibited with your LINE.
TRANSACTION EXAMPLES
LENDING
BORROWING
BUYING PROPERTY
SELLING
PROVIDING SERVICES
VACATION RENTALS
PERSONAL GUARANTEES
Remember all of these transactions are good business as long as they are with the right people and businesses. STAY AWAY FROM YOUR OWN FAMILY LINE!
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