Setting Up a Self-Directed IRA

Setting Up a Self-Directed IRA

A self-directed IRA allows you to invest outside traditional assets and increase your returns. You might need to set up a self-directed IRA if you want to diversify your retirement savings and prevent your money from losing value over time due to inflation. But how do you do it?

You set up a self-directed IRA by choosing a custodian specializing in nontraditional assets and opening investment accounts. The custodian can be a credit union, bank, or financial institution. 

The rest of this article is a comprehensive guide to everything you need to know about a self-directed IRA. 

What Is a Self-Directed IRA?

A self-directed IRA is a retirement savings account that allows alternative investments you won't otherwise find in other types of IRAs. While traditional IRAs offer common assets such as mutual funds, bonds, and shares, self-regulated IRA offers investments such as:

  • Real estate
  • Cryptocurrency
  • Gas and oil investments
  • Government securities
  • Precious metals
  • Private stock 

Though the increase in investment options lowers your financial risk, it can also increase your susceptibility to fraud. To combat that, the Internal Revenue Service (IRS) requires only qualified custodians to hold investments for investors. 

The self-regulated IRA custodian facilitates your transactions as requested but doesn't offer investment advice. You'll have to hire a qualified financial advisor or consultant for that purpose.

Steps for Setting Up a Self-directed IRA

Setting up a self-directed IRA is a straightforward process you can complete even at home. 

On average, it takes ten (10) days to set up a self-directed IRA, and here are the steps you should follow. 

Step 1: Choose a Custodian or an Administrator of Your Account

The custodian you choose influences how your investment will perform and how much time you'll spend managing your account. Therefore, it's essential to do your research to ensure your custodian aligns with your investment goals and is qualified to be a self-directed IRA custodian.

Some of the factors you should consider are:

  • Specialization: Some custodians specialize in traditional investments, while others excel in alternative investments. Though some deal with both types, the one specializing in only alternative investments is the best for self-directed IRAs, as they likely have an advantage in terms of experience.
  • Your investment strategy: A custodian can support a single investment over the long term or multiple weekly transactions. If you intend to choose the latter, the turnaround time of your custodian should be fast enough to boost your investment performance.

Step 2: Open a Traditional or LLC Self-Directed IRA Account

After choosing a custodian, the next thing you want to do is to create an account and fund it. You can create an account with a Limited Liability Company (LLC) that owns the IRA. This means your funds go to the LLC, which will facilitate your transactions.

A self-directed IRA LLC is ideal if you want to do multiple transactions since it's faster. A traditional self-directed IRA would serve you better if you want to hold your investment for longer. 

To create a self-directed IRA LLC account, you'll need to:

  •  Draft a compliant LLC operating agreement 
  •  Provide your tax ID number
  •  File to establish an LLC

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Step 3: Fund Your Account

To carry out any self-directed IRA transactions, your account must have money. There are three ways to deposit cash into your account.

  • Out-of-pocket contributions: This involves funding your self-directed IRA account from your personal income or savings. Your spouse can also contribute on your behalf to increase your earning potential 
  • Transfers: In this case, you transfer funds from an existing IRA account to your self-directed IRA account. You can make a partial or full transfer, but both accounts must be yours.
  • Rollovers: This involves moving funds from a qualified plan such as a 403(b) or 401(k) when you receive a distribution from your plan provider or previous employer. Rollovers are typically limited to once a year.

Once you fund your account, you can decide the investments you want to hold and purchase them from the broker. You may also ask your custodian to carry out the transaction. 

Can You Have More Than One Self-Directing IRA Account? 

You may open several self-directing IRA accounts if you have lofty investment and retirement goals because there's no restriction on the number of accounts an investor can hold. However, your total contribution in all your accounts should not exceed $6,000. 

Some benefits of having more than one self-directing IRA account include:

  • It helps you separate your assets into different accounts to make it easy to evaluate your financial performance.
  • It helps you enjoy tax-free income and deductible contributions, which maximizes your earnings.

How Much Does it Cost To Set Up a Self-Direct IRA?

The setup cost depends on the expertise and quality of services a custodian offers. On average, you can expect to shell out anywhere between $150 and $350. Other costs you'll incur after setting up your account include transaction fees and the annual fee, which custodians should provide in the fine print.

Types of Self-Directed IRA

  • Self-Directed Traditional IRA: The only difference between a self-directed traditional IRA and a traditional IRA is that the former allows alternative investments. You make a tax-deductible contribution, and the total amount is taxed on withdrawal as income. It saves you more money if you anticipate tax rates to go down in the future.
  • Roth Self-Directed IRA: Contributions in a Roth self-directed account aren't tax deductible. This can benefit you over the long term because all earnings such as interest, capital gains, and dividend income grow tax-free. To withdraw your distributions tax-free, you must have owned your account for more than five (5) years.
  • SIMPLE IRA: SIMPLE IRA (Saving Incentive Match Plan for Employees) is a retirement saving plan for small businesses without other retirement saving plans. It's a better alternative to 401(k) because it's cheaper, allowing you to lower your tax liability.
  • SEP IRA: A Simplified Employee Pension (SEP IRA) is a retirement saving plan for a small business employer willing to contribute on behalf of employees. It allows employers to make significant contributions compared to a traditional IRA.

Investment and Withdrawal Limits in Self-Directed IRAs

Below is a table that summarizes the limits for self-directed IRAs.


Type of Self-Directed IRA Annual Limit Contribution Below 50 Years Annual Contribution Above 50 Years Age for Penalty-Free Withdrawal Early Withdrawal Penalty
Traditional $6000 $7000 59 ½ 10%
Roth $6000 $7000 59 ½ 10%
SIMPLE $14000 $17000 59 ½ 10%
SEP $61000 $61000 59 ½ 10%


Self-Directed IRA Prohibitions

IRS doesn't give the approved investments to investors. But it does provide rules for disallowed transactions in self-directed IRA investments. Violating these regulations can cause you to lose the tax privileges that should otherwise come with your account.

No Transaction with Disqualified Persons

Self-directed IRA investors shouldn't transact with disqualified persons. These are essentially individuals or businesses the IRA cannot transact with due to potential conflicts of interest. Examples include:

  • IRA owner (you)
  • Your beneficiary or family members
  • An entity owned by a disqualified person

No Trading in Disallowed Investments.

Although self-directed IRAs give the flexibility of trading in various investments, some items don't count as "investments" as far as these IRAs are concerned, including:

  • Life insurance
  • Collectibles such as stamps, gems, and works of art

Final Thoughts

With a self-directed IRA, you can invest in alternative investments and enjoy deferred tax earnings. All you need is a qualified custodian and a funded account to make your investment work. Although you can diversify your income, there are some investments and transactions you should avoid to keep your account working for you.