An Individual Retirement Account can provide long-term, tax-advantaged savings if you conform with IRS regulations. The difference between a self-directed IRA and any other type of IRA is that you are in control of your investment decisions with a self-directed plan. Usually, IRAs at banks and mutual fund companies are managed by the custodian, whereas IRAs opened at a brokerage house are self-directed, although you can specify your preference at most firms.
IRA Characteristics
Except for the control of the investments within, most personal IRA accounts share the same overall characteristics. For example, all Roth IRAs enjoy tax-free growth and withdrawals, and all Traditional IRAs offer the deferral of taxes until distribution, regardless of whether they are self-directed or not.
Contributions
Contributions to all Traditional and Roth IRAs are limited to $5,000 for 2010, or $6,000 if you are age 50 or older. Roth contributions may be further restricted by your modified adjusted gross income. For example, in 2010 you are not allowed to make a Roth contribution if your MAGI is $120,000 or over for a single filer, $176,000 or over if you are married and filing jointly.
Investment Strategy
Although IRA accounts have tax advantages over regular taxable investment accounts, the investment strategy behind self-directed IRA investing should be similar. For all investment accounts, you should first determine your investment objectives and risk tolerance before you begin. Your investment objective represents the type of profit you intend to generate within the account. In the broadest terms, you should ask if your goal is to generate income or growth. Your selection will help direct you towards the types of investments you should own. Your risk tolerance is your ability to handle value fluctuations within your account. Some investors can handle wild swings in the value of their account, while others prefer a more stable and consistent valuation. As with your investment objective, your risk tolerance helps dictate the types of investments you should own.
Tax Implications on IRA Investments
As IRA investments are tax deferred, or tax free in the case of Roth IRAs, you can afford to make certain investment choices within an IRA that might be less practical in a taxable account. For example, if you have a diversified portfolio, you might consider buying your income-generating investments within your IRA, as the income is not currently taxable. Similarly, if you actively trade stocks with a portion of your portfolio, you might prefer making your short-term trades within your IRA account, as those short-term gains would otherwise be taxable at ordinary income tax rates.
Investment Restrictions
As with all IRAs, the IRS prohibits investing in collectibles such as rugs and coins in self-directed IRAs. Many IRA custodians also prevent real estate investments in IRAs, although they are not technically prohibited by the IRS.
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