Individual Retirement Accounts (IRAs) allow you to invest your money in a variety of assets. These accounts offer tax benefits, which can help you reduce your tax bill. There are many different types of IRAs, including traditional IRAs and self-directed IRAs. Both accounts have their advantages, but the best choice depends on your preferences. We’ll compare these two types of IRAs to help you decide.
Traditional IRA
Traditional IRAs are tax-advantaged retirement savings accounts. In these accounts, contributions are tax-deductible and growth grows tax-deferred. Distributions are taxed as ordinary income, but these accounts can still be advantageous if you expect to be in a lower tax rate in retirement.
Traditional IRAs are managed by a custodian, such as a bank or investment company, and while you have control over your investment choices, your options are usually limited to traditional investments like stocks, bonds, and investment funds.
In 2024, the contribution limit for a traditional IRA is $7,000. If you’re over age 50, the limit is $7,500. This is the combined contribution limit for traditional and Roth IRAs. However, unlike Roth IRAs, traditional IRAs don’t have income limits.
Self-Directed IRA
A self-directed IRA (SDIRA) is an IRA that gives you greater discretion in selecting and managing the investments you hold, which opens up the possibility of pursuing alternative investments beyond what most traditional IRAs allow.
For example, with an SDIRA you can invest in assets such as:
- real estate
- Private equity (equity in privately held companies, start-ups and venture funds)
- Precious metals (gold, silver, platinum, etc.)
- Cryptocurrencies (Bitcoin, Ethereum, etc.)
These accounts offer the same tax benefits as regular IRAs, including pre-tax contributions and tax-deferred growth. SDIRAs, also known as Roth accounts, allow for after-tax contributions and tax-free qualified withdrawals.
Reasons for choosing a Self-Directed IRA include diversifying your portfolio, having more control over your investment choices, and the potential for higher returns, but as with any choice of alternative investments, this also means increased risk.
Self-Directed IRAs vs. Traditional IRAs
Although IRAs and SDIRAs have many similarities, they also have more differences than meet the eye. Here’s how the two account types compare:
| Features | Traditional IRA | Self-Directed IRA |
|---|---|---|
| Investment Options | Stocks, bonds, mutual funds, exchange-traded funds | From traditional IRAs to alternative assets like real estate, precious metals, and cryptocurrencies |
| Control | You are in control of your account | You are in control of your account |
| Fee | May be lower than SDIRA fees | Fees can be higher than traditional IRAs |
| Tax incentives | Tax-deductible contributions and tax-deferred growth | Tax-deductible contributions and tax-deferred growth |
The main advantage of an SDIRA over a traditional IRA is that it offers a wider range of investment options. However, SDIRA fees can be higher, and there can be greater risk when holding alternative investments in an SDIRA.
Things to consider when choosing one over the other
Both traditional and self-directed IRAs have benefits, and which is the better choice depends on your situation. Here are some things to consider:
- Your investment preferences: If you’re not that interested 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 maximum diversification? Then an SDIRA is ideal. If you have a lower risk tolerance and prefer more traditional investments, a traditional IRA may be a better fit.
- Long-term growth potential and retirement planning: SDIRAs are a higher-risk, higher-return alternative investment that can potentially offer higher long-term growth rates. However, because of the higher risks, we recommend investing in them only if you have many years, or preferably decades, until retirement. If not, an SDIRA may not be the right choice for you.
When choosing between a traditional IRA and an SDIRA, be careful not to focus too much on the potential return — your own situation and long-term financial goals are just as important.
Conclusion
The main difference between a traditional IRA and an SDIRA is that an SDIRA allows you to invest in a wider range of assets, giving you access to real estate, precious metals, and cryptocurrencies. However, SDIRA fees can be higher and, more importantly, they carry higher risks. Before proceeding, it’s important to consider these factors and whether an SDIRA fits into your retirement strategy.
Editorial Disclaimer: All investors are advised to conduct their own independent research into any investment strategy before making any investment decision, and please note that past performance of any investment product is no guarantee of future price appreciation.
