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How Do Self-Directed IRAs Work?

Self-Directed IRAs

What is the importance of an IRA? Establishing an IRA is important to prepare for retirement and take advantage of tax savings while you’re working. But why is it important to know about the types of Self-Directed IRAs, and how the Self-Directed IRA can take care of you during retirement?

Most of us participate in our first retirement account through an employer’s 401(k) program, but there are other reasons for contributing to a Self-Directed IRA.

Learning the different types of Self-Directed IRAs will help you choose which is best for your future and investment goals.

The Self-Directed IRA

A Self-Directed IRA is not a legal term that you will find in the Internal Revenue Code. In other words, the IRS does not define what a self-directed IRA is. A Self-Directed IRA simply refers to an IRA account which permits you to invest in traditional assets, such as stocks, but also alternative assets, such as real estate or even cryptocurrencies. Commonly held alternative investments include:

Learn More: What Can I Invest in With a Self-Directed IRA?

Self-Directed IRAs provide essential benefits, like flexibility and tax advantages. In the last several years, the number of self-directed IRA accounts has grown significantly. Today, there are approximately 50 million IRAs totaling about $9.3 trillion dollars.

With your Self-Directed individual retirement account, you decide when to buy, sell and what investments you wish to make. As a result, you better diversify your retirement portfolio and gain the ability to invest in asset classes you feel confident about.

*While IRA Financial Group allows you invest in a variety of alternative and traditional assets, not all Self-Directed IRAs allow these options. Before opening a Self-Directed IRA with another company, make sure to ask what types of alternative assets you can purchase.

Traditional IRAs vs. Self-Directed IRAs

Traditional financial institutions do not allow IRAs to invest in IRS-approved alternative assets because their focus is on earning fees through traditional investments. Hence, the birth of the Self-Directed IRA industry.  Self-Directed IRAs differ from traditional IRAs by using passive custodians. Contrasting traditional IRA custodians, Self-Directed IRA custodians do not offer advice or sell investments.

Today, the Retirement Industry Trust Association (RITA) estimates anywhere between 4-7% of all IRAs are invested in alternative assets.  Accordingly, the Self-Directed IRA is the only way one can purchase alternative assets in an IRA.

Why Choose a Self-Directed IRA?

This type of IRA allows investors to use their IRA funds to make diverse investments. Many IRA investors believe they can only use an IRA for traditional investments, such as bank CDs, the stock market or mutual funds. Fewer investors know that the IRS permits investments like real-estate to be held inside individual retirement accounts.

The two main advantages of using a Self-Directed IRA to make investments is that you can invest in what you know, and all the income and gains are tax-deferred or tax-free in the case of a Roth Self-Directed IRA.

Types of Self-Directed IRAs

Any type of IRA can be turned into a Self-Directed IRA.  In other words, if you have any type of IRA at a bank or traditional financial institution, you can transfer the IRA funds tax-free to a Self-Directed IRA for the purpose of making alternative asset investments. Below is a review of the different types of Self-Directed IRA accounts.

Traditional IRA

The traditional IRA is an individual retirement arrangement (IRA) which was established by the Employee Retirement Income Security Act of 1974 (ERISA).  The Traditional IRA was created to help more Americans save for retirement.  In 2024, the maximum IRA contributions are $7,000 or $8,000 if you are at least age 50.  Contributions to a Traditional IRA is tax deductible.  Distributions taken before the age of 59 1/2 are subject to tax and a 10% early distribution penalty.  After the age of 73, one is required to take an annual required minimum distribution.

Roth IRA

The Taxpayer Relief Act of 1997 introduced the Roth IRA. The Roth IRA is an after-tax IRA which allows any US person with earned income under a set income threshold (for 2024, if under $161,000 if single and $240,000 if married and file jointly) to make after-tax contributions up to $7,000 or $8,000.  So long as any Roth IRA has been opened at least five years and you are at least age 59 1/2, all Roth IRA distributions would be tax free.  Also, with a Roth IRA there are no required distributions. Like a traditional Self-Directed IRA you can also use your Self-Directed Roth IRA to purchase investment properties, gold, cryptocurrencies, and more! 


The 1978 Revenue Act implemented the Simplified Employee Pension IRA (SEP IRA), which provided for a contributory retirement account, primarily for small businesses.  A SEP IRA must be adopted by a US-based business.  A SEP IRA is essentially a profit-sharing plan. In 2024, the maximum SEP IRA contribution is $69,000 and must be made in pretax dollars.  Contributions are based on a percentage of income/salary (20% or 25% if W-2) and must be made to all eligible employees.


The 1996 Small Business Job Protection Act saw the implementation of the Savings Incentive Match Plan for Employees (SIMPLE IRA).  A SIMPLE IRA can be set up by any US business. A SIMPLE IRA plan can be established by any employer who has less than 100 employees.  It has a lower deferral limit than a 401(k) plan.  However, unlike a 401(k) Plan, the SIMPLE IRA plan uses an IRA-style trust to hold contributions for each employee, rather than then a single plan like a 401(k) or other qualified retirement plan.

In 2024, the annual employee deferrals are limited to $16,000 with $3,500 catch-up contributions for those at least age 50.

Below is a chart that summarizes the characteristics of all IRAs

 EligibilityMax Contributions 2024PretaxDistribution Rules
IRAU.S.-based earned income or retirement funds to roll over.   Note – deductions may be limited based on access to a 401(k) plan and income above a set threshold$7,000 or $8,000 if age 50+YesBefore 59 1/2: Tax plus 10% early distribution penalty. After 59 1/2: tax on amount of distribution.
Roth IRAU.S.-based earned income less than $140,000 if single or $240,000 if married.$7,000 or $8,000 if age 50+No, only after-taxRoth IRA contributions can always be taken tax free.  If over the age of 59 1/2 and a Roth has been opened at least 5 years, all Roth IRA distributions are tax-free (“qualified distribution).  A non-qualified distribution would be subject to tax and a 10% penalty on the earnings
SEP IRAU.S.-based business. Eligible employees:  reached age 21, has worked for the employer in at least 3 of the last 5 years and received at least $650 in compensation for 2022$69,000 max based on 20% or 25% (W-2) of compensation for each SEP participantYes, only pretaxBefore 59 1/2: Tax plus 10% early distribution penalty. After 59 1/2: tax on amount of distribution
SIMPLE IRAU.S.-based business. Eligible employees are those who received at least $5,000 in compensation from you during any 2 preceding calendar years (whether or not consecutive) and who are reasonably expected to receive at least $5,000 in compensation during the calendar year$13,500 with $3,000 catch-up contribution for those at least age 50.Yes, only pretaxBefore 59 1/2: Tax plus 10% early distribution penalty. After 59 1/2: tax on amount of distribution

Self-Directed IRA Tax Advantages

It is never too later to save for retirement.  This because the retirement system is based on the power of tax deferral.  Tax deferral is when all gains generated by a pretax retirement account investment flow back into the retirement account tax free. This allows your retirement funds to grow at a much faster pace than if the funds were held personally, allowing you to build for your retirement more quickly.  This is also known as compounding interest, which Albert Einstein has coined the 8th wonder of the world.

Learn More: Tax Deferral vs. Tax Free

Types of Self-Directed IRA Tax Structures

Now that you know about the different type of self-directed IRA accounts you can use to buy alternative assets in a tax efficient manner.  Let’s review the two ways you can structure your Self-Directed IRA investments.

On top of having the advantage of sheltering income and gains from tax, establishing a Self-Directed IRA is also a great way to better diversify your retirement savings, gain the ability to hedge against inflation, invest in assets you know and trust, as well as gain exposure to potentially lucrative investments, such as pre-IPO stock, investment funds, as well as cryptos.

Self-Directed IRA vs. Solo 401(k)

Individuals who are self-employed and have no full-time employees have the option to set-up a Self-Directed SEP IRA, or a Self-Directed Solo 401(k). While SEP IRAs remain popular, you may want to explore a Solo 401(k) to assess the additional benefits this plan offers. Individuals who do not have self-employment income are eligible to establish a Self-Directed IRA or a Self-Directed IRA LLC. Although both plans have benefits, it is important to understand the different features that differentiate a Self-Directed IRA and a Self-Directed IRA LLC.

It is also important to note that investment options may vary by Self-Directed IRA custodians. Many Self-Directed IRA companies limit investors to Gold, Cryptos or precious metals. However, at IRA Financial, you have access to various types of alternative assets that will allow you to diversify your portfolio.

Self-Directed IRA Services

There are two important self-directed IRA services that every retirement investor must be aware of:

  1. Choosing the right IRA custodian
  2. Navigating the IRS prohibited transaction rules

1. Choosing the Right Self-Directed IRA custodian

A Self-Directed IRA custodian (passive custodian) allows you to engage in non-traditional investments, but generally does not offer investment advice or serve as a fiduciary. Not all self-directed IRA custodians are the same. For one, not all self-directed IRA custodians allow individuals to invest in a wide range of alternative investments. IRA Financial Group also offers checkbook control, giving you full control over your investments. Furthermore, IRA Financial Group is also licensed, regulated and insured. It is imperative that before opening a Self-Directed IRA you are working with a company licensed custodian.

Self-Directed IRA custodians have different fee schedules. Some, such as IRA Financial Trust (a self-directed retirement company), charge a flat annual fee with no asset valuation fees. But others charge a fee based on the value of the IRA.

Additionally, one of the more important self-directed IRA services is the efficiency in which the IRA custodian can open and fund the account. This is by way of a transfer or rollover.

2. IRS Prohibited Transaction Rules

The Internal Revenue Code (IRC) acts as a guide to prevent IRA holders from triggering prohibited transactions. However, the IRC does not describe what investments a self-directed IRA can make. It does, however, describe what the IRA cannot invest in.

If the self-directed IRA does not purchase life insurance, collectibles, or engage in a prohibited transaction outlined in Code Section 4975, then you can make the investment.

When it comes to navigating the prohibited transaction rules, it is important to work with an IRA custodian that can help you understand whether the transaction you want to make will be a violation of the rules.

The good news is, establishing a self-directed IRA is now easier than ever. The key is choosing the right self-directed IRA custodian who can perform all the required self-directed IRA services efficiently and cost-effectively.

Self-Directed IRA Custodian – “Passive Custodian”

A passive custodian is an IRS Approved FDIC backed custodian who allows for non-traditional types of investments, like real estate. The passive custodian earns fees by establishing and maintaining IRA accounts, not by selling investment products. Whereas, more traditional custodians, such as Charles Schwab, make money by selling traditional investment products.

The passive custodian provides no advice or recommendations regarding the investments you choose to make. The passive custodian simply executes investment decisions by the IRA owner and performs custodial/administrative duties to maintain the tax-deferred status of the IRA (individual retirement account).

In a nutshell, the passive custodian establishes and maintains retirement accounts. They are in attendance to satisfy IRS regulations. How to Set Up a Self-Directed IRA LLC

Individuals who are self-employed and have no full-time employees have the option to set-up a Self-Directed SEP IRA, or a Self-Directed Solo 401(k). While SEP IRAs remain popular, you may want to explore a Solo 401(k) to assess the additional benefits this plan offers. Individuals who do not have self-employment income are eligible to establish a Self-Directed IRA or a Self-Directed IRA LLC. Although both plans have benefits, it is important to understand the different features that differentiate a Self-Directed IRA and a Self-Directed IRA LLC.

Learn More: SEP IRA vs. Solo 401(k)

Custodian vs. Checkbook Control

Again, not all Self-Directed IRAs are the same. For example, many traditional IRA custodians advertise themselves as offering Self-Directed retirement accounts, because you direct them to make investments. However, with traditional institutions, like Fidelity and Vanguard, you will need approval from a custodian before making an investment. Furthermore, most IRA custodians limit you to stocks, bonds and other traditional investments. You will not be able to buy real estate, precious metals, or any alternative investment, because traditional institutions do not make money this way.

As a result, if you wish to diversify your retirement and make non-traditional investments, you will need to work with a Self-Directed IRA custodian, such as IRA Financial Trust.

In the case of a “truly” Self-Directed IRA, a limited liability company (LLC) is established that the IRA account owns and the IRA holder manages. This provides the IRA holder with “checkbook control” over his or her funds. A Self-Directed IRA with checkbook control remains a popular option for individuals who invest in real-estate.

Custodian Controlled Self-Directed IRA Without “Checkbook Control”

A second type of structure is custodian controlled. With the custodian controlled Self-Directed IRA structure, many types of nontraditional investments, such as real estate, are permissible. However, you need custodian consent to enter into and execute transactions.

For example, before you engage in an IRA investment, you must receive the consent of the custodian. To this end, you have to provide the custodian with the transaction documents for review as part of their transaction review process. Furthermore, obtaining custodian consent can be a long process, depending on what types of investments the individual is trying to purchase. Despite the longevity of this process, there is no guarantee that the custodian will approve your investment even if it doesn’t violate IRS rules. A Self-Directed IRA with custodian control allows you to make non-traditional investments, but time delays and high custodian fees are the common characteristics of choosing the custodian-controlled structure.

The Self-Directed IRA LLC “Checkbook Control Solution”

The Self-Directed IRA LLC with “checkbook control” is a tax court and IRS approved retirement plan. With the Self-Directed LLC, you must establish a Limited Liability Company (LLC). The IRA will own the LLC and the IRA holder manages it. This setup gives the IRA holder “checkbook control” over his or her retirement funds. Begin to make any IRA investment as easily as writing a check or wiring funds from the Self-Directed IRA LLC bank account.

With checkbook control, you no longer need custodian consent. As a result, there are no delays when making an IRA investment. You, as manager of the LLC, determines which investments you want to make. The Self-Directed IRA LLC structure provides maximum flexibility and is ideal for IRA holders who plan to make multiple investments.

How a Self-Directed IRA LLC Works

With a Self-Directed IRA LLC, after the LLC is established, the IRA holder’s IRA funds are then transferred by the Custodian to the LLC’s bank account. This provides the IRA holder with “checkbook control” over his or her IRA funds.

The Self-Directed IRA LLC “Checkbook Control” structure is approved by the U.S. tax court and has been widely popular for over 20 years. The notion of using an entity the IRA owns in order to make investments was first reviewed by the Tax Court in Swanson V. Commissioner 106 T.C. 76 (1996).

The Self-Directed IRA LLC allows you to eliminate the delays from an IRA custodian, and immediately make investments as the opportunity presents itself.

Read More: What is a Self-Directed IRA LLC

How Do I Open a Self-Directed IRA?

You can easily open a Self-Directed IRA with IRA Financial online, throughout our app, or over the phone. You can start your account free, with no obligation to pay up front until you fund your account. After your account is open, you will need to fund your Self-Directed IRA before you can make investments. You have the option of funding your Self-Directed retirement account with current funds or completing an IRA rollover.

Learn More: Open a Self-Directed IRA Online

How to Establish a Self-Directed IRA LLC

You can set up a “Checkbook Control” Self-Directed IRA LLC structure in a matter of days.

First, seek the consultation of a professional financial group, such as IRA Financial, the leading provider of checkbook control Self-Directed IRAs. IRA Financial has partnered with Capital One Bank to simplify how you establish your Self-Directed IRA. You will be assigned to a specialist who will set up the structure, open the plan bank account and complete all necessary documentation so you never have to set foot in a bank. Set-up for a Self-Directed IRA can take between 7-21 days to complete. The time-frame is largely dependent upon the state of formation and the custodian holding your retirement funds.

There are many advantages to a Self-Directed IRA LLC, which may be why it’s growing in popularity. It gives your portfolio diversity and enables you to have full control over your finances. Additionally, you can invest in what you know and understand, which can decrease the risk of losing your funds.

In three simple steps, here is how to set-up a Self-Directed IRA LLC with Checkbook Control.

1. Transfer Retirement Funds Tax-Free

First, your retirement funds from your current custodian must transfer to an IRS approved FDIC backed passive custodian. You can make transfers from any retirement account, including:

  • Traditional IRA
  • Roth IRA
  • 401(k)
  • 401(3)(b)

You can transfer or rollover funds to the passive custodian tax-free.

Learn More: How to Complete a Self-Directed IRA Rollover

2. Investment of IRA Funds into New LLC

You, the IRA owner, will direct the passive custodian to invest IRA funds into the new Limited Liability Company (LLC). Because the LLC is treated as a flow-through entity for federal income taxes, generally all income or gains of the LLC will flow to the IRA tax-free.

3. The Power of Checkbook Control

Because you’re the manager of the LLC, you have the authority to direct the LLC to make investments in real estate, precious metals, tax liens and any other alternative asset class. You can also make traditional investments at your choosing. Again, all income and gains of the LLC flow back into the IRA tax-free.

As you can see, how a Self-Directed IRA LLC is works is fast and simple when you with an IRA specialist. 

Did You Know?

A Self-Directed IRA you can help you to save for retirement by funding traditional investments like stocks and bonds, as well as in alternative assets, such as private placements, cryptocurrency, real estate, and much more. Contact IRA Financial today to get started!


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