Five Questions to Ask Before Setting up a Self-Directed IRA
A 2012 report by McKinsey and Co. found a 14% increase in alternative investments, from $2.9 trillion in total funds invested, to $6.5 trillion in 2011. Alternative investments include self-directed IRAs, in which account holders can invest in a broad array of options, such as small businesses, real estate, and more. Since the market crash of 2008, the rate of movement away from traditional IRA options and towards alternatives such as real estate has accelerated, as more investors seek the stability of underlying assets such as real estate. Investing with a self-directed IRA takes more commitment than turning your savings over to a financial manager, however. In addition to learning about and performing diligence on your investment choices, you also need to be aware of the IRS rules that govern the use of IRA funds. Here are five questions you should ask before setting up a self-directed IRA.
1. How Will I Invest my Retirement Savings?
It seems obvious, but this is a critical starting point. Just wanting to diversify away from the stock market is not an investment strategy in and of itself. You need to know what you plan to invest in and how you plan to approach those investments. If you want to invest in real estate, will you pursue rentals, flipping or being a hard money lender? Do you know your local real estate market well, or do you plan to invest out-of-market in regions where the ROI is higher and the cash requirements are lower than in your local area? Will you focus on cash flow or potential for appreciation? Is leveraging with a mortgage part of your plan? By starting with an investment focus, you can then work with your investment team to make sure you are asking the right questions and planning for long term success.
2. What type of Self Directed Plan do I need to Achieve my Goals
There are several types of self-directed IRA and 401(k) retirement plans with different features and benefits. Ensuring that you select the right platform to suit your needs is a critical factor. Two previous blog posts share additional information about each plan type to help you select the right one, view part I and part II of the series.
Common types of self-directed plans include:
Custodian Managed Self-Directed IRA Account
An IRA with a self-directed IRA custodian (generally a trust company) is just like any other IRA, except for the fact that self-directed custodians have the capacity to document the ownership of non-traditional assets such as private placements, real estate, precious metals and other investment options not available through the public exchanges served by Wall Street firms. This model works well for investments that are more singular and static in nature such as buying shares of a privately held company or undeveloped land. The reason is that the custodian executes all transactions for the benefit of the account, and must therefore sign every document, issue payment for all expenses and receive all income. Each of these account interactions requires paperwork, a few days for processing and processing fees. Such accounts are poorly suited for more complex or time-sensitive investments such as owning rentals, flipping houses, investing in tax liens, or even holding a number of static investments such as private mortgages.
Checkbook IRA LLC or Solo 401(k)
IRA and 401(k) plans offering Checkbook Control are superior to a custodian held account for investors wanting to participate in more time-sensitive or interactive investments, or who wish to have a broad array of assets within their plan. Through the creation of a legal entity such as a LLC or Trust that can be controlled by the account holder, these plans are able to operate out of a bank or brokerage account of the investor’s choosing. All plan transactions then take place through the entity account without the need for 3rd party processing, delays and fees. Because of the immediate access to funds provided by these plans, an investor can participate in foreclosure or tax lien options. For managing real estate rentals or flipping houses, the ability to deal with expenses immediately is critical. Imagine having a water heater break in your rental and needing to find a plumber willing to do the work today, but get paid from your IRA custodian in 4-7 days. IRA plans are broadly applicable. A Solo 401(k) can be a nice program for those investors who are self-employed and have no full time employees. In addition to providing self-directed investment choices with checkbook control, the 401(k) offers generous contribution limits and other features not available in an IRA.
Business Funding IRA
IRA and Solo 401(k) plans are designed for passive arm’s length investments where all returns are tax-sheltered back into the plan. For those investors wishing to utilize existing retirement savings to start or grow a business in which they are personally involved, a different format known as a Business Funding IRA or Rollover as Business Startup (ROBS) Plan is used. Unlike an IRA or 401(k) where the IRS rules strictly prohibit any personal benefit from the plan investments (other than growing your retirement savings, of course) this option allows the investor to be actively engaged in a business in which their retirement plan is a shareholder. The difference is that the business itself operates in the taxable realm. Plan funds can be used to start or acquire a business and pay for operating expenses including your own salary.
3. Has my IRA provider earned positive customer reviews?
Selecting an IRA provider is a significant decision that will impact your investments for years to come. The self-directed IRA industry is served by many reputable firms with long track records of delivering excellence, but also some firms with less than stellar customer service (much like traditional banking and investment services). While the plans are not new, demand for self-directed plans has exploded in the last ten years and many newer firms have entered the market. Therefore, it’s wise to spend some time researching customer reviews, Better Business Bureau information, and the word on the web about each IRA team you consider. Be sure to focus on the expertise of the advisors and what level of access you will have to ongoing support. Setting up the plan takes a few weeks, investing with the plan is something you will do for many, many years. A lot of firms can market the products, but only a handful back their plans with support provided by experts in the areas of tax law and non-traditional investments such as real estate.
4. What is my long-term exit strategy?
Retirement investing with an IRA or 401(k) is not just about your returns for the next quarter or year, but about the financial foundation you are building for your golden years. Investing for cash flow is different than investing for value, especially once you start drawing down the account in retirement. Will you have income other than your IRA and social security in retirement? How much will you need to access from your IRA to live on? Will you be able to get by on the earnings from your investments, or will you need to liquidate the investments and draw down the principal on the account? Asking these questions now and planning accordingly can eliminate a lot of sleepless nights down the road. Another long-term consideration is whom you will designate as your IRA beneficiary or beneficiaries. Retirement account beneficiaries are not determined by wills. Rather, inheritance is set by a special beneficiary form, which must be filled out when the account is opened. Of course, you may later change your beneficiary as you choose, to family members, friends, a charity, or a trust. This complex issue demands its own attention; for more information we encourage you to read our blog on the advantages and disadvantages of naming spouses, children, or a trust as your IRA beneficiaries.
5. Who can I bring onto my team for investment success?
It takes a team to manage a strong retirement investment account. As the account holder, you will maintain prime responsibility for handling your account. For success, it’s best to create an ancillary team of realtors, lenders, property managers, lawyers, and financial wizards, depending on your plan and investment types. Just because the plan is self-directed does not mean you have to go it alone. Clearly there is more to self-directed investing than just calling around and selecting a plan provider. As you research your options with a self-directed IRA or 401(k), be sure to consult with experts who can help you ask yourself the right questions and thereby help you setup the right plan, choose the best investment strategies and achieve success in building for your future.
What our clients says about us
Quick answers to common questions
We’ll take you through a simple, step by step process designed to put your investment future into your own hands…immediately. Everything is handled on a turn-key basis. You take 100% control of your Retirement funds legally and without a taxable distribution.
YES! In 1974, Congress passed the Employee Retirement Income Security Act (ERISA) making IRA, 401(k) and other retirement plans possible. Only two types of investments are excluded under ERISA and IRS Codes: Life Insurance Contracts and Collectibles (art, jewelry, etc.). Everything else is fair game. IRS CodeSec. 401 IRC 408(a) (3)
It’s actually pretty simple. Early on, regulators let the securities industry take the lead in educating the public about retirement accounts. Naturally, brokers and banks promoted stocks, bonds, and mutual funds—giving the impression that those were the only allowed investments. That was never true... and still isn’t. You can probably guess why they kept the rest under wraps.
It is possible to use funds from most types of retirement accounts:
- Traditional IRA
- Roth IRA
- SEP IRA
- SIMPLE IRA
- Keogh
- 401(k)
- 403(b)
- Profit Sharing Plans
- Qualified Annuities
- Money Purchase Plans
- and many more.
It must be noted that most employer sponsored plans such as a 401(k) will not allow you to roll youraccount into a new Self-Directed IRA plan while you are still employed. However, some employers will allow you to roll a portion of your funds. The only way to be completely sure whether your funds are eligible for a rollover is by contacting your current 401(k) provider.
A Solo 401(k) requires a sponsoring employer in the format of an owner-only business. If you have a for-profit business activity – whether as your main income or as a side venture – and have no full-time employees other than potentially your spouse, your business may qualify. The business may be a sole-proprietorship, LLC, corporation or other entity type.
A self-directed retirement plan is a type of IRA or 401(k) that gives you greater control over how your retirement funds are invested. Unlike traditional accounts held at banks or brokerage firms that limit you to stocks, bonds, and mutual funds, self-directed plans allow you to invest in a wide range of alternative assets including real estate, private businesses, precious metals, cryptocurrency, and more.
These plans still follow the same IRS rules and maintain the same tax-deferred or tax-free benefits as conventional retirement accounts. The difference is simply in how and where you choose to invest.
No. Moving to a self-directed IRA or Solo 401(k) does not trigger any taxes, as long as your funds are eligible for rollover.
Self-directed retirement plans maintain the same tax-advantaged status as traditional plans offered by banks or brokerage firms. The key difference is flexibility—our plans are designed to give you greater control and allow for a wider range of alternative investments beyond stocks, bonds, and mutual funds.
A prohibited transaction is any action between your retirement plan and a disqualified person that violates IRS rules and can lead to serious tax consequences. Under IRS Code 4975(c)(1), prohibited transactions include:
- Selling or leasing property between your plan and a disqualified person Example: Your IRA cannot purchase a property you already own.
- Lending money or extending credit between the plan and a disqualified person Example: You cannot personally guarantee a loan your IRA uses to buy real estate.
- Providing goods or services between your plan and a disqualified person Example: You can’t use your personal furniture to furnish a rental property owned by your IRA.
- Using plan income or assets for the benefit of a disqualified person Example: Your IRA cannot buy a vacation home that you or your family use.
- Self-dealing by a fiduciary (using plan assets for their own benefit) Example: Your CPA shouldn't loan your IRA money if they’re advising the plan.
- Receiving personal benefit from a deal involving your IRA's assets Example: You can’t pay yourself from profits your IRA earns on a rental.
If a transaction doesn’t clearly fall within the allowed guidelines, the IRS or Department of Labor may review the situation to determine if it qualifies as a prohibited transaction.
Disqualified persons are individuals or entities that are prohibited from engaging in certain transactions with your IRA or 401(k). Doing so could trigger a prohibited transaction, which may result in taxes and penalties.
Here’s who is considered a disqualified person:
- You (the account holder)
- Your spouse
- Your parents, grandparents, and other ancestors
- Your children, grandchildren, and their spouses
- Any advisor or fiduciary to the plan
- Any business or entity owned 50% or more by you or another disqualified person, or where you have decision-making authority
These rules exist to prevent self-dealing and ensure your retirement plan remains in compliance with IRS regulations.
(Reference: IRC 4975)
Understanding and following these rules can be tricky, but it’s very doable. The best way to stay compliant is to work with professionals who specialize in self-directed retirement plans. They can help you navigate IRS guidelines and avoid prohibited transactions.
If an IRA holder is found to have engaged in a prohibited transaction with IRA funds, it will result in a distribution of the IRA. The taxes and penalties are severe and are applicable to all of the IRA’s assets on the first day of the year in which the prohibited transaction occurred.
Yes. While self-directed retirement plans allow for a wide range of investments, there are a few important restrictions.
You cannot invest in collectibles or life insurance contracts, and you must avoid prohibited transactions—activities that benefit you personally rather than the retirement plan. These include things like buying or selling property to yourself or family members, using plan assets for personal gain, or self-dealing in any way.
Violating these rules could cause your entire IRA to lose its tax-advantaged status. To protect your account, it’s essential to work with professionals who understand IRS regulations and can help you stay compliant.
This is a common misconception. In many cases, professionals may simply be unfamiliar with self-directed retirement plans, as they fall outside their usual scope of work. CPAs and tax preparers are trained to file taxes, not necessarily to advise on alternative retirement strategies. Financial advisors and brokers often work for firms that focus on traditional investments like stocks and mutual funds—and may not benefit from or support alternative options like real estate or private lending.
Self-directed retirement investing is legal under IRS rules—but like any specialized area, it requires working with professionals who understand how it works.
The IRS has rules in place to make sure your IRA is used only for the exclusive benefit of the retirement account—not for personal gain or to help family members. These rules can get complicated because there are many ways a conflict of interest can occur, even unintentionally.
For example, if your IRA buys a house and rents it to your mother, you might be reluctant to evict her if she stops paying rent. That emotional connection creates a conflict between what’s best for your IRA and your personal relationships, something the IRS aims to prevent.
These rules help ensure your retirement account stays compliant and protected. (See IRC 408)
Yes. Most tax-deferred retirement accounts—such as Traditional IRAs, old 401(k)s, 403(b)s, and TSPs—can be rolled over into a self-directed IRA or Solo 401(k), depending on your eligibility. Roth IRAs cannot be rolled into these accounts.
You can contribute directly from earned income, subject to annual IRS contribution limits. The method and amount depend on the type of plan you have (e.g., Solo 401(k) vs. IRA).
To take a distribution, you'll request funds through your custodian or plan administrator. Distributions may be taxable depending on your account type and age. Early withdrawals may be subject to penalties.
For 2025, the Solo 401(k) max contribution limit is $81,250 if age 60-63, $77,500 if age 50-59 or 69+, and $70,000 if under 50. Traditional and Roth IRAs have a limit of $7,000 ($8,000 if age 50+). Limits are subject to IRS adjustments.
Yes. IRA contributions are typically due by your personal tax filing deadline (e.g., April 15). Solo 401(k) contributions follow your business tax filing deadline, including extensions.
IRS reporting requirements vary depending on the type of self-directed retirement plan you have. Here’s a quick breakdown of what you need to know
Please note: Our team can help you understand what’s required for your specific account, but we don’t provide tax or legal advice. We always recommend working with a qualified tax professional to ensure full IRS compliance.
Self-Directed IRA (Traditional or Roth)
- Form 5498 – Filed by your custodian each year to report contributions, rollovers, and the fair market value (FMV) of your account.
- Form 1099-R – Issued if you take a distribution or move funds out of your IRA.
- Annual Valuation – You'll need to provide updated FMV for any alternative assets held in the account, such as real estate or private placements.
Solo 401(k)
- Form 5500-EZ – Required if your plan assets exceed $250,000 as of year-end. Must be filed annually by the plan participant.
- Form 1099-R – Required if you take a distribution or roll funds out of the plan.
- Contribution Tracking – Keep records of employee and employer contributions. These are not filed with the IRS but may be needed for tax reporting or audits.
SEP IRA
- Form 5498 – Filed by your custodian to report contributions and FMV.
- Form 1099-R – Filed by your custodian. Issued for any distributions.
- Employer Contributions – Must be reported on your business tax return (and on employee W-2s, if applicable).
Health Savings Account (HSA)
- Form 5498-SA – Filed by your HSA custodian to report contributions.
- Form 1099-SA – Filed by your HAS custodian. Issued for any distributions.
- Form 8889 – Must be included with your personal tax return to report contributions, distributions, and how funds were used.
