What is the advantage of a self-directed IRA?
The primary advantage is control. For an investor, being able to control where and how your funds are invested allows the investor to put the funds to work where, when and how the investor chooses to do so, not where some anonymous plan custodian thinks the funds should be placed. For example, if you hear about a great investment opportunity that will produce a 20% return on investment, you might be tempted to take out a loan against your home (often called a HELOC for “home equity line of credit”), since you can usually get the funds for a significantly lower rate. If you managed to earn 20% on the investment, and were able to borrow the funds at 5% from your HELOC, you would most likely have to pay taxes on the 15% difference, further reducing your net return. (In addition, the amount of funds you borrow against your HELOC may cause your FICO score to drop in some cases.)
On the other hand, if you used your self-directed IRA to invest the funds, your 20% return would go back into your IRA tax-deferred (or tax-free if it was a Roth IRA).
To use another example, if you used your self-directed IRA to purchase a real estate investment property, such as a single-family rental, the IRA would “own” the house, and the rental income would be sent to your self-directed IRA. If it was an all-cash purchase (no loan involved), the entire amount of the rent would go back into your self-directed IRA, minus costs of taxes, insurance, and property management fees. When the property is sold at a future date, assuming it sold for more than the purchase price, the net proceeds would go back into your self-directed IRA. No capital gains tax!
