Self-Directed Roth IRA: Its Pros and Cons? How Is It Different from Regular Roth IRA?

Thang Truong
Thang Truong
Updated on:

If you are a savvy investor, you might feel a little limited by the traditional IRA’s or Roth IRA’s. Those retirement accounts only allow you to invest in stocks, bonds, and mutual funds. If you’re interested in investing in things like cryptocurrency or precious metals, you’ll have to consider other opportunities and that’s where self-directed Roth IRA’s come into play. 

What is Self-Directed Roth IRA?

A self-directed Roth IRA is much like a regular Roth IRA. Both are investment accounts that set money aside for retirement. The money is held by a financial institution and invested. In both types of Roth IRA’s, you’ll invest after-tax dollars so that when you go to withdraw, the money can be taken without taxes. In a regular Roth, the account is overseen by brokerage firms like Vanguard or Fidelity; robo-investment firms like Wealthfront or Betterment; or financial advisor. They usually invest in index funds, ETFs, other mutual funds, stock, and bonds. 

A self-directed Roth IRA, on the other hand, the only person making the decisions about what to invest in is the account owner. You can invest in whatever you want, which gives you greater flexibility. 

>>MORE: Roth IRA: Everything You Need to Know

How does Self-Directed Roth IRA Account Work?

When you open a self-directed Roth IRA, you’ll go to a brokerage just as you would for a regular IRA. The brokerage will be the custodian for the account, which means they will do what you tell them to do. They don’t make recommendations; they don’t offer advice. It’s all up to you as far as where to invest your money. You can invest in:

  • Cryptocurrency
  • Property
  • Partnerships and franchises
  • Precious metals. Learn more about Gold Roth IRA: Is It A Good Idea?
  • Tax liens
  • Livestock
  • Companies that aren’t publicly traded

You can’t invest in absolutely everything, though. You’re not allowed to invest in:

  • Precious gems
  • Stamps
  • Collectibles
  • Art
  • Antiques
  • Rugs
  • Memorabilia
  • Life insurance

To be clear, you can invest in those things if you want to, but not through your self-directed IRA. Also, you can’t act as your own bank, so someone does need to be a trustee for the account. Not all financial institutions offer self-directed Roth IRA’s. Actually, popular brokerage firms such as Vanguard, Fidelity, Charles Schwab, or TD Ameritrade where you usually open traditional IRA or Roth IRA accounts, do not provide self-directed traditional IRA nor Roth IRA accounts.

Similarities and Differences Between Roth IRA and Self-Directed Roth IRA

Self-directed Roth’s and a regular Roth has many things in common. 

There are some key differences, though.

Regular Roth IRA Self-Directed Roth IRA 
Assets that you can invest in Index funds, mutual funds, ETFs, stocks, bonds, and money market accounts– Everything regular Roth IRA account can invest in, plus
– Cryptocurrency
– Real estate, Property
– Partnerships and franchises
– Precious metals
– Tax liens
– Livestock
– Companies that aren’t publicly traded
Where to open Traditional brokerage firms and banking institutions such as Vanguard, Fidelity, Charles Schwab, TD AmeritradeSpecialized brokerage firms specializing in self-directed IRA, both traditional and Roth.
We evaluated these 8 firms specializing in self-directed Roth IRA for your consideration.
Fees LowHigher
Regulations No special rulesSpecial rules by the IRS (see details below)

>>MORE: IUL vs. Roth IRA: Which One Is Better for Retirement Savings?

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Special Rules for Self-Directed Roth IRA’s

The IRS has two extra rules regarding self-directed Roth IRA’s: Disqualified persons and prohibited transactions. Prohibited transactions exist to prevent the IRA owner from using the funds improperly. These include:

  • Borrowing money from the account
  • Selling property to it (i.e. you can’t sell a property to your own investment account)
  • Using it as security for a loan
  • Buying personal property with funds from self-directed Roth IRA account

It sounds relatively straightforward, but the IRS gets very strict on this. For example, with a self-directed Roth IRA you can invest in property. The prohibited transaction rules prevent you from buying property for your own use. So, let’s say you have a rental property in your self-directed Roth. You’re in town, and you figure, why get a hotel room? Why not just spend the night at my rental property? Bam—you just violated the rule about not using the property for your own use. 

Likewise, say you own an electrical business through the IRA. You can’t hire your business to do the electrical work on your rental property. In case you happen to be an electrician, you can’t work on the property yourself, either. You actually can’t do any work on your rental property, because the IRS considers that as work you would’ve had to pay someone to do, but you didn’t. 

Disqualified persons are a list of everyone who can’t benefit from your self-directed traditional or Roth IRA, such as:

  • Any member of your family
  • Spouse
  • Children
  • Grandchildren
  • Legally adopted children
  • Investment providers of the IRA

If you violate either of these rules and the IRS finds out about it, your self-directed Roth will be distributed, and you will lose all of the tax benefits. You will owe taxes and penalties starting from the year the prohibited action took place. If your prohibited transaction took place in 2011 but the IRS didn’t find out about it until 2019, you still will owe taxes and penalties from 2011. 

The IRS makes these rules so that your traditional and Roth IRA, self-directed or not, is for your retirement. They know it’s tempting to take money from retirement accounts for not-terribly financially sound reasons such as going on vacation or buying a boat, and they want to discourage that. 

>>MORE: How to Start Preparing for Retirement at Age 40?

Advantages of a Self-Directed IRA

The main advantages are that you have a lot more flexibility as far as what you invest in. Keep in mind, in a regular Roth IRA, you are also making the decisions on what to buy or sell, it’s just that your limited to stocks, bonds, mutual funds, and the like. 

The potential for higher returns is definitely there in a self-directed IRA, provided you know what you’re doing. If you don’t, you may actually lose money, or worse yet, use the account in a way the IRS prohibits and incur taxes and penalties. 

>>MORE: Calculator: How Much Do I Need to Save Monthly for Retirement?

Disadvantages of a Self-Directed Roth IRA

You have to be careful not to violate any IRS rules regarding the account. You must also make sure you know what you’re doing so that you don’t lose tons of money. You need to do all of the research yourself. Also, not every financial firm offers self-directed Roth IRA’s because they are complex. Some companies specialize in them, but the fees are usually high. 

>>MORE: Should I Invest in S&P 500 Index Through an Indexed Universal Life Insurance Policy?

Who is a Self-Directed Roth IRA For?

You have to be an extremely savvy and sophisticated investor to make the most of a self-directed IRA. Honestly, for most people, a traditional IRA or Roth IRA is probably the way to go. They’re easier to understand and it’s much easier to find a brokerage firm that manages them. You still have the final say in what you buy and sell, it’s just that you can get advice or have questions answered. 

>>MORE: Retirement Savings Strategies for High Income Earners

>>MORE: Mega Backdoor Roth IRA: Step-by-step Setup at Fidelity

Last Thoughts

For most people, a regular Roth or a traditional IRA is better than a self-directed IRA. If they “self-directed” part is what’s appealing to you, know that you can pick and choose investments in regular Roth, and you can even invest in real estate through real-estate investment trusts. Explore those things first before you decide to look at self-directed Roth IRA’s.

>>MORE: Roth IRA Conversion Ladder: What Is It For? And How to Set It Up?

Thang Truong
Thang Truong

Thang Truong covers small business insurance and small business success at BravoPolicy. He is a licensed P&C insurance agent. Previously, he held product leadership positions at, Capital One, NerdWallet, and Mulberry Technology. He holds a MBA degree from UC Berkeley - Haas School of Business.


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