When it comes to investing for retirement, most people open an IRA, or individual retirement account. IRAs provide investors with a fairly simple way to store away money for their retirement while also allowing it to grow. Thanks to preferential treatment under the American tax code, IRAs also offer some fairly considerable tax benefits compared to other types of investment geared toward retirement.
IRAs typically fall into several different categories, each with their own characteristics and advantages. Among these categories, traditional and self-directed IRAs are two of the major types (along with Roth IRAs).
Here’s what all investors saving for retirement should know about traditional IRAs vs. self-directed IRAs, and the arguments to be made for each.
What is a Traditional IRA?
A traditional IRA is the most basic type of individual retirement account. Under this model, investors put their money into an account created with an SEC-approved institution that will manage the funds. The company that manages the IRA will then invest that money into equities such as stocks and bonds to help grow the assets.
Traditional IRAs have tax-deductible contributions, meaning that taxes are deferred until the time that money is withdrawn from the account.
What is a Self-directed IRA?
Self-directed IRAs are similar to traditional IRAs, but instead of an institution making the decisions about how the money is invested, the individual investor chooses from a broader range of allowed assets.
For example, an investor with a self-directed IRA can choose to invest in precious metals or real estate, which are assets that are rarely represented in more traditional securities funds. Certain investments, such as collectibles, still aren’t allowed under the self-directed IRA model.
A common point of confusion in the difference between traditional and self-directed IRAs comes from the fact that a self-directed account can, in a certain sense, be traditional. In addition to referring to accounts directed by large financial institutions, the term “traditional” is also applied to IRAs in the sense of having a standard tax structure in which contributions are deductible.
This contrasts with a Roth IRA, in which income tax is applied to contributions but no tax is applied when the money is withdrawn. Self-directed IRAs can be either traditional or Roth IRAs, depending on when investors want to be taxed.
Advantages and Disadvantages
For some investors, traditional IRAs have considerable advantages. Since they are administered by professional investment institutions, these accounts require very little active work from the investors who hold them. Aside from deciding on contribution levels, investors with traditional IRAs can take a hands-off approach that’s better-suited to those without much investment experience. A disadvantage to traditional IRAs is that investors may feel they have to give up control over how their money is handled.
Self-directed IRAs are quite the opposite. With a self-directed IRA, investors enjoy complete freedom to invest the money they have contributed into any class of assets that’s allowed by the U.S. Securities and Exchange Commission. This arrangement allows investors to pursue higher returns or allocate their portfolios for very conservative growth as they see fit. It also allows investors to quickly change the composition of their portfolios when market conditions seem to demand it.
Although self-directed IRAs are more flexible and give investors more control, they aren’t without their disadvantages. For people without any significant investment experience, these accounts can present more risk than traditional IRAs. Because they are managed by the investors who open them, self-directed IRAs also require a more active approach, and therefore a greater investment in time and effort than traditional IRAs.
Is One IRA Better Than the Other?
As with most comparisons in the realm of investments, the difference between traditional and self-directed IRAs is less about one being a better option than the other and more about how each route fits the individual investor.
For investors who don’t have much experience actively picking and allocating capital to assets, traditional IRAs may be a safer bet. For more experienced investors who want to take advantage of the preferential tax status of an IRA and who are more comfortable exercising control over the assets they invest in, a self-directed IRA can be a better fit.
Another benefit that investors can take advantage of through a self-directed IRA is the opportunity to invest in precious metals. Gold, silver, platinum, and palladium are considered safe investments during periods of volatility in the markets, as well as a long-term alternative to cash during periods of high price inflation. As such, incorporating precious metals into a self-directed IRA can be a savvy way to protect against economic downturns and inflation.
If you’d like to build some gold or silver into a self-directed IRA, consider learning about our gold and silver-backed precious metal IRAs. Simply open a self-directed IRA account, fund it, and allow your provider to help you select the right investment-grade metals for your portfolio. It’s that easy. In this way, you can diversify your portfolio and make it more resilient with physical precious metals.
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