Traditional IRAs vs. self-directed IRAs: Key differences explained

Traditional and Roth IRAs are the most common form, but an alternative option known as self-directed IRAs is becoming more prevalent. If you’re thinking about opening a self-directed IRA to diversify your holdings or to invest in different assets, learn about how they work and how they differ from traditional IRAs so that you can make an informed decision.  

What is a traditional IRA?  

Unlike a 401(k) plan, IRAs aren’t connected to an employer, so you can start one and contribute on your own. That feature makes them a popular option for those planning for their retirement.  

A traditional IRA is a tax-advantaged investment account. With an account open, you can invest in stocks, bonds, mutual funds, and exchange-traded funds (ETFs). You can contribute up to a set amount each year, and your contributions to the account may be deductible from your taxes.  

The money in the account is invested, and you don’t pay any taxes on the account’s growth until you retire or take withdrawals. Once you retire, your IRA withdrawals are taxable as income.  

They’re fairly inexpensive to open and maintain.  

“These days, costs are really low,” said Jamie Taloumis, a certified financial planner (CFP) and portfolio manager with Reynders McVeigh Capital Management. “You can open up an account virtually for free, with usually low funding minimums. You can invest in stocks, mutual funds, and ETFs to get good broad exposure to the market at a very low rate.” 

Another option is a Roth IRA. Available to those who earn less than $153,000 (or $228,000 if you’re married and filing jointly), you make a contribution to a Roth IRA with after-tax dollars, and when you make eligible withdrawals in retirement, the withdrawals are not taxable as income. 

What is a self-directed IRA? 

Self-directed IRAs are less common than traditional accounts but they are a legitimate tool for retirement savings. They are a special type of IRA that is held by a custodian, and they allow investors to invest their money in a broader variety of assets than a traditional IRA. In a self-directed IRA, investors can invest in real estate, precious metals, cryptocurrency, and other assets. Common types of self-directed IRAs include:  

• Bitcoin IRAs 
• Gold IRAs 
• Precious metal IRAs 

Self-directed IRAs have increased in popularity, which may be due in part to worries about the economy’s direction.  

“When you have situations like we’re in now, where there is perceived a lot of uncertainty around the economy, around interest rates or around an election, that gives these investment vehicles [self-directed IRAs] an opportunity to market them to people who may be feeling uneasy,” said Lawrence Sprung, a CFP and founder of Mitlin Financial. “The perception is that this [opening a self-directed IRA] is a way to go against the grain because traditional assets may not do well because of those issues.” 

To invest in alternative assets in a self-directed IRA, you must appoint a custodian—a trust approved by the IRS to handle these assets. Depending on the type of assets you want to invest in, you may need a broker-dealer to help you handle transactions and a depository to secure your assets.  

Key differences between a traditional IRA and self-directed IRA 

Self-directed IRAs are subject to the same rules as traditional IRAs, including annual contribution limits and required minimum distributions. However, there are several key differences you should know:  

Investment options 

Traditional IRAs allow you to invest in stocks, bonds, mutual funds, and ETFs. These are securities that are highly regulated and traded on the stock market. By contrast, self-directed IRAs invest in alternative assets, such as cryptocurrency or precious metals.  

Fees 

Traditional IRAs are a relatively inexpensive account option. Major investment firms often allow people to open accounts with $0, and the monthly or annual fees are low. Typically, the fee is about $20 per year. They may not charge online trade fees, and management fees are usually between 0.25% and 1.00% of your account assets.  

According to the United States Securities and Exchange Commission (SEC), self-directed IRAs can have higher fees than traditional IRAs.  

“Self-directed fees can have significant fees with regard to the custodian and the handling of the assets,” Sprung said.  

For example, the following fees may apply:  

• Setup fees: To open an account, you typically have to pay an application fee or startup fee; the fee is usually $30 to $75.  
• Annual fees: Self-directed IRAs are more complex than traditional IRAs, with more administrative and tax paperwork requirements. As a result, they have higher fees; annual fees are usually $250 to $500.  
• Storage fees: If you invest in a physical asset, such as gold or other precious metals, you’ll have to store the assets in a depository and pay storage fees. The fee is usually $100 to $200 per year.  
• Trading fees: When you purchase or sell an asset in a self-directed IRA, there is usually a trading fee. Fees range from 1.00% to 2.00% of the transaction amount.  

With the higher cost, self-directed IRAs are usually best suited for those with a higher net worth.  

“I would only recommend self-directed IRAs for more sophisticated investors who are looking to get certain exposures, whether it be in cryptocurrencies, or real estate, that they cannot get through a normal IRA account,” said Taloumis. 

Required minimum distributions 

With both traditional IRAs and self-directed IRAs, you must abide by required minimum distribution (RMD) rules; once you reach 73, you must withdraw a portion of your account balance every year.  

With a traditional IRA, the process is relatively easy. You can use your investment firm’s portal to sell shares of stocks or bonds and withdraw money from the account. With a self-directed IRA, it’s more complicated—it’s more challenging. If you invest in physical assets, such as real estate or gold, you’d have to either sell your asset—which may not be liquid—or take in-kind distribution, which may require the assistance of a lawyer.  

How do decide between a traditional IRA and self-directed IRA  

For most investors, a traditional IRA is adequate for your needs and financial goals. You can invest in a broad range of securities at a relatively low cost, with little paperwork or administrative demands.  

A self-directed IRA only makes sense if you want to invest in alternative assets, such as cryptocurrency or precious metals in a retirement account. They can be quite expensive, so they may not be the best option for the typical investor.  

The takeaway  

Traditional IRAs and self-directed IRAs are both useful tools to save and plan for retirement. They have the same contribution limits, tax benefits, and RMDs, but they differ substantially in terms of fees and ongoing costs.  

 “I would say for most individuals, a traditional IRA is completely sufficient, and they don’t need to delve down the path of a self-directed IRA,” said Sprung. “There are opportunities and situations where it [a self-directed IRA] may make sense for them. But I would say that that’s really a rarity.” 

Regardless of which account type you choose, the earlier you start, the better off you’ll be. Opening an account and setting up recurring contributions will put you on a strong path toward financial security in retirement.