What Accounts Can Be Self-Directed?

If you are thinking about utilizing a self-directed IRA, it’s important to have a clear understanding of which types of accounts can actually be self-directed. For now, let’s focus on IRAs and similar account types. Refer to section A to learn about 401k’s and QRP accounts (these accounts can also be self-directed). Most custodians will tell you there are at least six different types of IRAs: Traditional IRA, Roth IRA, SEP IRA, SIMPLE IRA, HSA, and ESA. Each of these account types can be fully self-directed, and come with their own set of pros and cons.

These six account types can be broken down into three primary categories. The first category is individual accounts, meaning that they are set up by an individual for their own use. These will be the traditional and Roth IRAs. The next category is employer accounts. This will be the SEP and SIMPLE IRA accounts, which are typically set up by self-employed individuals or small businesses. Lastly, we have specialty accounts, which include HSAs and ESAs.

Self-Directed Account Types


Traditional IRA

Individual Account

A Traditional IRA can have several different names depending on the custodian that is managing your account. You may hear the terms Roll Over IRA, Pre-Taxed IRA, Trad, or tax-deferred IRA, all of which are different ways to refer to a traditional IRA. A traditional IRA is the most common account type because employer plans such as a 401K, 457, 403B, etc., typically convert into a traditional IRA when an employee leaves the company they work for.

These accounts will always grow tax deferred, meaning that you are delaying paying any taxes until you pull out funds and spend them for personal use (also known as a distribution). Because you are deferring taxes, a traditional IRA will always have a Required Minimum Distribution (RMD). Essentially this means that once you reach a certain age, the IRS requires a minimum amount of funds to be withdrawn and taxed. As of today, the RMD age starts at 73, but this will increase to age 75 in 2030.


Roth IRA

Individual Account

The Roth IRA was created as a method of saving funds for the future without paying taxes. This account is a relatively new concept since it has only been in circulation since 1997. Unlike the traditional IRA, which grows tax deferred, the Roth IRA grows completely tax free if all requirements are met. For more detailed information about Roth IRAs, head to the Roth IRA section. The main characteristics to keep in mind are that Roth IRAs can grow tax free, and there are no RMDs. Furthermore, the Roth IRA is arguably one of the best ways to pass on generational wealth since your heirs can inherit the account tax free as well.


SEP IRA

Employer Account

The Self-Employed Pension (SEP) IRA is a retirement account that is popular with small business owners. However, businesses of any size can utilize a SEP plan, including self-employed individuals. This account allows a company to make a contribution to an employee’s IRA on behalf of said employee. However, the employee is not allowed to contribute to the SEP account on their own. This contribution is usually based on the employee’s overall yearly salary, with a percentage of that salary constituting the amount that can be contributed. These percentages can vary, but the maximum amount is 25% of your self-employed income. As a basic example, if you paid yourself 100K, you could contribute 25K to the SEP IRA.

Remember, the employer is the one making the contribution. This means the employer gets to chose whether it will be a pre-taxed contribution (treated like a traditional IRA), or a post-tax contribution (treated like a Roth IRA). Because the employer and the employee are both typically the same person, it is easy to contribute large sums of cash to a SEP IRA. Additionally, you can max out a contribution to a SEP while simultaneously maxing out a contribution to a Traditional or Roth IRA.


SIMPLE IRA

Employer Account

A Saving Incentive Match Plan for Employees (SIMPLE) IRA plan is another employer plan that is typically utilized by small business owners. These accounts are often set up by small practices and allow for both the employee and employer to make contributions. The max contribution is a fraction of what the SEP IRA maximum is ($13,500 for SIMPLE in 2023), but it can still provide significant income during retirement. The majority of the contributions made to a SIMPLE IRA will always come directly from the employee. Because of this, the SIMPLE IRA is actually the least “self-directed” of these account types. Most employees are better suited to have a financial advisor or a big brand custodian manage their IRA. Contributions to a SIMPLE IRA from an employer are generally tax deferred, whereas an employee can now choose if they want their contributions to be post-tax or pre-tax (this change was made under SECURE ACT 2.0).


HSA

Specialty Account

A Health Savings Account (HSA) is arguably one of the most powerful self-directed accounts that an individual can set up (assuming they qualify). This is because when you make a contribution to an HSA, you can qualify for a tax deduction (in the same manner that you would with a traditional IRA). In addition to the tax benefit, distributions can also be made tax free, just like in a Roth IRA. For funds to be withdrawn from an HSA tax free, they must be employed for a qualified medical expense (see IRS Publication 969 for a full list of these expenses). Qualified expenses can include anything from paying for over-the-counter medicine, eyeglasses, COVID-related materials, and more. To qualify for an HSA, you must have a High Deductible Health Plan in place with your insurance provider. Overall, these accounts can be very powerful, and are often referred to as the best of both worlds in terms of savings accounts.


ESA

Specialty Account

An Education Saving Account, or ESA, is one of the more difficult self-directed account types to invest with. This is due to its low contribution limits combined with the usual fees associated with any self-directed IRA. As of 2024, the maximum amount you can contribute to an ESA is $2,000, which can be very difficult to use in any private-style investment. These accounts are designed to save and invest money specifically for educational purposes, such as saving for college or contributing to costs for tutoring and educational supplies. However, they cannot be set up and contributed to once the student is past the age of 18. Another factor to keep in mind is that these accounts must be distributed by the time the student on the account turns 30 years old to meet the qualifications for tax-free distributions, so it may not be prudent to grow the account to a large dollar amount.


Recap

There are six account types that can typically be self-directed:

  1. Traditional IRA
  2. Roth IRA
  3. SEP IRA
  4. SIMPLE IRA
  5. HSA
  6. ESA

Each of these account types fall into three distinct categories:

  1. Individual
  2. Employer
  3. Specialty

Almost any custodian can set up any of the plans listed above.

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