Self-Directed IRA vs Traditional IRA: What’s the Difference?

Estimated reading time: 4 minutes

Let’s clear up a common misconception—“self-directed IRA vs. traditional IRA” isn’t even the right question. 

Why? Because a self-directed IRA (SDIRA) can be a traditional IRA.

A traditional IRA typically means the funds haven’t been taxed yet, and can grow without taxation until a withdrawal in retirement. On the other hand, a Roth IRA means the funds have been taxed, though the funds may grow entirely tax-free. 

Both traditional and Roth IRAs can be self-directed, giving you the freedom to invest in alternative assets like real estate or precious metals.

The real question is this: self-directed IRA vs. conventional IRA.

What’s the difference? In three words: Flexibility. Control. Responsibility.

In this article, we’ll explore how self-directed IRAs differ from conventional IRAs typically offered by banks or brokerages, the pros and cons of each, and tips for deciding which one is right for you. 

Let’s dive in.

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KEY TAKEAWAYS

• Conventional IRAs are retirement accounts that provide access to publicly traded securities, such as stocks, bonds, and mutual funds.

• Self-directed IRAs are similar to conventional IRAs in structure, but with one key difference—investment flexibility. SDIRAs let you invest in a much wider range of assets, including real estate, private equity, promissory notes, and more.

• Conventional IRAs typically have lower fees but limit your ability to truly diversify your portfolio.

• Self-directed IRAs offer greater diversification and potential for higher returns but require more due diligence from the investor and often come with higher fees.

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The Differences Between a Self-Directed IRA and Conventional IRA

Self-directed IRAs provide the same tax benefits as conventional IRAs. Both can be set up as traditional or Roth, depending on your financial goals. The key differences? Control, risk, and fees.

Here’s a detailed comparison:

Self-Directed IRA vs Conventional IRA: What’s the Difference?

Why Can’t I Get an SDIRA From my Existing IRA Provider?

Most IRA custodians specialize in traditional investment products such as stocks, bonds, and mutual funds. These providers operate on economies of scale, managing large volumes of standard investments with automated systems and lower fees.

While some transactions within real estate and private equity can be automated, in general, these transactions require much more time and resources from the provider. 

SDIRA providers, like The Entrust Group, have a business model specifically designed to handle the unique requirements of alternative investments, including higher fees to administer these complex assets.

Self-Directed IRA vs Conventional IRA: Pros and Cons

Here’s a breakdown of the pros and cons of SDIRAs compared to conventional IRAs:

Pros of Self-Directed IRAs

1. Greater Investment Flexibility

SDIRAs allow you to invest in a wide range of alternative assets, such as real estate, private equity, promissory notes, precious metals, and cryptocurrencies. This flexibility enables true portfolio diversification beyond the traditional stocks, bonds, and mutual funds available in conventional IRAs.

2. Potential for Higher Returns

By investing in non-traditional assets, SDIRAs open the door to opportunities with higher growth potential, especially for knowledgeable investors who can spot undervalued or niche assets.

3. Portfolio Diversification

Alternative assets often have low correlation with the stock market, reducing overall portfolio risk and providing a hedge against market volatility.

4. Control Over Investments

Investors have complete control over their asset choices, enabling a more hands-on approach to building wealth. Plus, an SDIRA allows you to invest in assets that you care about, whether that’s local or impact investing.

Cons of Self-Directed IRAs

1. Higher Fees

SDIRAs often come with higher administrative fees due to the complexity of managing alternative assets. Unlike buying shares of a stock like Nvidia, purchasing an investment property involves multiple steps: earnest money deposits, escrow preparation, deed transfers, and more. 

Ensuring all documents are handled correctly requires expert oversight from our team, including many members who have earned the Certified IRA Services Professional (CISP) designation.

To remain financially viable, SDIRA providers account for this time and effort in their fee structures, which typically include account setup fees, transaction fees, and ongoing administrative fees. At The Entrust Group, we’ve designed our fees to scale with the complexity of administering the account, whether you invest $20,000 or $2,000,000.

2. Must Adhere to the IRS Rules

SDIRAs must comply with strict IRS rules, including, but not limited to:

• No investments in collectibles (e.g., art, antiques), life insurance, or S Corps.
• No transactions involving disqualified persons (e.g., yourself, your spouse, or certain relatives).
• All income from IRA-held assets must flow directly back into the IRA.

Any violation can result in significant penalties, including disqualification of the entire IRA.

3. More Responsibility

Publicly traded investments, like those in the S&P 500, are typically vetted by numerous financial analysts, making it unlikely for them to be total failures.

In contrast, private market investments—such as real estate or private equity—may offer greater potential upside, but that invariably comes with greater potential downside. SDIRAs require investors to conduct their own thorough due diligence. Additionally, investors must be sure to avoid non-compliant investments or prohibited transactions.

4. Illiquidity

Many alternative assets, such as real estate or private equity, are illiquid and may take years to generate returns or convert back into cash. This may pose a problem if you need access to your retirement funds quickly. 

Pros of Conventional IRAs

1. Ease of Use

Often managed by banks, brokerages, or other financial institutions, conventional IRAs are simple to set up and maintain. 

2. Low Fees

Conventional IRAs often have lower fees since the purchase and sale of assets (e.g., mutual funds, ETFs) is typically fully automated, requiring less administrative oversight.

Cons of Conventional IRAs

1. Limited Investment Options

Conventional IRAs restrict investments to publicly traded securities, excluding alternative assets like real estate, private equity, and precious metals.

2. Less Diversification

Portfolios are often heavily tied to the stock market, increasing vulnerability to market volatility.

3. Lower Growth Potential

Investors miss out on the potentially higher returns associated with alternative investments.

Self-Directed IRA vs Conventional IRA: Which Type is Right for You?

Choosing the right IRA depends on your financial goals, risk tolerance, and investment strategy.

Conventional IRAs might be ideal for investors seeking low-risk, stable growth with familiar assets like stocks and bonds. They are simple to manage and come with lower fees, making them a great foundation for long-term retirement savings.

On the other hand, SDIRAs offer unparalleled investment flexibility and the potential for higher returns through alternative assets like real estate, private equity, and precious metals. While they require more hands-on management and due diligence, SDIRAs can diversify your portfolio and reduce your reliance on traditional market-based investments.

Want to learn more about SDIRAs? Download our free SDIRA Basics Guide. Inside, we’ve included a comprehensive breakdown of the IRS rules, examples of what you can and cannot invest in, and a step-by-step process to get started.

Note: The Entrust Group does not endorse, recommend, or advise on any investment product or service. Rather, The Entrust Group provides the administration, information, and tools to make self-direction straightforward and compliant. This information in this document is not a substitute for professional advice from a certified financial planner or trusted tax advisor.