Individual retirement accounts (IRAs) allow you to invest your money in various assets. These accounts are tax-advantaged, allowing you to reduce your tax liability. Various types of IRAs exist, including traditional IRAs and self-directed IRAs. Both accounts can have advantages, but the best choice depends on your preferences. We’ll compare these two types of IRAs to help you decide.

Traditional IRA

A traditional IRA is a tax-advantaged retirement savings account. These accounts offer tax-deductible contributions and tax-deferred growth. While distributions are taxed as regular income, these accounts are still advantages if you expect to be in a lower tax bracket in retirement.

A traditional IRA is maintained by a custodian, such as a bank or investment firm. While you may have control over your investment selections, your choices are usually limited to traditional investments, such as stocks, bonds and investment funds.

In 2024, the contribution limit to traditional IRAs is $7,000. For those aged 50 and over, the limit is $7,500. This is the combined limit for contributions to traditional and Roth IRAs. However, unlike Roth IRAs, traditional IRAs don’t have income limits.

Self-directed IRA

A self-directed IRA (SDIRA) is one over which you have broader discretion to select and manage the investments it holds. This opens the possibility of pursuing alternative investments beyond what most traditional IRAs allow.

For instance, an SDIRA enables you to invest in assets like:

  • Real estate
  • Private equity (shares in private companies, startups or venture funds)
  • Precious metals (gold, silver, platinum, etc.)
  • Cryptocurrency (Bitcoin, Ethereum, etc.)

These accounts have the same tax advantages as regular IRAs, including pre-tax contributions and tax-deferred growth. An SDIRA can also be a Roth account, with after-tax contributions but tax-free qualified withdrawals.

The reasons for choosing a self-directed IRA include portfolio diversification, greater control over investment selection and the potential for higher returns. However, this can also mean greater risk, as is often the case when choosing alternative investments.

Comparisons between self-directed and traditional IRAs

While IRAs and SDIRAs share many similarities, they also have more differences than may initially seem. Here is how the two account types compare:

Feature Traditional IRA Self-directed IRA
Investment options Stocks, bonds, mutual funds, exchange-traded funds Everything from traditional IRAs plus alternatives like real estate, precious metals and cryptocurrency
Control You manage the account You manage the account
Fees Can be lower than fees for SDIRAs Can be higher than fees for traditional IRAs
Tax advantages Tax-deductible contributions and tax-deferred growth Tax-deductible contributions and tax-deferred growth

The main advantage of SDIRAs over traditional IRAs is that they offer more expansive investment options. However, the fees can be higher for SDIRAs. In addition, the risk can be greater if you hold alternative investments in an SDIRA.

What to consider when choosing one over the other

Traditional IRAs and self-directed IRAs both have advantages, and which one is a better choice depends on the situation. Here’s what to consider:

  • Your investment preferences: If you have little interest in alternative investments, a traditional IRA might make more sense. Otherwise, choose an SDIRA.
  • Risk tolerance and diversification: Do you have a high risk tolerance and want the greatest possible diversification? If so, an SDIRA is ideal. If your risk tolerance is lower and you prefer traditional investments, a traditional IRA might be better.
  • Long-term growth potential and retirement planning: Long-term growth can be higher with an SDIRA due to higher-risk, higher-reward alternative investments. However, due to their high risk, it’s best to invest in them only if you have many years until retirement — preferably decades. If not, an SDIRA may not be the right choice.

When choosing between a traditional IRA and SDIRA, remember not to focus too much on potential returns. Equally important is your situation and long-term financial goals.

Bottom line

The main difference between traditional IRAs and SDIRAs is that SDIRAs allow you to invest in a broader array of assets, providing access to  real estate, precious metals and cryptocurrencies. However, the fees can be higher for SDIRAs and, crucially, so can the risk. It’s important to consider these factors and whether an SDIRA can fit into your retirement strategy before moving forward.

Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.