Self-Directed IRA vs. Traditional IRA: Key Differences Explained

The debate over a Self-Directed IRA vs. Traditional IRA often creates confusion, especially since both accounts follow the same IRS rules but offer very different investment opportunities.

For decades, the Individual Retirement Account (IRA) has been one of the most popular tools Americans use to save for retirement. But as alternative investments like real estate, private equity, cryptocurrency, startups, and precious metals have become more common, many investors are asking an important question:

What is the difference between a Traditional IRA and a Self-Directed IRA?

The answer is both simpler and more interesting than most people expect. From a legal and tax perspective, there is no distinction at all. The differences exist because of how financial institutions choose to operate, not because of how the IRS defines an IRA.

Below is a clear breakdown of how Traditional IRAs and Self-Directed IRAs differ, how Self-Directed IRAs came to exist, and what investors should look for when choosing a Self-Directed IRA custodian.

What Is a Traditional IRA?

A Traditional IRA, as most people use the term, refers to an IRA opened at a traditional financial institution such as:

• Fidelity
• Vanguard
• Charles Schwab
• Bank of America
• Chase

These institutions primarily offer access to publicly traded investments, including:

• Stocks
• Bonds
• ETFs
• Mutual funds
• CDs and money market funds

Traditional IRA providers are built around the Wall Street model. They earn revenue through commissions, spreads, asset-based fees, and managed investment products. Their platforms are designed for convenience, automation, and public market investing, not for holding alternative assets.

Because of this business model, traditional IRA custodians generally prohibit investments in most alternative assets.

What Is a Self-Directed IRA?

A Self-Directed IRA is simply an IRA that allows you to invest in the full range of assets permitted by the IRS, not just Wall Street products.

A Self-Directed IRA can invest in assets such as:

• Real estate, including residential, commercial, and raw land
• Private equity and venture capital
• Cryptocurrency
• Startups
• Private loans and mortgages
• Precious metals
• Tax liens
• Syndications and private funds

Nearly any investment is allowed, with the exception of collectibles and life insurance.

Importantly, Self-Directed IRAs follow the exact same tax rules as any other IRA:

• A Traditional Self-Directed IRA grows tax deferred
• A Roth Self-Directed IRA grows tax free

The only real difference is the custodian’s willingness and ability to hold alternative assets.

ERISA History: There Is No Legal Distinction Between IRAs

When Congress created IRAs under ERISA in 1974, the tax code made no distinction between a so-called Traditional IRA and a Self-Directed IRA.

Under the law, all IRAs were treated the same. Investors could invest in anything except:

• Collectibles (IRC §408(m))
• Life insurance (IRC §408(a)(3))
• Prohibited transactions outlined in (IRC §4975(c))

So why did traditional banks and brokerages avoid alternative investments?

The answer is simple. It was not profitable for them.

Wall Street custodians make money by selling and managing financial products. They do not make money holding deeds, private fund documents, real estate contracts, operating agreements, or cryptocurrency wallets.

This was a business decision, not a legal restriction.

As a result, a new industry emerged: Self-Directed IRA custodians, typically trust companies designed specifically to hold alternative assets.

IRS Prohibited Transaction Rules: The Real Limitation

Whether you use a Traditional IRA or a Self-Directed IRA, all IRAs are subject to the same prohibited transaction rules under IRC §4975.

These rules prohibit transactions between your IRA and certain disqualified persons, including:

• You
• Your spouse
• Your parents and grandparents
• Your children and grandchildren
• Any entity you control at 50 percent or more

Prohibited transactions include activities such as:

• Using IRA assets for personal benefit
• Buying or selling property between your IRA and a disqualified person
• Providing services to an IRA-owned LLC
• Taking personal possession of IRA-owned assets
• Using IRA funds to benefit a business you control

Understanding these rules is critical. Violations can cause your entire IRA to lose its tax-advantaged status, which is why working with a knowledgeable custodian matters.

Why You Need a Specialized Self-Directed IRA Custodian

A Self-Directed IRA custodian is typically a state-chartered trust company authorized to hold retirement assets and process private, non-public investments.

Their responsibilities usually include:

• Holding Self-Directed IRA assets
• Processing alternative investment transactions
• Reviewing documents for proper IRA titling
• Filing required IRS forms such as Forms 5498 and 1099-R
• Maintaining IRS compliance
• Supporting checkbook control structures

Traditional IRA custodians generally do not offer these services because they lack the operational infrastructure, cannot process private investment documents, and rely on a product-based revenue model.

A true Self-Directed IRA custodian exists specifically to support alternative investments.

What to Look for in a Self-Directed IRA Custodian

Choosing the right Self-Directed IRA custodian is essential. Here are the most important factors to consider.

1. Deep Expertise in Alternative Assets

• Real estate closings
• Private equity and venture capital documentation
• Cryptocurrency custody
• Syndications and fund structures
• Checkbook control LLCs
• UBIT and UDFI rules
• Prohibited transaction regulations
• IRS reporting requirements

Without this expertise, small mistakes can lead to major tax consequences.

2. Flat Fees, Not Asset-Based Fees

Asset-based fees can significantly reduce returns over time.

For example, if you hold $500,000 in real estate and your custodian charges 1 percent annually, you are paying $5,000 per year regardless of performance. A quality Self-Directed IRA custodian charges flat fees. Your success should not increase your costs.

3. Ongoing Consulting and In-House Tax Support

• Unlimited consulting
• Access to tax attorneys
• Prohibited transaction analysis
• Investment structuring support
• UBIT and UDFI review

This level of support is especially important for real estate, private equity, and startup investors.

4. Full IRS Tax Filing Services

• Form 990-T for UBIT or UDFI
• Form 1065 for IRA-owned LLCs
• State LLC filings
• K-1 reviews
• Annual fair market valuations

Only a small number of custodians offer these services in house.

The IRA Financial Difference

IRA Financial is a national leader in Self-Directed IRAs and Solo 401(k) plans, serving more than 27,000 clients and administering over $5 billion in retirement assets. The firm is led by Adam Bergman, Esq., a tax attorney and one of the nation’s leading experts on self-directed retirement strategies, as well as the author of nine books on Self-Directed IRAs and Solo 401(k)s. IRA Financial stands apart through its flat fee pricing, fast account setup via web and mobile platforms, industry-leading compliance support, and comprehensive IRS tax reporting, and fair market value reporting. The firm also provides UBIT and UDFI tax filing services, full LLC tax filings using Form 1065, unlimited consulting, and deep expertise across all alternative asset classes, while pioneering the Checkbook IRA and Solo 401(k) structures.

No other custodian combines this level of legal expertise, technology, and tax reporting infrastructure.

Conclusion

While the tax code makes no distinction between a Traditional IRA and a Self-Directed IRA, the investment opportunities, custodial models, expertise, and fee structures are dramatically different.

If you want to invest in alternative assets like real estate, cryptocurrency, private equity, startups, or precious metals, you need a true Self-Directed IRA custodian, not a traditional brokerage.

With proven expertise, unmatched support, and a flat fee model built specifically for alternative investors, IRA Financial stands out as a leader in the Self-Directed IRA industry.