Managed Versus Self-Managed IRA Investing: How to Choose

You may be maxing out contributions to an individual retirement account, or IRA, every year, but how you invest those funds is an essential part of maximizing your retirement wealth.

Investors can open a managed IRA and let a professional guide their decision-making, or they can choose to self-manage the investments within the account. There are benefits to each approach, as well as a few potential drawbacks to consider. The IRA investing option you choose will depend primarily on your investing knowledge, financial goals and tolerance for risk. Here's what you need to know before you decide.

What are managed IRAs?

Managed IRAs involve having a financial professional oversee the investments in your account—from evaluation to selection to executing transactions on your behalf. You won't have to research dozens of investments, and you'll be less likely to worry about making the wrong choices or stress over market dips when you know that a professional is taking care of all that for you.

When you work with a professional to manage your IRA, you'll have an initial conversation to review your financial goals and talk about your comfort level with investment risk. Based on this discussion, the manager will consider both your IRA investments and your full portfolio to set targets for how much to invest in various asset classes and for how long. Regular check-ins can help ensure that these targets continue to reflect your objectives.

With the authority to make investment decisions on your behalf, the financial professional in charge of your account will take care of the day-to-day transactions as well.

"Our personal trust department offers clients fully managed IRAs," says Tammy Harrison, ATFA, CISP and IRA specialist for First Citizens. "We have a conversation to set the objectives, and then we do all the work for you."

Benefits and drawbacks of managed IRAs

The advantages of a managed IRA include the confidence of having a seasoned professional handle your account, especially during volatile market periods.

A professional may also have access to advanced modeling tools that can help you select the best investments for your unique situation. In addition, they may be able to help you take advantage of strategies like tax-loss harvesting, and they may automatically rebalance your portfolio as needed to help you meet your goals—a good choice for busy investors.

The main drawback of a managed IRA is that you'll pay higher fees compared to self-managed accounts. However, in return, you receive professional guidance tailored to your unique financial goals.

Managed IRAs may be best for affluent investors who prefer to have someone else manage the details.

What are self-managed IRAs?

Self-managed IRA investing is another option to consider. You can open an IRA at many financial institutions that offer brokerage services. You'll have the option to invest in a variety of standard and highly liquid asset classes—such as publicly traded stocks and bonds, mutual funds, exchange-traded funds and real estate investment trusts.

With self-managed IRAs, you're able to choose IRA investments based on your personal situation and goals.

Broadening your investments into alternatives

With a fully self-managed IRA—also referred to as a self-directed IRA, or SDIRA—you have the option to invest in the same standard asset classes as everyone else as well as nonstandard assets, some with much lower liquidity. For example, your SDIRA may include alternative investments in cryptocurrency, real estate, private placements, limited partnership shares, hedge funds, and racehorses and other livestock. In fact, the only prohibited investments are life insurance policies, collectibles and S corporation stocks.

What makes alternative assets attractive is their potential for higher growth, and investors with unique knowledge or expertise may be especially well-positioned to capture above-average returns. However, you'll need to work with a special custodian for an SDIRA. One key to success lies in finding a reputable custodian and a financial professional who fully understand all of the rules, as they can be challenging to navigate.

Benefits and drawbacks of self-managed IRAs

For savvy investors, digital investment platforms streamline the process of designing a custom portfolio, choosing investments and deciding when to make changes. Some self-directed investing platforms even offer commission-free trading in many situations.

While setting up a self-managed IRA may be a fairly straightforward process, there are a few key rules investors should know. One potential complexity is the restriction on prohibited transactions. Generally, these restrictions are in place to prevent an IRA owner or a disqualified person from directly or indirectly benefiting from an IRA transaction before retirement. A few examples or these restrictions include:

• Using IRA funds to purchase property for personal use
• Lending money to or borrowing money from the IRA
• Selling personal assets to the IRA

Individuals with professionally managed IRAs generally don't have to worry about the prohibited transactions rule, according to Harrison. But those who self-manage their IRA and hold alternative assets have a higher chance of breaking this rule, which can result in a harsh penalty.

"One common mistake that's made is with real estate," she says. "Let's say that your SDIRA holds a beach house as an investment. As owner of the IRA, you're not able to use that beach house and neither are your family members. You can't treat the beach house as your personal vacation home, because it's not. It's an asset of and belongs to your SDIRA instead. This is where there's a chance that a prohibited transaction could occur."

Finding a trustworthy SDIRA custodian can be another challenge. According to the SEC and FINRA, fraudsters often target this space to scam unsuspecting investors. Custodial fees are something else to consider. "Many of these custodial companies tack on extra fees for things like deposits, wire transfers or expenses," Harrison says. "Make sure you understand the pricing."

Another challenge with SDIRAs is due diligence. Because there's often little or no public information for alternative assets, you'll need to perform your own due diligence on every investment. In addition, it may be harder to liquidate alternative assets when you need cash. And that can cause problems once you or your heirs have to start taking required minimum distributions.

Self-managing your IRA investments might be most appealing to experienced investors. If you wish to explore alternative asset investments, you may want to seek guidance from a financial professional to help you avoid mistakes.

IRA investing your way

It's a good idea to consult with a financial professional to help you settle on the type of IRA investing that best fits your goals and level of risk tolerance. Having access to an independent advisor who is knowledgeable about the restrictions on prohibited transactions is essential, especially if you're interested in investing in alternative assets, because the penalties for making a mistake can be significant.

Whichever option you choose, having a solid understanding of the pros and cons can help you take the best next step.