So you’re researching the IRA LLC strategy, like all the benefits and decide that you are going to set up a self-directed IRA LLC.  You have identified several IRA custodians to work with but every one of them wants to see your IRA LLC Operating Agreement and you don’t have one.

You are not alone in your scenario – this is the fork in the road that could lead you down one of two paths.  One path is smooth, mapped out and within no time you are on the other side utilizing all the benefits and flexibility you wanted in your IRA LLC.  The other path is a rough tangle of brush, full of trial and error and may leave you wishing you took your financial advisor’s advice when he told you to stay on the bus.

I talk to a lot of people who have half the picture and just need the other half to get on the right path.  So I decided to map out some prep work to do before establishing a self-directed IRA LLC and provide the necessary language to implement in the IRA LLC operating agreement.

Prep Work

First things first – Choose the right IRA custodian The self-directed IRA should be housed with a custodian, not a trustee.  You can also choose a third-party administrator but don’t confuse TPAs with custodians.  The IRA custodian should be familiar with the IRA LLC strategy and be open and comfortable with their clients utilizing checkbook control.  Out of the thousands of IRA custodians in the U.S. most custodians are not open to this method and the institutions that are will be especially interested in covering their a$$ before you go out and start writing checks under their custodianship.

IRA custodians vary in fees ranging anywhere from under a couple of hundred dollars a year to over a couple of thousand dollars a year.  When all is said and done the custodian you chose won’t matter that much because they won’t hold your cash or manage your investments.  The custodians role in the IRA LLC strategy is to act passively and simply hold the IRA LLC on behalf of your IRA and report annually to the IRS.

Second – Choose the right state for your IRA LLC.  Every state is different; filing fees, corporate friendliness, asset protection and even taxes (yes, IRAs are not immune to all taxes) vary from state to state so you will want to choose a state that is right for you and your investments.  Keep in mind your IRA is not generally meant to “do business” anywhere but instead is there to make investments to grow your retirement.

If your intent is to make passive investments all over the place then it would be best to choose a state that is low maintenance, low cost and corporate friendly.  If you plan on making local investments only then you might as well domicile the IRA LLC in your home state.  A registered agent will be required in all 50 states so using your home state will eliminate the need to hire one.

Third – Transfer/Rollover/Contribute to your new self-directed IRA.  Transfers, rollovers and contributions are different methods of funding an IRA and each is used for its own reason.  For example, if you currently have an IRA you will want to use the trustee-to-trustee transfer method for security and reporting purposes.  If you are moving funds from a 401(k) you would initiate a rollover from the plan into your IRA custodial cash account.  Contributions are payments you make directly to an IRA.

Fourth – Consider WHY you need an IRA LLC Operating Agreement.  Does the IRS, state, DOL, bank, broker, etc.. require an IRA LLC operating agreement?  The answer is typically no, but most limited liability companies should have one for a number of reasons – for starters you will want to define roles and purposes, avoid default state rules, limit the liability of members and managers, document capital contributions, assign roles and execute the agreement so there is evidence that all parties are in agreement.

The main reason for an IRA LLC operating agreement is to satisfy the IRA custodian; they will not draft one for you or provide much guidance and they won’t accept a standard LLC operating agreement.  Remember that self-directed IRA custodians are best at covering their a$$, and you can’t blame them for that.  Managing thousands of clients that are funding an endless array of investment possibilities across the country via checkbook control is a difficult task – and one that is not possible under a cost-effective fee schedule.  For that reason the IRA custodian will need to see specific provisions within your operating agreement to satisfy their compliance team.  The custodian will also need you to agree and bind yourself to those terms and hold them harmless for decisions you make.

Drafting an IRA LLC Operating Agreement

Step One – Choose the DIY method or Hire Help – To pay or not to pay, that is the question.  The first time I painted a room I did not want to pay someone hundreds of dollars to do it.  A few hundred dollars in material and several days later the job was done and I had the color and the room I almost wanted.  Maybe I didn’t do the best job taping off the corners and they didn’t end out perfect, and sure, I ruined a good pair of jogging shoes and nearly broke my back falling off a step-ladder, but I saved a lot of money!  At least that’s what I told my wife.

This is a decision we all have to make sooner or later, to spend time or money.  Making this decision in your IRA LLC is weighing risk vs. cost.  Choosing to hire an attorney or someone “in the business” to draft your IRA LLC operating agreement will make sure it is done right the first time and cover those corners you didn’t think about, after that you just need to read it.  Drafting your own IRA LLC operating agreement won’t cost $300 bucks an hour but will probably only cover the bare essentials.

Step Two – Name your operating agreement – Most states call the main LLC governing document an operating agreement but depending on the state this may be called a company agreement, company bylaws, etc.  If you are going to draft a legal document that sticks it should have the right terminology.  Check the state statutes or ask an attorney what your agreement should be named.

Step Three – Legal-ese and IRA language

This is where you get to tell your IRA custodian how you are going to run your IRA LLC and prove you know the rules well enough to handle a self-directed IRA LLC.  Drafting the right agreement the first time is important because IRA custodians won’t go through trial-and-error methods with you, and it’s a conflict of interest to write this agreement for you.  If you slop together an average joe piece of paper that sounds good to the layman it will most likely get rejected and your next chance will need to be facilitated by an attorney or other professional.

Start with standard LLC articles that would typically be covered in your LLC state.  You can do this by obtaining a “Plane Jane” operating agreement for your state.  You can buy these online, have an attorney draft one or sometimes even download one on the internet for free.  Read through the operating agreement to see if there are any provisions that violate IRA rules and make the necessary changes.  A few other IRA technical provisions to add are:

  1. Include language regarding internal revenue codes section 408 and 4975.
  2. Include language regarding the potential or the avoidance of Unrelated Business Taxable Income (UBTI) and, if incurred, that the manager will complete and ensure the timely filing of all relevant tax returns to the IRS and state authorities.
  3. Include language regarding additional capital contribution(s) and whether they are allowed or disallowed; if allowed, the agreement should state that: “Subsequent investments by the single member are permitted and do not create a prohibited transaction under IRC Section 4975” (may need legal opinion letter depending on your custodian).
  4. Include language that defines the capacity in which you operate the company i.e. manager, director and that you will not violate IRA codes or applicable provisions of E.R.I.S.A. while acting in this capacity.
  5. The member should be your IRA – this is usually written as “XYZ Custodian CFBO YOUR NAME”.
  6. Leave a space on the operating agreement for you and your custodian to sign.

Step Four – Read and understand your agreement

Now that you have an operating agreement for your IRA LLC make sure to thoroughly read through it several times so that you fully understand the responsibilities you are agreeing to.  When this is complete and you’re satisfied you can send all the necessary documents to your IRA custodian for approval.

On top of the LLC operating agreement you may want to draft a couple of other governing documents for your IRA LLC.  For example, some states require you keep a registered agent consent on file; an organizational meeting stating you don’t need to keep minutes may strengthen your entity; and a banking resolution will come in handy when establishing a bank account.

To conclude, these are the basics behind an IRA LLC operating agreement.  So long as you have a solid understanding of IRA prohibited transactions you should be well on your way to growing wealth with a true self-directed IRA.