So you’re dissatisfied with the limitations of your traditional Individual Retirement Account (IRA) investing and would like to have more control over your financial destiny. You understand the regulations and the risks and liabilities of self-directed IRA investing, or you’re prepared to find out. You’re a risk-taker and feel comfortable that risks are worth the benefits of greater control and more flexibility in yourinvesting — or you feel that managing your own money is safer and will produce a greater ROI than letting someone else manage it for you.
You’re ready for self-directed IRA investing! If that’s the case, please contact us to find out how we help you by handling the legal work. Assistance with legal papers from the experts helps minimize risks.
If you’re just beginning to think about self-directed IRA investing, though, here are some things you need to know:
1. What, exactly, is self-directed IRA investing? The term “self-directed” is widely used by many different institutions so it often has different meanings. Typically what self-directed IRA means is an IRA provided by some financial institutions that allows alternative investments that the IRA holder chooses. IRA regulations require that a qualified custodian hold the account on behalf of the owner and every custodian has their own “in-house” rules and restrictions. The custodian explains their process, handles record-keeping, processes transactions and reports to the owner. The custodian may limit possible investments beyond what the IRS allows.
2. Self-directed IRA investing is like owning a pot in which you can cook and a stove on which to cook it. The pot will do what it does, act as a receptacle or tool, and the stove will do what it does, act as a heat source to change the contents of the pot, but you need to come up with the recipe. If you know nothing about how various foods and seasonings interact, you might be surprised by the results — pleasantly or, more likely, unpleasantly.
3. IRS Code Section 408 prohibits, with some specific exceptions, investments in life insurance and collectibles. In addition, section 4975 prohibits transactions with particular categories of people (disqualified persons). The purpose of these prohibited transactions is to prevent self-dealing or conflict-of-interest transactions.
4. Some allowable investments that many IRA holders are unaware of include: real estate, private equity, mortgages, partnerships/joint ventures, precious metals, accounts receivable, tax liens/deeds, structured settlements, oil and gas, limited liability companies, etc… The reason you can pick and choose your own investments in these general areas is the same reason you can pick and choose from the more popular investments like stock, bonds, futures, ETF’s, CDs and mutual funds. The answer is simple – these investments are not prohibited the tax code.
5. Self-directed IRA investing is increasingly popular because of advantages in control, flexibility and diversification, and the opportunity for enhanced returns. As real estate developers and others recognize that 14 trillion dollars sits in IRAs and 401k accounts, they offer many attractive options to self directed IRA investors. For an investor who likes the research, the greater range of options and the ability to control their own financial destiny, self-directed IRA investing is an attractive option.
6. What are the disadvantages? There are a few:
– The Securities and Exchange Commission (SEC) and the North American Securities Administrators Association announced in September 2015 put out an investor alert on self-directed IRA fraud. Scams are becoming more common (not that they don’t exist on Wall Street as well). Buyer: research and beware. If someone offers a great return and little due diligence items you should avoid it. There are no guarantees.
– There are some tax liabilities: if you lose money, you can’t deduct your losses, and you won’t get capital gains treatment on profits when you make withdrawals. If you borrow money your IRA could have a liability or “tax on unrelated debt-financed income“. The same goes if your IRA is running a trade or business instead of making passive investments.
– Liquidity issues: If you own a property in your IRA, and the property needs costly servicing you should have a buffer of cash within your account to cover those expenses. You can’t just pay for IRA expenses with your own money and IRA contribution limits still apply to a self directed account. With caps on what you can put into an IRA yearly, it might take you longer to pay back the loan than you hope. Of course, that involves interest, and it has tax implications.
– What if IRA non-liquid investments don’t generate enough money to pay your Required minimum distributions (RMD)? You might be forced to sell your whole investment for much less than you could if you held it longer.
With self-directed IRA investing, you are running on your own knowledge and ability unless you hire people at strategic places for research, advice and assistance. Your path is riskier if emotions enter into your strategy, if you don’t know what you own, if you don’t do your homework, if you don’t diversify or if you base your investment strategy on always waiting for the right moment. If you’ve done the research and determined an investment strategy, stay on track unless you decide to make a researched and planned change.
In summary, you must have the knowledge or the time, interest and ability to do the research into regulations and statutes and determine what makes a strategy with the potential for success, investment viability and tax implications. Alternatively, you must hire assistance at critical points. Well-managed, though, self-directed IRA investing can pay off in much higher ROIs and in a much safer environment.
When you’re ready to move forward with self-directed IRA investing, please contact us for assistance with the legal end of things.