What is a Self-Directed IRA?
Legally speaking, a Self-Directed IRA is no different than any other IRA. Having a Self-Directed IRA simply means that you are allowed to direct the investments of the IRA. Many custodians claim that they allow you to self-direct your IRA investments but then turn around and restrict what you can invest in. A truly Self-Directed IRA allows you to make the decisions without restriction.
What is a Self-Directed IRA Custodian?
The Custodian is a bank or savings and loan association, as defined in IRC 408(n), or any other entity that has the approval of the IRS to act as Custodian. Self-Directed IRAs must be maintained by a Custodian who will allow investments in non-traditional investments.
A Retirement Account Facilitator or Administrator can set up the legal structure, such as an LLC or C Corporation, to provide checkbook control of the funds. Unlike the Custodian, the Facilitator or Administrator does not hold the funds, but typically works directly with a Custodian who holds the funds, as part of the service provided.
Are my funds safe with one of these Custodians?
A Custodian must be a registered Trust Company. There are stringent state requirements to be a Trust Company, and the Custodian must have adequate reserves. Your money is kept separate for your benefit and is not subject to creditors of the Custodian. With your funds placed in an LLC or C Corporation, the Custodian never has control of your funds, you do. You are always in control.
Why haven’t I heard of this before? Is it legal?
Congress passed ERISA in the Securities Act of 1975. As a result of this passage, banks and brokerage houses found that this was an ideal time and market to bring IRA and 401(k) plans to individuals and employers and sell the products they wanted to sell….stocks, bonds and mutual funds.
Nothing in the IRS code states that you can only invest with a brokerage house…let alone in stocks, bonds and mutual funds. But this IS what 97% of the population believes. Banks and brokerage houses have a vested interest in having you invest in stocks, bonds and mutual funds – not real estate, businesses and other non-traditional investments.
As investors have become more disillusioned and frustrated with traditional investment choices, they have begun looking for alternatives. After the steep stock market decline, corporate scandals and corruption (e.g. Enron, ImClone, Worldcom) and many investors seeing their retirement accounts cut in half, they are ready to take control of their own investments. They often want more tangible investments such as Real Estate. However, when they ask their current custodians/brokers, they are typically told that such investments are illegal, too complicated or that it can’t be done. But those are self-serving and/or uninformed responses.
What can my IRA invest in?
The real question is, what CAN’T my IRA invest in? There are some very strict IRS regulations that must be followed. The IRS does not, however, provide an all-inclusive list of possible investment options, but rather stipulates what you CANNOT invest in, specifically: life insurance contracts and collectibles. The following list is a SAMPLE of some permissible investments with your Self-Directed IRA:
Residential Real Estate
Commercial Real Estate
Raw Land Trust Deeds, Mortgages, and Mortgage Pools
Private Notes and Loans
Private Stock Offerings
Limited Liability Companies (LLC)
Limited Partnerships (LPs)
Stocks, Bonds, Mutual Funds
Medical Industry Investments
Oil & Gas Investments
Contract Conversion Financing
Is there a limit to the investments I can make?
No, except as mentioned before, you cannot invest in insurance contracts or collectibles, and except as explained below regarding prohibited transactions and self-dealing. As long as you stay within the guidelines of what to invest in and how to manage the investment, there is no limit to the amounts, frequencies, combinations, etc.
What is ERISA?
ERISA stands for the Employee Retirement Income Security Act. It more or less passed along the responsibility of an employee’s retirement plan from the employer (company sponsored pension) to the employee. As a result of this act, the IRS only excludes what can be invested in. These two prohibited investments are: life insurance contracts and collectibles.
What types of retirement accounts can be moved into self-directed status?
Coverdell Education Savings (ESA)
Profit Sharing Plans
Money Purchase Plans
Government Eligible Deferred Compensation Plans
Note that most employer sponsored plans such as 401(k) will not allow you to roll your account into a new Self-Directed IRA plan while you are still employed. However, some employers will allow you to roll a portion of your funds. Contact your current 401(k) provider to determine if your funds are eligible for a rollover.
How do I know this is legal?
You can expect to be told by many accountants and CPAs, including possibly yours, that this is not legal or is very dangerous to do. Neither is true. As mentioned before, this is legal as a result of the ERISA Security Act passed over 30 years ago. It is more of a question of whether an individual SHOULD do it (see the next question). Find out for yourself by going to the Internal Revenue Service’s website www.IRS.gov and request IRS Publication 590. On pages 40-41 you will see what investments are not allowed (see below – collectibles, life insurance, s-corporation stock, etc.). Real Estate is NOT mentioned as a disallowed investment just like stocks, bonds, mutual funds are not mentioned as a disallowed investment.
Should everyone do this? How do I know if it is right for me?
Of course, you know the answer to this question is NO. Not everyone should do this and not everyone will. It really depends on a person’s interest level to self-direct. Some folks would rather bury their heads in the sand and just hope that everything turns out okay for retirement. Others have done well with the brokerage accounts and have not diversified into real estate. However, the best aspect of a truly self-directed plan is that you can invest in non-traditional assets (i.e. real estate) and STILL invest in stocks, bonds and mutual funds.
How many people have Self-Directed IRAs?
Recent numbers show over 45 million IRA holders in the U.S. with less than 4% of these funds held in non-traditional assets. Awareness of Self-Directed IRAs is growing, however. The expected trend indicates that upwards of $2 trillion will enter the market in the next two years. The number of Self-Directed IRAs is expected to increase dramatically over the next 5 years as increasing numbers of individuals are their financial advisors become more familiar with Self-Directed IRAs.
Are there certain investments disallowed?
The IRS Code excludes one from investing in life insurance contracts and collectibles. These are referred to as “prohibited transactions.” “Prohibited transactions” are defined in IRC 4975(c)(1) and IRS Publication 590. As manager of the Self-Directed IRA, you must remember that every transaction must be undertaken for the exclusive benefit of the retirement plan. No “self-dealing” is permissible. Self-dealing occurs when an IRA owner uses their individual retirement funds for their personal benefit rather than to benefit the IRA. As an IRA owner, if you violate these rules, your entire IRA could loose its tax-deferred or tax-free status.
What are prohibited transactions?
Prohibited transactions, as noted by IRC 4975(c)(1), identifies prohibited transactions to include any DIRECT or INDIRECT:
• Selling, exchanging, or leasing, any property between a plan and a disqualified person;
• Lending money or other extension of credit between a plan and a disqualified person;
• Furnishing goods, services, or facilities between a plan and a disqualified person;
• Transferring or using, by or for, the benefit of a disqualified person the income or assets of a plan;
• Dealing with income or assets of a plan by a disqualified person who is a fiduciary acting in his own interest or for his own account;
• Receiving any consideration for his or her personal account by a disqualified person who is a fiduciary from any party dealing with the plan in connection with a transaction involving the income or assets of the plan.
Who is a disqualified individual?
As it relates to IRC, the following would constitute disqualified individuals with regard to entering into any investment or arrangement, directly or indirectly:
The IRA holder and his or her spouse;
The IRA holders ancestors, lineal descendants and their spouses;
Investment advisors and managers;
Any corporation, partnership, trust or estate in which the IRA holder has a 50% or greater interest;
Anyone providing services to the IRA such as a trustee or custodian.
Please note that too many individuals are playing games with the disqualification provision of an IRA holder who has 50% or greater interest in an investment. A word to the wise, do not play games with this provision by placing the IRA holder as a 47%, 48% interest in the endeavor. This is dangerous grounds to walk on for reasons to be examined later…but use caution if you are advised to do this.
How do I get started?
We’ll take you through a simple, step-by-step process designed to put your investment future into your hands, with checkbook control, immediately. You gain 100% control of your retirement funds legally and they are transferred without a taxable distribution. Contact us today to get started.