A Self-Directed IRA is about the same as any other IRA (or 401k rollover to an IRA). The difference is the investment options.
Why haven’t some people have heard of self-directed IRAs? Most IRA custodians earn a commission when you invest in stocks, bonds, mutual funds and CDs. So that’s all they allow. But the IRS allows a whole lot more: real estate, mortgage notes, private placements, tax lien certificates and more. A self-directed IRA custodian allows ALL of the investments that the IRS regulations allow.
Self-Directed IRA Benefits
On top of the regular IRA benefits – tax free profits, asset protection from lawsuits and estate planning – you are also able to invest in other growth tools that you may understand. This includes things such as rental property, which often creates a MUCH better return for yourself than a typical mutual fund.
Why don’t more people do this?
More do than you might think. But investment firms make money on stock commissions and not typically on real estate. So there is no financial incentive for them to tell you about these options. Self-directed IRAs have been around since 1974. Investing in alternatives to stocks, bonds, and mutual funds, has always been allowed by the IRS (See IRS Publication 590). Self-Directed IRAs have not received large attention because most custodians who offer IRAs (banks and brokerage firms) only allow traditional investments at their firms.
The IRS does not tell you what your IRA can invest in. It only gives you a short list of what what you cannot invest in.
The law does not permit IRA funds to be invested in life insurance or collectibles. With some exceptions, collectibles include the following:
- Alcoholic Beverages (That’s right – you cannot drink your IRA.)
- and Certain other tangible personal property.
Exception. Your IRA can invest in one, one-half, one-quarter, or one-tenth ounce U.S. gold coins, or one-ounce silver coins minted by the Treasury Department. It can also invest in certain platinum coins and certain gold, silver, palladium, and platinum bullion.
The general idea is that these are funds for retirement…not for things that you can use beforehand.
Keep in mind many CPAs and other advisers have not heard of self-directed IRAs
Because they are not generally promoted by the big financial institutions they would not automatically be exposed to them. You can certainly keep your CPA in place. Because this is a specialized field, our self-directed IRA custodian can work with you (and your CPA) to keep compliant.
Protecting your IRA
Real estate owners can be sued. It is easy to protect your IRA by using limited liability companies if your self-directed IRA owns real estate. So you will want to own each piece of real estate in a separate limited liability company so that the lawsuit is limited to that one piece of property rather than exposing your entire retirement plan to a nasty lawsuit.
Can you be assured that self-directed IRAs are allowed under IRS rules?
As long as you follow relevant rules the answer is yes. There are specific rules regarding IRAs, and in particular, self-directed IRAs that you should be familiar with to make sure you staying within the guidelines.
There are certain types of transactions that you cannot perform through an IRA. Most importantly, the IRS prohibits “self-dealing,” which are investments in which you or your family members of lineal descent have prior ownership. You couldn’t have your IRA buy a house from yourself, for example. It couldn’t buy a house from or for the use of your parents, kids or grandkids, for example. But it can buy a house from a third party and rent it out to another third party.
Here is how a Self-Directed IRA investment works
Investing with a self-directed IRA isn’t much different than investing outside of an IRA. In fact, in three simple steps you can be on your way to making tax-free or tax-deferred profits.
- Identify Your Investment and Request Funds From Your Custodian
Important: All documents related to the investment must be titled in the name of your IRA, not to you personally. For example, if you invest in real estate, the title of the property would be:
XYZ Custodian FBO (Pat Smith’s) IRA
- Process the Investment
a. Your custodian will look over the purchase documents.
b. Then funds will be sent from your IRA for the investment
- Manage and Sell the Investment
Once your IRA owns the investment – all expenses and profits related to the investment must come from and return to the IRA. When you are ready to sell the investment you will complete an investment form which instructs the custodian to remove the asset from your account. Then funds from the sale of the investment return to your self-directed IRA tax-free.