You can own gold, real estate, private companies, hedge funds, and more in your IRA. You won’t hear this from most IRA custodians. They limit your investment choices to mutual funds and publicly-traded stocks and bonds and maybe a few other assets. Their idea of a self-directed IRA is that you can choose from these mainstream assets.
A relatively small group of IRA custodians allow true self-directed IRAs that allow you to invest in almost any asset that isn’t prohibited by the tax code. These custodians say any asset that they can acquire title to can be held in their IRAs.
More people are interested in true self-directed IRAs these days, because they are less interested in simply owning stocks and bonds. They want alternative assets and strategies in their portfolios.
There’s a cost, several costs actually, to a true self-directed IRA. The custodian charges higher fees at every stage. You normally pay a set up fee and a fee for each transaction. In addition, the tax code requires the custodian to determine the value of assets at the end of each year. For many assets, that requires a paid appraisal, and you bear that cost. Because of expenses, a self-directed IRA isn’t for a small investment.
We reported extensively in past visits on true self-directed IRAs. You can find these in the IRA Watch section of the Archive on the members’ web site. You also can find details about what is and isn’t allowed in an IRA in my IRA Investing Guide: A Road Map for Avoiding the Traps and Penalties for IRA Investments, available through the Bob’s Library tab on the web site.
In the face of the growing popularity of self-directed IRAs, the SEC and the state securities commissioners jointly issued a warning to investors about the risks of self-directed IRAs, emphasizing three added risks.
The investments in self-directed IRA usually lack liquidity, meaning that they can’t readily be bought and sold. Often you have to find a buyer and negotiate a price, and that takes time. These illiquid investments also often don’t have the same level of disclosure as traditional investments. Because the investments put in self-directed IRAs generally don’t meet the definition of “security” under the law, they aren’t required to comply with securities law disclosure rules.
These factors can combine to create the third factor the regulators warned about: fraud. A number of the investments in Bernard Madoff’s ponzi scheme were made through self-directed IRAs, and he was reported to refer investors to a particular self-directed IRA custodian. Other frauds also gathered many investments from self-directed IRAs, and the regulators believe scam artists target owners of such IRAs.
Owning a self-directed IRA of course means you’re open to owning non-traditional investments. Scam artists like IRAs because the taxes and penalties on distributions (especially on those under age 59½) make investors hesitant to take money out of the IRA. The long-term nature of the IRA also can make people complacent about the investments in their accounts.
It’s important that you understand the role of a custodian of a self-directed IRA. The custodian has no legal or contractual liability to do more than process the transactions as you direct. Some scam artists refer prospective investors to particular custodians and say the custodians have performed due diligence on the investment. That’s rarely true. The custodian isn’t responsible for vetting an investment, and most specifically disclaim any responsibility to do so in their contracts with customers. When an investment promoter says his investment has been approved or checked out by a custodian, consider what that indicates about his or her credibility.
The alert from the regulators offers some advice for avoiding frauds in self-directed IRAs. Be skeptical of investments that imply a high return is either guaranteed or earned with low risk. Be especially skeptical of unsolicited investment offers, even if they come from someone you know and trust. Of course, investigate the investment yourself. Ask detailed questions about it and verify the answers. It’s also a good idea to seek another, objective opinion.
Because of the scams that used self-directed IRAs in recent years, you can expect to find the accounts less available. Smaller and midsize brokers are planning to restrict the investments that can be put in IRAs of which they are custodians, even when the account is monitored by a registered investment advisor, according to Investment News.
There’s been a surge in arbitration cases involving self-directed IRAs, and the arbitration panels are holding investment advisors and brokers who recommend IRA investments to higher standards than for non-IRA business. Broker-dealers don’t want to be caught in that snare.
When you’re interested in a self-directed IRA, you have to navigate all the pitfalls. You need to find a reliable custodian and comply with all the tax rules to avoid prohibited investments and transactions. You’ll find the details, including a list of established custodians for true self-directed IRAs, in my IRA Investing Guide.
RW January 2012.
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