The Essentials of Self-directing Retirement Accounts

By Ann Siford , Professional Network Manager, Equity Trust Company
8/18/09

Since the IRA was created in 1974, investing in real estate, oil/gas, notes, private placements and other assets has been allowed as long as IRS guidelines are followed.
What you need to know…

Recently the Investment Company Institute reported in a recent study The U.S. Retirement Market, First Quarter 2009 that at the end of the first quarter of 2009, retirement assets were down $4.8 trillion, or a decrease of 4.4%, to $13.4 trillion. The study further notes declines in financial markets have lead to declines across all types of retirement funds.

With declining figures such as this, the interest in taking control of one’s retirement account investment decisions through self-directing has been growing significantly. A self-directed IRA allows investors to directly manage their retirement portfolio, diversifying beyond the traditional mutual funds, stocks and bonds to include assets such as real estate, promissory notes, tax liens, private placements and oil/gas.

For some, combining investments that they know and understand with the advantages of an IRA (tax-free or tax-deferred growth) or retirement plan can be a powerful investment strategy. And, as the self-directed retirement account market continues to grow at a phenomenal rate, investors are actively seeking professionals such as attorneys, CPAs and financial advisors to guide them. Clients still require professional expertise with regard to managing risk, tax exposure and understanding how the investment fits into their overall financial and estate plan. This provides a significant opportunity for advisors to help their clients diversify their retirement portfolios.

IRS Rules You Need to Know

A full range of investment options
Since the IRA was created in 1974, investing in real estate and other assets has been allowed as long as IRS guidelines are followed. IRS Publication 590 provides the regulations and states what investments are prohibited including artworks, rugs, antiques, metals, gems, stamps, coins, alcoholic beverages, life insurance policies and certain other tangible personal property. An exception to this narrow list is that the IRS allows investors to 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. An IRA account can also invest in certain platinum coins and certain gold, silver, palladium, and platinum bullion.

While real estate, including residential, commercial, undeveloped land and foreclosures, is a common option, the list of unique options grows every day as investors seek investment classes where they have an expertise. They are actively self-directing in assets from timber, livestock and renewable energy to receivables, grain cars and medical equipment.

Prohibited transactions and disqualified individuals
In addition to the short list of investments the IRS states an IRA cannot make, there are two other red flags to watch for with alternative assets. The IRS also requires that investors do not directly benefit from the investment causing it to be a prohibited transaction. For example, the IRS defines a prohibited transaction for a traditional IRA account as any improper use of the account such as borrowing money from it, selling property to it, receiving unreasonable compensation for managing it, using it as security for a loan and buying property for personal use (present or future) with IRA funds. Account owners cannot sell an investment to, or otherwise be involved with, disqualified persons as deemed disqualified in IRS Publication 590.

Disqualified individuals include the investor’s fiduciary and members of their family including their spouse, parents (and their spouses if re-married), grandparents (and their spouses if re-married), children (and their spouses). A fiduciary is defined by the IRS in Publication 590 as anyone who performs any of the following:

• Exercises any discretionary authority or discretionary control in managing your IRA or exercises any authority or control in managing or disposing of its assets.
• Provides investment advice to your IRA for a fee, or has any authority or responsibility to do so.
• Has any discretionary authority or discretionary responsibility in administering your IRA.

Plans that allow for self-directing in alternative investments
Self-directing in alternative investments isn’t just limited to IRAs (traditional and Roth) and investors can use Simplified Employee Pension Plans (SEPs), Savings Incentive Match Plan for Employees (SIMPLE), 401(k), Solo 401(k), Roth 401(k), Health Savings Accounts (HSAs) and Coverdell Education Savings Accounts (CESAs). Investors who are self-employed or small business owners may qualify for small business retirement accounts and qualified plans that enable them to contribute a significantly larger amount, leverage tax breaks for the business and offer competitive employee benefits.

Not all custodians can hold alternative assets
Most traditional financial institutions and IRA custodians do not hold alternative investments. If you clients have a particular investment in mind, check with the self-directed IRA custodian in advance as some may limit investment options depending on their areas of expertise. In addition to reviewing quality of service, track record and pricing value you will want to understand how the custodian is regulated through state and federal agencies and how cash balances are being protected.

Ann Siford is Manager of the Professional Network at Equity Trust Company, a custodian specializing in the investment of retirement funds in alternative assets. The Professional Network provides professionals in the self-directed retirement account industry with educational resources, access to expertise from peers and industry experts and targeted promotional tools to aid in expanding their business.

For more information on the Professional Network, contact Ann at 1-888-382-4727 x255 or visit http://www.trustetc.com/pronetwork to sign up.

Disclaimer: Equity Trust is a passive custodian and does not provide tax, legal, or investment advice. It does not endorse or recommend any contributor, company, or specific investments. Any information communicated by Equity Trust Company is for educational purposes only and should not be construed as tax, legal, or investment advice. Whenever making an investment decision, please consult with your legal, tax, and accounting professionals.