Over the last few months we have been asked, and have heard rumblings, of utilizing Individual Retirement Accounts (IRAs) to invest in assets such as private businesses and/or real estate. At first glance, this seems like an attractive deal – invest in a private business with potentially high returns while doing so in a tax-efficient way – yes please. However, like anything else, once you start down the rabbit hole, it becomes more clear that using an IRA to invest in “alternative” assets has as many pro’s as there are con’s. So, let’s dive into the intricacies of utilizing the sought after self-directed IRA. What is the difference between a self-directed IRA and an IRA?
The name itself is a bit misleading – it postulates not all IRAs are self-directed. When thinking of self-directed, it’s logical to assume it references the individual making the decision. However, the self-directed piece isn’t referring to investment decisions, but is a label for the type of assets you can invest in within an IRA. To help clarify, here is the Securities and Exchange Commission’s (SEC’s) explanation: “A self-directed IRA is an IRA held by a trustee or custodian that permits investment in a broader set of assets than is permitted by most IRA custodians. Most IRA custodians are banks and broker-dealers that limit the holdings in IRA accounts to firm-approved stocks, bonds, mutual funds and CDs. Custodians and trustees for self-directed IRAs, however, may allow investors to invest retirement funds in other types of assets such as real estate, promissory notes, tax lien certificates, and private placement securities.”[1] As you can see the difference between a “self-directed” IRA and a “regular” IRA is the type of assets an individual may invest in – that’s it! The tax advantages, contributions’ limits, required minimum distribution limits, etc. are all the same. The kicker is the expansion of the investable options. Lastly, self-directed IRAs can come in different forms such as a traditional IRA, Roth IRA, SEP IRA, and/or SIMPLE IRA. What are some of the nuances to a self-directed IRA?
b. A fiduciary’s act by which he or she deals with plan income or assets in his or her own interest c. A fiduciary’s receipt of consideration for his or her own account in a transaction that involves plan income or assets from any party dealing with the plan d. Any of the following acts between the plan and a disqualified person: i.Selling, exchanging, or leasing property ii.Lending money or extending credit iii.Furnishing goods, services or facilities And a disqualified person[5]: a. Grandparents b. Parents c. Spouse d. Children/Adopted Children and their Spouses e. Grandchildren and their Spouses f. A Fiduciary (…) g. A person providing services to the plan, such as an CPA or Attorney h. Companies owned by disqualified parties This is important, because as you begin to invest in alternative assets, the probability of committing a prohibited transaction increases. For example, you want to purchase a vacation property with your self-directed IRA. If you were to purchase the property and use it, it would be considered a prohibited transaction. If you commit a prohibited transaction, you lose the tax-advantaged status of the account, and depending on the situation you may be hit with ordinary income taxation and a penalty.
Conclusion Unraveling a self-directed IRA begins to show its true colors – its complicated. The opportunity to hold real estate and/or a private company is attractive, but if you are unaware of the details behind this vehicle type, the potential benefits could be washed away in an instance. When asked if a self-directed IRA is a good idea or not, our answer is simple – it depends. Every individual and/or household is different from its finances to its goals. A vehicle such as a self-directed IRA is complex, and if used correctly can be beneficial and if not can cause harm. The only definitive answer we can provide – before making the decision to use your IRA to purchase alternative assets, talk to your trusted advisors, especially a CPA. They should be able to help educate you on the vehicle as well as assess if it is the right fit for you. And if you don’t have any one to talk to, we at LBW are always happy to lend a helping hand. With all of that said, we feel a quote from Rob Lowe perfectly sums up this post – “Every relationship has its complications”[9]. Sincerely, LBW [1] https://www.sec.gov/investor/alerts/sdira.pdf [2] Please reference the SEC’s following document for further information https://www.sec.gov/investor/alerts/sdira.pdf [3]https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-prohibited-transactions [4]https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-prohibited-transactions [5] https://www.pensco.com/self-directed-iras/the-basics/prohibited-transactions/ [6] RMD’s are calculated based on the individual’s account balance from December 31st of the year that precedes the year of their distribution. That number is then divided by the amount indicated in the IR’s “Joint Life and Last Survivor Expectancy Table” of the “Uniform Lifetime Table”. [7] Please consult a qualified CPA for further information. [8] Please consult a qualified CPA for further information. [9] https://www.brainyquote.com/quotes/keywords/complications.html Comments are closed.
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