Top Questions for Self-Directed IRAs and 401Ks

Yes, You Can Ask Questions!

Yes, You Can Ask Questions!

There is a lot of websites, companies and blog that tout the benefits of the self-directed IRA.  Actually, all things being equal the self-directed 401K is probably a better option for most…as long as one qualifies for the 401K.  That being said, let’s look at some common questions that are raised related to self-directed IRAs and 401Ks:

1) 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.

2) Why Haven’t I Heard of This Before/Is It Legal?

Congress passed ERISA in the Securities Act of 1975.  As a result, 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 cannot invest in other assets.  You are restricted from investments in life insurance contracts and collectibles….but, otherwise, you can invest in any asset class that you want…including real estate.   Obviously, banks and brokerage houses have a vested interest in having you invest in stocks, bonds and mutual funds – that’s how they earn their commissions!

3) What Can My IRA or 401K Invest In?

Well, the real question should be what CAN’T your IRA or 401K invest in?  As  stated earlier, the IRS does not provide an all-inclusive list of possible investment options but rather excludes and stipulates what you CANNOT invest in: life insurance contracts and collectibles.

The following list is an EXAMPLE of some permissible investments with your self-directed IRA or 401K:

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)
Tax Certificates
Receivables
Stocks, Bonds, Mutual Funds
Annuities
Options
Currency
Futures
Commercial Paper

4) What Types of Retirement Accounts can be Moved into Self-Directed Status?

Traditional IRAs;
Sep IRAs ;
Roth IRAs;
401(k)s;
403(b)s;
Coverdell Education Savings (ESA);
Qualified Annuities;
Profit Sharing Plans;
Money Purchase Plans;
Government Eligible Deferred Compensation Plans;
Keoghs

But, please keep in mind that Roth IRAs cannot be rolled over into a 401K!

5) How Do I Know This is Legal?

As many have discovered when speaking to their CPA or broker, an initial response is that this type of investing is not legal and should not be done.  Then, many will hear that, while legal, it is much too difficult for the “common” man.   Neither is true. It is more of a question of whether an individual SHOULD do it (see question #6).

Find out for yourself by going to the Internal Revenue Service’s website www.IRS.gov. Request 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.

6) Should Everyone Do This? How do I Know it is Right for Me?

Ah, the $64,000 question.  Only you can answer this $64,000 questions.  Self-directed plans are not for everyone and should not be “sold” that way by custodian, administrators or facilitators.  However, for someone who wants the freedom and flexibility to invest in both “traditional” and “non-traditional” assets from the the convenience of one account….self-direction may be for them.

7) Are There Certain Investments Disallowed?

Of course. As previously mentioned, IRS Code does exclude 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.

The biggest concern at times is for the Manager (you) of the IRA self-directed account to REMEMBER that any and every transaction that the SD IRA engages in is for the exclusive benefit of the retirement plan. An individual cannot “self-deal”. 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.

8) What Are Prohibited Transactions?

Prohibited transactions as noted by IRC 4975 (c) (1), identifes 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.

9) Who Is a Disqualified Individual?

As it related to IRC, the following would constitute disqualified individuals for entering into any investment or arrangment with, 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; and,

– Anyone providing services to the IRA such as a trustee or custodian.

10) What are the Differences in Fees Between Companies?

Typically, one will do extensive research online to find significant differences in fees amongst custodians, administrators and facilitators.  Basically, what it boils down to is whether you wish to pay on-going annual fees (custodians, administrators) and, typically, NOT control your IRA or 401K retirement checkbook, OR pay a usually larger, one-time fee where your IRA or 401K is established with little to no on-going, annual fees.