Self-Directed IRA: A Vehicle for Increased Diversification
Posted by Richard on December 18, 2013
Looking for a way to invest in alternative investments not normally issued through a bank or brokerage, such as real estate or a business? Consider a self-directed IRA. A self-directed IRA can be an effective way to add diversification to your retirement portfolio. But it’s a strategy that takes careful planning and due diligence.
Because they can hold such a wide array of asset types, self-directed IRAs tend to appeal to investors looking to diversify their retirement holdings and reduce correlation with stocks and bonds.1 The self-directed IRA is often used to complement, rather than replace, a more traditional IRA.
Types of Allowable Investments
Self-directed IRAs can be invested in just about anything with a few exceptions. Among the types of investments allowed include:
• Real estate (however, not in a property the account holder or his/her family may use).
• Secured and unsecured notes.
• Limited partnerships.
• Judgments and structured settlements.
• Precious metals, including gold, platinum, silver, and palladium.
• “Green” investments such as solar energy, biofuel, wind energy, and water power.
• Tax liens and deeds.
Among the types of investments that are not allowed are:
• Vacation homes or other properties to be used by the account holder.
• Collectibles, including art work, gems, stamps, and antiques.
* Life insurance.
• Stock of an S corporation (an entity that elects to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes).
Understanding the Rules
The IRS has established rules to maintain that everything the IRA engages in is for the exclusive benefit of the retirement plan. One of the most prevalent is that regarding a “self dealing” transaction, specifically regulating that IRA money may not be used to invest in a property that the account holder or “disqualified” person may use. Disqualified persons include your spouse, your parents, and your children and grandchildren as well as your investment advisor, fiduciary, and custodian.
Additionally, if the self-directed IRA is invested in a business wholly owned by the account holder, that account holder is not allowed to draw a salary from the business. And, while self-directed IRA funds can be used to start a business, they cannot be used to purchase equity in an existing business that is already 50% or more owned by you and/or other direct family members.
The Risks of a Self-Directed IRA
There are a number of risks associated with making investments in a self-directed IRA, including the following.
• Lack of transparency. Most of the investments associated with a self-directed IRA are unregulated and could be illiquid, making them hard to value and hard to sell. Verify the information in your account statements. Self-directed IRA custodians often list the value of the investment as the original purchase price, the original purchase price plus returns reported by the promoter, or a price provided by the promoter. None of these valuations necessarily reflects the price at which the investment could be sold, if at all.
• Potential investments can be fraudulent. Since many of these securities are unregulated, financial and other information necessary to make a prudent investment decision may not be readily available. This lack of available information for alternative investments makes them a popular tool for fraud promoters, who can deceive investors into believing that their investments are legitimate or protected against losses.
As with any alternative investment, be sure to weigh the pros and cons before making your decision. Contact your financial professional to help you determine if a self-directed IRA is right for you.
1Diversification does not assure a profit or protect against a loss.
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