Top 10 Questions For Self-Directed IRAs
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With all the questions related to self-directed IRAs...with some of them being answered here...more people who "fit the box" should be seriously considering a self-directed 401(k) rather than a self-directed IRA.
As mentioned in a previous blog, if an individual enters into a prohibited transaction within their IRA , the plan as nationally-recognized tax expert, Tim Berry, states, "blows up." In this parlance, it simply means that the individual will face full distribution on the first day of the calendar year which the prohibited transaction occurs, incur early distribution penalties (if they apply) and taxes. Yikes, that doesn't sound user-friendly to me.
But, let's not digress and.....now for the Top 10 list:
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 of this passage, 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 can only invest with a brokerage house...let alone in stocks, bonds and mutual funds. But this IS what 97% of the population believes. Banks and brokerage houses have a vested interest in having you invest in stocks, bonds and mutual funds - not real estate, businesses and other non-traditional investments.
As investors have become more disillusioned and frustrated with traditional investment choices, they have begun looking for alternatives. After the steep stock market decline, corporate scandals and corruption (e.g. Enron, ImClone, Worldcom) and many investors seeing their retirement accounts cut in half, they are ready to take control of their own investments. They often want more tangible investments such as Real Estate.
However, when they ask their current custodians / brokers, they are typically told that such investments are illegal, too complicated or that it can't be done. But those are ignorant and self-serving responses. Although those custodians / brokers may not allow it, it can be done. It is just likely you can't do it through your current custodian so they financially suffer if you make a move.
3) What Can My IRA Invest In?
Well, the real question should be what CAN'T my IRA invest in? Now, that being said, there are some very strict IRS regulations that must be followed, but 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:
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 is ERISA?
ERISA stands for the Employee Retirement Income Security Act. It more or less passed along the responsibility of an employee's retirement plan from the employer (company sponsored pension) to the employee. As a result of this act, the IRS only excludes what can be invested in. These two prohibited investments are: life insurance contracts and collectibles.
5) 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
6) How Do I KNow This is Legal?
Well, first of all, be prepared to be told by many accountants and CPAs (and possibly yours) that this is not legal or is very dangerous to do. Neither is true. First of all, as mentioned before, this is legal as a result of the ERISA Security Act passed over 30 years ago. It is more of a question of whether an individual SHOULD do it (see question #7).
Find out for yourself by going to the Internal Revenue Service's website http://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.
7) Should Everyone Do This? How do I Know it is Right for Me?
Of course you know the answer to this question is NO. Not everyone should do this and not everyone will. It really depends on a person's interest level to self-direct. Some folks would rather bury their heads in the sand and just hope that everything turns out okay for retirement. Others have done well with the brokerage accounts and have not diversified into real estate. However, the best aspect of a truly self-directed plan is that you can invest in non-traditional assets (e.g., real estate) and STILL invest in stocks, bonds and mutual funds.
8) 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.
9) What Are Prohibited Transactions?
Prohibited transactions as noted by IRC 4975 (c) (1), identifies 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.
10) 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.
Please note that too many individuals are playing games with the disqualification provision of an IRA holder who has 50% or greater interest in an investment. A word to the wise, do not play games with this provision by placing the IRA holder as a 47%, 48% interest in the endeavor. This is dangerous grounds to walk on for reasons to be examined later...but caution if you are advised to do this.
By: John R Park
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How to Fund a Self Directed IRA
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The maximum yearly contribution to self directed IRA accounts is the same as that of a standard account. You must remember when funding a self directed IRA that in order to qualify for tax deductions, you have to follow certain rules.
There are certain transactions that could jeopardize the tax-deferred or tax exempt status of the account. The more you know about these rules, the better.
The first contribution that is typically made to a self directed IRA account is in the form of a "rollover". There is no yearly maximum for funding a self directed IRA in this manner. You can rollover as much as you like.
There may however be fees charged by the initial trustee and the trustee for the self-directed account. Consider the fees first, in order to make an intelligent decision and avoid a costly mistake.
Most people start out with a traditional IRA or 401K, before they decide that their investment choices are less limited with a self-directed approach. Real estate, for example, is becoming an increasingly popular investment option. But, deeds cannot be held in the more traditional accounts.
Once you decide to open a self directed account, you need to look at the difference between making a contribution to self directed IRA and the traditional IRA. There is, as I said, very little difference. But, it may be that your traditional contributions were automatically deducted from your paycheck.
Funding a self directed IRA in this manner may be accomplished through direct deposit, but typically employers will not become involved in the process. So, you may have to do a little extra work.
You should remember that contribution to self directed IRA accounts must be cash or cash equivalents. You can not transfer stocks or property. Everything must be liquidated and then transferred. You can always repurchase the stock if you want, but consider the fees involved, before you make the decision.
You also have to consider whether or not you will take a loss by liquidating at this time. If the stock value has gone up, then you will make a profit, but repurchasing the stock could eat into those profits.
Those are just some of the things to consider about funding a self directed IRA. Some people have questions about how to purchase real estate using the account.
The best choice is to find a "cash deal". When you make the initial rollover contribution to self directed IRA funds, consider looking for a property that can be purchased outright, while there is plenty of "un-invested cash" in the account. You can either look for a property to resell at a profit after making improvements or one that will return rental income to the account.
If there is inadequate cash funding a self directed IRA can "borrow" from a bank. But, remember that financing causes profits to be taxed under the "Unrelated Business Income Tax" regulations.
There's a lot more to learn as you continue investing within a self-directed account, but the profit potential is much greater. So, after you do some comparative shopping, go ahead and make that first contribution to self directed IRA and see how fast you can grow your retirement fund.
By: Ronald D. Frommert
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Making Self Directed IRA Real Estate Investments
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If you have a self directed IRA real estate is one option that you should have for investments. The problem is that most custodians do not offer their clients the real estate option. In a truly self directed IRA, you would think that you could invest in whatever you want, but that is not always the case. The key is finding the right custodian.
In order to meet IRS and other government requirements, you must have an account trustee or custodian. This person is responsible for filing the appropriate paperwork and making transactions, among other things.
In a traditional IRA, the custodian makes investments, with your approval. In a truly self directed IRA, the custodian performs the transactions, as directed by you. The only consideration should be whether or not the transaction fits into the parameters outlined by the laws that govern the IRA.
Self directed IRA real estate investments must fall within those parameters, just like any other type of investment. Some custodians feel that there is a "gray" area in the law when it comes to real estate, but it's really pretty simple.
You cannot use your IRA to purchase real estate for your own personal use and the property cannot be used by your family members. Purchases must be for investment purposes only.
Any funds required for maintenance or improvement of the property must be made with IRA, not personal funds. By the same token, self directed IRA real estate investment profits must be returned to the IRA. Otherwise, the profits would be subject to capital gains and/or income taxes.
In the truly self directed IRA, you can buy property, build, repair, remodel, resell, rent out...just about anything that you can think of. A knowledgeable custodian helps to insure that your transactions are allowed by law.
Equity Trust is a good choice for self directed IRA real estate investing. Each custodian is familiar with the dos and don'ts. One of the "don'ts" has to do with advice.
In a truly self directed IRA, the custodian is not allowed to suggest or persuade you to make this or that investment. That kind of advice could be construed as self-dealing, which means making transactions with IRA funds in order to benefit the broker or brokerage.
If you are unfamiliar with real estate investing, you may need some help on that front. They say that real estate is always a good investment, but not all real estate deals are profitable. If you have a good eye, you can grow your retirement funds quickly. If not, well, you could be stuck with swamp land.
Luckily, there are experienced investors that are willing to advice you about those self directed IRA real estate investments. They can help you find the deals that are most likely to be profitable and avoid the hassles and the headaches. With a little help, after just a few deals, your IRA may be growing faster than you ever dreamed possible.
By: Adam D. King
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Self Directed IRA Investments – What You Should Know About IRA Permitted Investments
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Ever wondered about self directed IRA Investments? I'm sure you've probably heard that they can bring returns far out pacing the standard custodian directed IRA accounts. But maybe you've been told that the rules governing the IRA permitted investments are just to difficult to understand and navigate. Or that they're only for the sophisticated investor.
The truth is that self directed IRA Investments can be used by anyone affectively if they follow a few simple actions.
The first point here is that your IRA must be setup with a knowledgeable self directed IRA custodian. These are the individuals that oversee your account and make sure that all the paperwork is filled out correctly,and that your transactions are legal and organized.
Self directed IRA investments can be a great help in maximizing your gains and diversifying your portfolio, because most IRA custodians only lead you to invest in things they get commissions on and that they are comfortable with. Unfortunately these areas of their expertise and comfort may not be the best investment for your highest and best return. To get the best possible returns, remember the point of your IRA account is for your comfort after retirement not so your custodian is comfortable right now.
The comfort that you are concerned with your custodian having is the kind that comes with experience in overseeing transactions in the broad areas of investment vehicles that the government allows for self directed IRAs and the rules that govern these accounts.
So you must look for a custodian that allows self directed IRA investments in a broad range of the IRA permitted investments and is very knowledgeable about the rules.
There's a problem here though because according to one study conducted by Forbes 90% of IRA account custodians don't know all of the IRA permitted investments or how they're supposed to be used. This means that there are very few truly capable custodians out there regardless of what firm they maybe affiliated with or how much they charge.
And of course knowing what the IRA permitted Investments are is the key we are after.
It may surprise you to find out just how many types of investment vehicles are allowed. In fact self directed IRA Investments nearly mirror main stream investing options with only a few exceptions.
The IRS won't allow investments in collectibles or life insurance.
But really the governments main concern is that it doesn't want to see any type of self dealing. That is they don't want you to benefit from a transaction with your IRA. The IRS wants your only benefit to be the tax advantaged return that your IRA gets. So for instance, you are not allowed to sell anything to the IRA, if you did you would be getting double benefits in the form of the tax advantages of the IRA and the personal profits from the sell to the IRA.
Nor would you be allowed to live in a home or apartment owed by your IRA. It's important to stay away from this type of double dipping.
This ban applies not only to you but to anyone closely related to you in your business and family life. Both you and the people in this group are considered disqualified persons.
Aside from those transactions your options can include many things like derivatives, notes, venture capital investments, futures, Real Estate and more.
Real Estate for example is one of the little known permitted IRA investments that is gaining in popularity because of the incredible returns possible by investing in property. You will definitely want to make sure your custodian is knowledgeable and experienced in administering investments in this area.
Now do yourself a favor and take advantage of self directed IRA investments with an administrator that really knows the rules on IRA permitted investments.
By: Will Pressley
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Understanding Funding a Self Directed IRA
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Making a contribution to self directed IRA accounts is relatively simple, as long as you follow a few rules. Funding a self directed IRA account can be accomplished in one of two ways.
The first contribution to such an account is usually a rollover, transfer or conversion from another retirement account, and occurs when the account is first opened. Most people start with the traditional IRA or 401K and then as they become better educated, they learn they can make investments on their own. By doing so, they open up numerous investment options that do not fall within the norm.
As you continue funding a self directed retirement account, you can only use cash or cash equivalents. Property and stocks can be purchased and held within the account, but the holdings cannot simply be transferred.
If you have an existing account and you want to open a self-directed account, the holdings in the first account must be converted to cash and then the "cash" can be transferred into the new IRA. Though there is a maximum contribution to self directed IRA accounts that is considered tax deferred, there is no maximum on roll-overs.
When funding an IRA like this, you should be aware of the maximum cash contributions for that year. For example, in 2006 and 2007, you could contribute 100% of your earned income or $4,000, whichever was less, if you were under the age of 50. The maximums generally increase to correspond to inflation.
Individuals aged 50 and over who are funding a self directed IRA can contribute more under the "catch up" rules. These individuals are closer to retirement, and are therefore allowed to contribute more to their IRA on a yearly basis.
In order to be tax-deductible, there is a maximum contribution to a self directed IRA, traditional or Roth combined. If for example, you have already contributed $2,500 into a traditional IRA, your remaining eligible contribution to your self-directed account will be $1,500, assuming the maximum for that year is $4,000.
If a contribution to your account is determined to be a prohibited transaction, the account will lose its beneficial tax treatment. For instance, you cannot "loan" money to the account to cover costs of maintaining a rental property or other holding. By the same token, you cannot "borrow" from your retirement savings.
So, you see, funding an IRA that you direct is pretty much the same as funding any other type of retirement account. You simply need to find a company that can properly manage your new IRA and has the experience and expertise to offer the real estate investment option.
IRA custodians may not offer all of the investment choices. Many individual retirement account custodians do not conduct real estate transactions. That's one of the things to consider when you are looking for a trustee.
It's a good idea to do some comparative shopping before you begin making a contribution to self directed IRA accounts, because the experience and fees that these companies charge, may vary greatly!
By: Paul Clinton
About the Author:
If you don't include self directed IRA's as part of your portfolio, you're missing out on a huge opportunity to grow your investment, even in a down economy.
Do yourself a favor and check out Paul's site at: http://www.Turn-Key-RealEstate.com
How to Find a Self Directed IRA Custodian
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Here's a really simple way to have more control over your investments and increase your returns: find a self directed IRA custodian. Many investors are unsure about how to go about self directing their accounts because of all the misinformation out there. People think self-directing their account requires a lot of extra work on their part when the reality is that the higher returns can be had with barely any extra effort.
Banks discourage their customers from having self directed IRA investments because they lose money that way. When banks appoint investment advisers to control your account, they can choose investment venues that benefit them, keep most of the profits, and give you only a portion. You will only know what is going on in your account when the quarterly reports come in.
On the other hand, when you work with a company that helps you manage your account by providing you with a self directed IRA account custodian, the custodian listens to your wants and acts accordingly. You aren't expected to be solely responsible for every transaction in your account but you will also be ultimately in control of what happens since your custodian works in your best interests.
Self directed IRA investments offer you a much wider array of investment options such as real estate, brokerages, franchises, partnerships, private equity, and more. This means you have more opportunities to increase your returns. The best investment venue is real estate because it is stable, lucrative, and largely untapped.
In order to take advantage of real estate investment, you need to find a company that is set up to help you self-direct your account and invest in real estate. Look for a company that can provide you with a self directed IRA account custodian with the inside knowledge, connection, and experience necessary in order to invest in real estate and make bigger returns.
It is possible to dramatically increase your returns with self directed IRA investments in real estate. Look for a company that can guarantee to at least double your returns or pay the difference. Better yet, look for a company that can guarantee to do so in the name of socially responsible investing. There are companies out there that will use a portion of their profits to buy neglected homes in urban areas, renovate them, and sell them to working-class families. Then they pass the profits on to the investors.
Now get out there and start looking for an experienced, knowledgeable company that can provide you with a self directed IRA account custodian to help you reach your financial goals. During an economic slump, investing in stocks is risky and not very lucrative. On the other hand, rolling over to a self-directed IRA and investing in real estate can maximize your returns and lead you on the path to a comfortable, financially secure retirement.
By: Ed Gosselin
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Self Directed IRAs and Passive Income
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There are many ways to make self directed IRA passive income. Truthfully, all of the investments you make from within your retirement account earn passive income, because of compounding interest and the tax-deferred or tax-free status of the account.
Look at this example. If at age 25, you began to put $4000 per year into a savings account earning 8% compounding interest, by age 55, you should have $449,133. But, you wouldn't, because the interest earned in a standard savings account is taxable.
So, in actuality you would only have $286,752, assuming a 31% tax rate each year. That's 43% less, a difference of $162,381. That amounts to over $5400 per year. In other words, just by opening an approved tax sheltered retirement account, you begin to earn more money every year, passively.
Some self directed IRA passive income is directly related to the amount of money that you make today. Depending on your income level and the type of account that you open, you could be eligible for as much as a $51,000 tax deduction, each and every year.
You have to realize that tax savings is the same thing as money earned. That's particularly relevant when you look at some less traditional investments that you can make from within the account.
Suppose you find a two bedroom "fixer-upper" that you can purchase for $24,000. Investing an additional $7500 allows you to rent the house out for $10,000 per year. You decide to have a third bedroom added to the home, to increase the property value to $135,000 and your tenant decides to buy it. After all is said and done, your net profit is $93,500.
But, since you used personal funds, instead of using your retirement fund, to conduct the transaction, you have to pay capital gains taxes and additional taxes on the rents received. That can add up to 23% of the total profits or $21,505.
This is an actual example of how an experienced real estate investor earns self directed IRA passive income. He did none of the work, himself. All of the expenses were paid from within the account. All of the profits returned to it. A contractor was hired to do the work. The only thing that he did was take advantage of a good deal when he saw it.
On top of his profits from the deal, the interest earned, just on the amount that he would have paid in taxes, will amount to another $25,000 in ten years. The $93,500 would more than double in ten years.
If this kind of self directed IRA passive income is made within a tax-sheltered Roth account, no taxes are ever paid on any of those earning. Roth contributions are taxed as regular income, but qualified distributions are not taxed.
With just a couple of profitable real estate investments, your self directed IRA passive income will grow faster than you ever dreamed possible. You just need to learn how to spot a good deal or get some good advice from an experienced investor.
By: Mark Nenneman
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Recent Posts
- Top 10 Questions For Self-Directed IRAs
- How to Fund a Self Directed IRA
- Making Self Directed IRA Real Estate Investments
- Self Directed IRA Investments – What You Should Know About IRA Permitted Investments
- Understanding Funding a Self Directed IRA
- How to Find a Self Directed IRA Custodian
- Self Directed IRAs and Passive Income
- Creating Self Directed IRA Passive Income
- Tips on Setting Up a Self Directed IRA
- Where To Invest Self Directed IRA!
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