Self-Directed IRA Frequently Asked Questions
What exactly is a Self Directed IRA?
Since the passage of the Employee Retirement Income Security Act (ERISA) in 1974 you have been allowed to invest in almost any type of asset through your IRA. Yet still today most IRA custodians (such as brokerage firms and mutual fund companies) limit your investment choices to publicly traded stocks, bonds and mutual funds. A truly Self Directed IRA (or “SDIRA”) allows you to direct your capital toward any IRS permitted investment you choose, including real estate, mortgages and trust deeds, pre-developed land, private placements, tax liens, franchises, and the list goes on. The IRA account itself must be held by a custodian or trustee on the IRA owner’s behalf, but the investment options extend well beyond the highly volatile stock and bond markets.
What can I invest in with my SDIRA?
It’s actually easier to define what you can not invest in since the IRS rules only exclude a handful of asset types. In general you are not allowed to invest in life insurance and collectibles (e. g., art, rugs, antiques, jewelry, coins, etc.) and S-corporations. Beyond this your investment options are virtually unlimited. There are industry stories of people investing in everything from sports franchises to thoroughbred horses, but most SDIRA investors focus on real estate and private companies.
While the “what” is expansive, the “who” and “how” are more particular. If the investments are not structured properly you risk significant penalties to your IRA. For this reason it is critical to work with a qualified advisor and custodian. For example, there are strict restrictions on dealings with any “disqualified persons.” A disqualified person is generally defined as:
- Yourself – you are not allowed to derive any personal benefit from your IRA’s investments. (In other words, your IRA can not invest in a property currently owned by you, nor can you use a property owned by your IRA. It must be purely for investment purposes.)
- The IRA owner’s spouse, ancestor, lineal descendant, or spouse of a lineal descendant. (Interestingly, siblings are not considered disqualified persons.)
- The fiduciary of the IRA, such as a trustee or custodian.
- An entity in which you own at least a 50% interest, or such interest is owned by any combination of disqualified persons.
- A 10% owner, officer, or director or highly compensated employee of such an entity.
Why haven’t I heard about SDIRAs before?
Most brokerage and mutual fund companies are set up to profit from the high volume of transactions in the publicly traded markets, and are not set up to facilitate self directed investments such as real estate. Since they are not able to facilitate these transactions they have no incentive to inform their clients of their full range of investment options. Some brokers (and accountants and lawyers for that matter) may even tell you it’s illegal to invest your IRA in real estate. The IRS, however, would disagree as section 408 of the Internal Revenue Code allows for IRA investments in all but a handful of excluded asset types.
Why should I make alternative assets (e.g., real estate) part of my retirement planning?
Real estate should not be considered an “alternative asset,” but a fundamental part of any well diversified retirement portfolio. Of the trillions of dollars of wealth in the United States only about 30% resides in the public stock markets. The other 70% encompasses mostly real estate and private companies. More millionaires made their fortunes in real estate than from any other source. Why would you bet your financial security entirely on the most volatile one-third of the market? For a retirement portfolio real estate offers the best potential for long-term asset appreciation.
In addition to diversifying your source of wealth, real estate provides an excellent hedge against the volatile swings of the stock market. Real estate is often called a “non-correlated” asset, meaning changes in value are not driven by movements in stocks. In fact, real estate frequently goes up when the stock market is dropping. The complex and time consuming nature of real estate transactions also prevents the rapid declines often seen in the stock market when investor sentiment sours.
Can anybody set up a Self Directed IRA?
For the most part, yes. Some traditional pension plans and company-sponsored defined contribution plans may not be easily converted but simpleIRAs, rollover IRAs, SEP IRAs, Roths, and the new Solo 401k can all easily be converted, whole or in part, to a self directed IRA.
How do I get started?
If done correctly the process should be simple and painless. The process should always begin with a thorough assessment of your current position, investment goals and risk profile. An appropriate custodian or administrator must be chosen, accounts established and funds transferred. Fund transfers are easy but must be done correctly to avoid unexpected tax consequences. Shepherd will guide you through each of these steps. Contact us today for a free self directed IRA evaluation.
