In: Root » Legal and finance » Investing
Would you ever consider relinquishing financial or management control of your company to someone you’ve never met or never even speak to? It sounds like an inconceivable and even ludicrous idea, yet we do it with our IRAs every day. As the annual deadline for IRA contributions rapidly approaches, it is an opportune time to consider a surprising and beneficial alternative to the traditional manner in which we have been taught to set up our IRAs. This alternative is referred to as a self-directed IRA. To understand the unique characteristics of a self-directed IRA, let us first examine the IRA offerings typically provided by brokerage firms such as Schwab, Fidelity, and a myriad of other similar trading institutions. Although these companies provide a wide variety of investment options for your IRA account, they are limited to the following investment types: mutual funds, individual stocks and bonds, certificates of deposit, and money market accounts for cash reserves along with a selection of proprietary mutual funds offered exclusively by the firm itself. Once you have set up and funded an IRA, it is true that you can choose to allocate your money among these offerings. However, since the mutual funds are managed by a fund manager, you as the investor, really have no voice in the strategy or management of each of your holdings. For this reason, these types of IRAs are not truly self-directed. Yet, millions of people are dependent upon this method and these services to build their retirement nest egg. Self-directed IRAs have been available since 1981, yet they are not widely known and are often misunderstood by those unfamiliar with this alternative investment solution. “Investors are usually surprised to learn they no longer have to settle for mediocre returns from big brokerage firms. They can take their hard earned retirement dollars and see the double-digit returns with self-directed IRAs.” says Jay Pearson, the IRA Coach® and renowned expert on self-directed IRAs. The power of self-direct IRAs lies in the investor’s ability to take active, direct control of them by finding and researching investment opportunities outside the realm of those offered by the aforementioned types of companies. These vehicles include real estate, real estate options, mobile homes, tax liens, promissory notes, equity positions in privately held companies and private placements for new business launches. Mr. Pearson further states, “People like the idea of investing in assets they understand, such as real estate and promissory notes. Very few people truly understand the stock market.” With a virtually limitless array of investment choices, you can now place your self-directed IRA money in a broader variety of investments that potentially offer greater returns than what mutual funds yield. All types of IRAs, both traditional and Roth, as well as qualified pension plans are eligible to become self-directed IRAs. In the self-directed model, an account is set up with a company that provides this service. This company becomes your custodian and is responsible for overseeing that account activities and transactions comply with federal guidelines. Once the account is open, your annual contribution can be deposited directly into it and balances from existing IRAs can be rolled over into it. Once the money is in the account, the fun begins! When you locate an investment that appeals to you, simply direct the custodian through instructions specified on a Buy/Sell Direction Letter to make the transaction on behalf of your self-directed IRA. The custodian will review and file the proper documentation and wire the funds. Your IRA is now the proud owner of either a piece of real estate, a promissory note or whatever you have chosen to purchase. It is also critical to understand and adhere to these limitations that govern self-directed IRAs. • Business with Yourself Self-directed IRA rules prohibit you from conducting business with yourself under any circumstances. This means that you cannot use self-direct IRA monies to buy or sell businesses or assets that you control or partly own. For example, if your self-directed IRA invests in a condominium, you cannot live or vacation in that condo. On the business side, it is forbidden for you to invest your own selfdirected IRA funds into your own business as a cash infusion or equity position. • Family Members It is also off limits to do business with immediate family members including your spouse, children or parents. You may, however, engage in transactions with siblings’ companies provided that they have documented legal control of the business. • Works of Art A self-directed IRA cannot purchase or sell precious gems, art, wine or other specified collectibles. A comprehensive list of prohibited goods is available from the IRS or from your self-directed IRA custodian. Be sure to obtain clear, written guidelines for clarifications of all restrictions to avoid penalties. Partnering with your IRA is an excellent strategy for extending your financial reach. For example, if an investment is attractive and meets your criteria but is too expensive for you to consider, you can partner with your self-directed IRA to make the purchase. Partnering means that you put in some of the money personally, and fund the balance through your self-directed IRA, so that you both own your respective percentage of the asset. When employing this strategy, all expenses and profits must be divided proportionally as dictated by the percentage of ownership retained by each partner. The partnering concept can also be applied with another individual. If, for instance, you have decided to purchase a piece of property, but don’t have enough money in your self-directed IRA to do so, your selfdirected IRA can purchase a portion of the property and the other party, using personal or self-directed IRA funds, can purchase the remainder. Again, all profits and expenses that originate from the IRA must go back into the IRA. Using self-directed IRAs is a creative way to gain control of your IRA and to leverage opportunities to fast-track results. With this control comes the responsibility of performing rigorous due diligence on potential investments to ensure alignment with your risk tolerance and financial objectives. Mr. Pearson encourages investors by saying, “Selfdirection requires some self-sacrifice – mostly of your time. However, the rewards can be incredible.” By Irene Eraklidis
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