Self Directed IRA FAQ - Frequently Asked Questions
Self Directed IRAs, 401(k)s and other qualified plans allow the account owner to have a lot of flexibility of choices of what they can invest in. However with these choices comes a set of rules that needs to be followed to ensure the IRA remains compliant. We realize that reading through the Internal Revenue Code, ERISA rules, and other related areas is not high on the priority list for most investors. We have created this Self Directed IRA FAQ for investors, to help answer a lot of their questions.
If you do not see your question listed here, please contact us for more information.
What is a Self-Directed IRA?
A Self-Directed IRA is an Individual Retirement Account (IRA) that the government has created which helps investors to save for use in retirement. There are a few types of self-directed IRA: Traditional IRA, Roth IRA, SEP IRA, and SIMPLE IRA. Each of these retirement accounts provides some tax benefit to the account holder while the funds are held in the account.
The account owner is allowed to invest their funds into any investment permitted by the Internal Revenue Code. (See What Can I Invest in? Permitted Investments)
I Have never heard of Self-Directed IRAs before. Are they new?
The Individual retirement Account (IRA) was created in 1974. The purpose was to create a way for Americans to save for retirement and give them some incentive to do so by providing tax benefits for the money held in the IRA.
The rules pertaining to Individual Retirement Accounts have only changed slightly over the years. The ability to invest outside the stock market has always been allowed.
The reason you may not have heard of self-directed IRAs before is that the retirement industry is mostly dominated by transaction-based companies that sell a narrow selection of investment products. They specialize in these products and have positioned traditional investments as a suitable investment strategy for many people. Since they do not provide many of the alternative investment options available to IRA account holders, many investors are not aware that these options exist.
You can review IRS Pub 590 for more information, or speak with your attorney, tax or financial advisor for more information.
IRA vs Self-Directed IRA (What's the Difference?)
An Individual Retirement Account or IRA, is an account that allows you to save money for retirement with tax benefits. You might be surprised to learn that both IRAs and "self directed" IRAs are identical. There the terms are used differently, but they essentially refer to the same thing. All IRAs are self-directed, hence the term, Individual Retirement Account. This is compared to 401(k) accounts which are not "self-directed", since the employer determines the plan investment options.
You should understand that despite the terms meaning the same thing, people use them to refer to different things. In most cases, the term "IRA" is used to describe a retirement account that is held at a broker dealer and used to invest in traditional investments such as stocks, bonds, and mutual funds.
When the term "self directed IRA" is used, it is typically referencing an IRA account held at a custodian that allows the IRA account holder to invest in alternative investments such as real estate, horses, gold, private company stock, tax liens, and more. While the terms mean the same thing, common usage refers to different types of investing.
While both terms mean the same thing, essentially the difference boils down to the custodian. The Internal Revenue Code requires that an IRA be held at a qualified custodian. It is up to the qualified custodian to determine what investments they will allow to be held at their firm. So even though it is permitted that investors can invest in horses or mutual funds, it does not mean that the custodian will allow them at their firm.
The way to solve this problem is to look for a qualified custodian that can provide custody services for the investment you are considering. If you are looking to find a qualified custodian that can provide custody for alternative investments, you should read our Special Report, Quick Start Guide to Self-Directed IRAs, for more information.
What can I invest in with my self-directed IRA?
The Internal Revenue Code (IRC) does not state what investments are allowed to be held in your self directed IRA. Your choices are virtually limitless. The IRC does state however what is prohibited from being held in a self-directed IRA.
The following assets are prohibited from being held:
- Life Insurance
- Collectibles (such as: stamps, coins, gems, metals, alcoholic beverages, antiques, rugs, or artwork)
Withstanding these few exceptions, virtually everything else is permitted. Here are some examples of alternative investments that could be considered for your self-directed IRA:
- Real estate
- Precious metals
- Tax Liens
- Trust deeds
- International real estate
- Water rights
- Raw Land
- Private company stock
- Secured or unsecured notes
- Structured settlements
- And more...
If you are looking for more alternative investment ideas for your investment portfolio, get our Free Report, The Big List of Alternative Investments - 75 investments that can help you invest outside the stock market. Click on the button below to get your free report.
How can I fund my self-directed IRA account?
Self Directed IRAs can be funded one of two ways: Contributions or Rollovers
Contributions: Each year you are allowed to contribute to your self directed IRA up to the annual limit. In 2016 the limits for Traditional and Roth IRAs are $5,500 plus a $1,000 catch up provision for people age 50+. Find out if you qualify to contribute this year.
Rollovers: If you have a 401(k), 403(b), or other qualified plan, this can be rolled into a self-directed IRA once you leave your employment. this type of rollover allows you to consolidate all your prior group plans into a self directed IRA so that you can control how you want to invest your retirement funds.
Which self directed IRA custodian do you recommend working with?
We do not recommend one custodian or administrator over another one. I'll explain why. You might assume that we could just give you a one-size-fits-all answer, but it is not that simple. This is one of the most common questions we are asked by our new clients. It is so common that we have created a resource to help you get the answer to this question (see below). Choosing a self-directed IRA custodian or administrator is challenging, and there is no singular "best" company to work with. Each one has their pros and cons. If you are having trouble choosing, here is a list of questions we suggest you ask each custodian or administrator you are considering. Your specific investment needs should dictate which company you choose.
You are most likely thinking, which companies does Innovative Advisory Group recommend? Also a common question we hear frequently.
We have experience working with a number of these companies, and while we have our opinions each of them, our opinions may not be relevant to your investing situation. To address this need, we created this self directed IRA resource. Our Ultimate Insider's Guide to Self Directed IRA Custodians and Administrators was created to help you find the best custodian or administrator for your investing needs. There are over 47 companies that specialize in this custody and administration. This guide will save you a lot of time doing research and unnecessary aggravation. It will simplify your investing process by giving you the tools you need to find the best fit self directed IRA custodian or administrator
How can I find a self directed IRA custodian with good service and low fees?
Each self directed IRA custodian and administrator has their own fee schedule. Many of these companies have similar fee schedules, but none of them are the same. Some of them price their fees based on an asset-based fee model and others price their fees on a transaction-based, or flat-fee model. Which one is the lowest will depend on your investment strategy.
If you want to compare fees of different custodians and administrators, you should use our Ultimate Insider's guide to Self Directed IRA Custodians and Administrators. This guide will help you estimate the fees you would pay at one or more of the self-directed IRA custodians and administrators.
What makes a self-directed IRA custodian different from the custodian that holds my stocks?
Qualified custodians are allowed to hold virtually any asset inside an Individual Retirement Account (IRA) with certain exceptions. While the Internal Revenue Code (IRC) only has a few limitations, each custodian is also allowed to limit what they hold in an IRA for clients.
The custodian that holds your stocks, bonds, and mutual funds will most likely not want to hold your alternative investments. They would rather specialize in more traditional investments. The custodian that is willing to hold your real estate investment probably will not want to hold your traditional investments. You can read more about choosing a self-directed IRA custodian here for more detail.
What retirement accounts are allowed to be rolled or transferred into my self-directed IRA?
It is important to note that only certain accounts may be transferred or rolled from one qualified account into another. This is a list of accounts that can be rolled into a self directed IRA:
- Traditional IRA
- Rollover IRA
- SEP IRA
- SIMPLE IRA
- Profit Sharing Plans
- Defined Benefit Plans
- Money Purchase Plans
Do I need a qualified custodian to hold my self-directed IRA assets?
Yes. In accordance with the Internal Revenue Code(IRC) Section 408. it is required that every qualified plan have a qualified custodian to provide custody for those plan assets. Companies that may qualify as qualified custodian are: non-depository banks, depository banks, or trust companies. If you are looking for a qualified custodian for your self-directed IRA, we have a list that you can review for more details. See: List of Self-Directed IRA Custodians and Administrators.
What is a prohibited transaction?
A Prohibited Transaction, according to IRS Pub 590, is improper use of a self directed IRA by a disqualified person. For more information about Prohibited Transactions.
Some examples of a prohibited transaction:
- Your IRA owns a rental property and it is rented out to your mother.
- You borrow money from your self directed IRA.
- Your self directed IRA buys a piece of real estate from you which you currently own.
- Using your IRA as collateral on a loan
- Getting personal benefit from an investment held in your self directed IRA
What is a disqualified person?
A Disqualified Person, according to IRS, is a person or entity who is disqualified from getting a benefit from or providing benefit to the self directed IRA. For more information about Disqualified Persons.
When am I allowed to withdraw money from my self-directed IRA?
According to the Internal Revenue Code (IRC), People with self-directed IRAs can start withdrawing funds penalty-free at 59.5 years old. At age 70.5 years old they are required to take Required Minimum Distributions (RMD) (except for Roth IRAs).
There are some exceptions for early withdrawals without paying a penalty such as:
- IRC Section 72(t) or Substantially Equal Periodic Payments (SEPP)
- First-time home purchase
- Qualified educational expense for yourself or family member
- Health insurance premiums if you are unemployed
- Certain medical expenses
- Qualified Domestic Relations Order (QDRO)
- Due to being called to military active duty
Can my self-directed IRA invest with other investors or partners?
Yes. As long as the other people are not disqualified persons, your self-directed IRA can invest alongside with anyone else.
Can I get a mortgage on real estate held in my self-directed IRA account?
Yes. You are allowed to have a mortgage on real estate held in your self-directed IRA. However, it would have to be a non-recourse loan that you as the owner of the IRA are not personally liable for. You should also consider that the having a loan on an asset in your self directed IRA might cause some tax consequences.. You should consult your tax or financial advisor to see if this applies to you.
Can I use my self-directed IRA as collateral on a loan?
Using your Self-Directed IRA as collateral on a loan creates a prohibited transaction. This is not permitted and would create adverse tax consequences.
Other options to consider:
- Your IRA can loan money to other people that are not considered disqualified persons.
- You can take a loan from your 401k account (assuming your 401k plan has loan provisions).
- If your self-directed IRA is investing in an asset such as real estate, that piece of real estate could have a mortgage. This is allowed however this could trigger Unrelated Business Income Tax (UBIT). It would have to be a non-recourse loan and you as the owner of the IRA could not be personally liable for the mortgage.
Am I required to get annual valuations on assets held in my self-directed IRA account?
Yes. One of the requirements for self-directed IRAs is that at least one-time per year, each asset held in your IRA account must have Fair-Market Value (FMV) placed on it. The IRS has provided some guidelines on what is required, but their interpretation is changing, you should consult a financial advisor, attorney or CPA to provide you with advice in this matter.
Someone have told me I should have a LLC for my self-directed IRA investments. Is this necessary?
No it is not necessary. Your self-directed IRA can be used to invest in a variety of investments inside and outside the publicly-traded stock and bond markets. A few companies promote the idea that you should create a "checkbook" IRA or single-member LLC to hold your investments in your self directed IRA. While this is an option, it is not required. In many cases it may actually create additional problems for you as an investor.
If one of the companies promoting the idea of a "checkbook" IRA is also selling you the LLC, you should consider the validity of this advice. There are valid reasons for considering an LLC to own certain investments, but it is not a one-size-fits-all solution. If you are considering whether to use this solution for your investments, consider whether the person is qualified to provide financial advice or whether they are selling you a product that they happen to provide.
Where can I find more information about self-directed IRAs?
There are many rules and regulations pertaining to self-directed IRAs. While you can spend months trying to figure out all the rules as I did many years ago, why bother? We have done that for you by putting all the relevant rules, regulations, and court cases on one page as a reference guide.
We have created many self-directed IRA resources on our website for investors to learn what they need to know. Take some time to navigate our site and I'm sure you will find what you need.
How can I get advice about self-directed IRAs?
Most qualified custodians are not legally allowed to provide legal, tax, or investment advice. If you want advice from licensed professionals, you should consult an attorney, CPA or financial advisor who have a clear understanding of the rules pertaining to self directed IRAs. Many Attorneys, CPA and financial advisors have never heard of self directed IRAs and have little to no experience with how they work. I would suggest that you consider finding one that specializes or has experience with Self-Directed IRAs. We have created a complete list of licensed attorneys, accountants and financial advisors that can help you find the appropriate person to assist you. This an extensive list of professionals who understand this area of the tax code.
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Self Directed IRA Resources:
- Self Directed IRA Terminology
- Self Directed IRA Rules, Regulations and Resources
- The Ultimate List of Self Directed IRA Custodians and Administrators
- The Complete List of Advisors For Your Self Directed IRA Services
- 9 Common Self Directed IRA Mistakes
- 28 Questions to Ask Your Self Directed IRA Custodian or Administrator
- The $100 Million IRA