Should You Open A Self Directed IRA Account?

Most modern day companies cannot provide the traditional pension plan most of our grand parents knew.  Sure, a few huge corporations still have legacy pension plans in effect, but it’s only a matter of time before even they are replaced with something a bit less costly. Partly for this reason, congress passed the Employee Retirement Income Security Act (ERISA) and the Individual Retirement Account (IRA) was born.  Eventually, the IRA spawned several variations including the Roth IRA, simple IRA, SEP IRA, and several others.  Traditionally, IRA’s have been offered through mainstream brokerages and banks that likewise limited the universe of available investment options to the mainstream:  stocks, bonds, and perhaps commodities. And for the vast majority of investors that’s just fine; however, for some advanced investors a so-called self directed IRA account allows investors to hold a variety of alternative asset classes such as direct ownership in real estate, physical gold bullion, currency futures, timber land, etc.

Advantages And Disadvantages Of Self Directed IRA Accounts

What’s the advantage of holding non-traditional assets in an IRA, you may ask?  For starters, the potential for greater diversification and the resulting superior risk-adjusted returns.  However, there’s a catch:  complexity. You have to use a self directed IRA custodian to oversee the account, and this usually doesn’t come cheap.  Additionally, the IRS has tight rules on what investments are allowed even in these self-directed IRA accounts.  Granted, the non-allowed investment list can put a damper on things, but the ability to invest IRA funds directly in real estate or another alternative asset class is appealing to many investors.

After the IRS, self directed IRA custodians have the final say on whether an investment is allowable or not.  If a non-allowable investment is made, the owner of the IRA stands to be penalized and taxed by the IRS. In addition, it is important to know who is allowed to sell what to the IRA so as to maintain an arms-length relationship at all times. For example, the owner of the IRA cannot sell to the IRA property they already own.  The law is very clear about this and it would pay to research it on the IRS web site and not just take the word of the custodian.

One of the things to be aware of is the high self directed IRA fees charged by most custodians.  Since most self-directed IRA custodians don’t earn transaction fees like normal brokerages do with mutual funds, they tend to charge significant fees for starting and closing the account as will as on-going account maintenance fees.  Other things to look out for in hiring custodians are to make sure they are approved by the IRS. Length of time in the business will give some idea if they understand the IRS codes.  Know what they are licensed for, especially if real estate is being bought in other states beyond your local area.

Should you check into self directed IRA investing?  Probably not.  While there are always exceptions, most investors would be better off in professionally-managed index stock and bond mutual funds. But for those who want a little more control over their money, a self-directed IRA may be worth a look.