Does the stock market make you nervous… or even totally turn you off?
Are you an expert in some kind of investing – maybe real estate or precious metals – and you’d like to use that skill to build a financial war chest for retirement?
If you answered “yes” to any of these, then a Self-Directed IRA could be a great fit for you.
What is a Self-Directed IRA?
A self-directed IRA is a tax-advantaged account that allows you to save for retirement, and to invest those savings in nearly any type of asset you want.
You’ve probably heard the name “IRA” before, but maybe without “self-directed” in front of it.
That kind of conventional IRA – which I call a “captive” IRA – usually only allows you to invest your IRA in stocks or mutual funds or CD's.
Self-directed IRA’s are different.
With a self-directed IRA, you can invest in anything the law allows. And here’s the great news:
The law places shockingly few limits on how your IRA money can be invested!
What Can You Buy in a Self-Directed IRA?
Repeat after me: There are SHOCKINGLY FEW limits on the types of assets that you can buy in a self-directed IRA.
In fact, there were originally only two limits: life insurance and collectibles. That was it.
Even now, there are really only two additional asset-class limitations:
You can only buy precious metals if they meet certain quality thresholds, and you shouldn’t buy corporations organized under the “S” tax election (“S-corporations”).
That’s about it.
That leaves an entire universe of potential investments for your self-directed IRA!
By far, the single most common asset type purchased in self-directed IRA’s is real estate. But that’s far from the only choice you have. You can also invest your IRA money in:
- Private Loans
- Precious Metals
- Private Companies
- Tax Lien Certificates
- Domain Names
- Accounts Receivables
- Hedge Funds
- Oil & Gas
- Notes (Private Debt)
- Vanity Telephone Numbers
- Heavy Equipment
- The Sky’s The Limit!
Why Are Some IRA's "Self-Directed" and Others Are Not?
There’s only one difference between a captive IRA that will limit you to stocks and bonds versus a self-directed IRA, with the nearly unlimited plethora of investment options it offers…
…That one thing is the custodian of your IRA.
The custodian is the company that holds the assets of your IRA. Think of your custodian as the “bank” that holds on to the money and assets owned by your IRA.
But the truth is that most custodians view IRA’s not as a way to maximize your investment choices, but to force you to invest your IRA funds into their financial products exclusively.
And that’s why I call those types of IRA’s “captive” rather than “self-directed”.
Am I Taking A Great Risk By Using a Self-Directed IRA?
You don’t fundamentally take more risk by using a self-directed IRA versus a captive IRA. But you absolutely have to accept greater responsibility with a self-directed IRA, and failure to wisely manage that responsibility can increase the risk to your retirement funds.
There are two reasons for that:
First, it's a lot easier to break the IRS rules if you use a Self-Directed IRA than otherwise, because you have much greater flexibility...
...and if you break those rules, you could be looking at a serious problem... maybe even a financial cataclysm.
Second, there’s a higher risk you’ll be targeted by hucksters looking to steal your money, since the breadth of investment flexibility is so great with this type of account.
Here’s what I mean: I know of one investor who made a lot of money by investing in dairy cattle. But I also imagine it would be easier to steal an investor’s money by offering dairy cattle investments than through conventional investments.
But let’s not kid ourselves: There’s plenty of large-scale fraud that’s damaged investors who have invested in conventional stocks. Have you ever heard of Enron? Or Lehman Brothers? Or Worldcom? Or Waste Management?
Each of those were multi-billion dollar frauds that happened in the conventional Wall Street world. In fact, the Enron scandal was bigger in size than the total value of all fully self-directed IRA’s combined.
There are many, many more examples of conventional public companies that were operated either fraudulently or so carelessly than investors suffered greatly for it.
I don’t believe that the risk is greater for self-directed IRA’s overall, but…
…The risk you face is that there are more kinds of fraud you could face, since captive IRA’s tend only to allow you to buy stocks or mutual funds, whereas self-directed IRA’s allow you to buy nearly anything.
Here’s the bottom line: Your burden of responsibility as a user of self-directed IRA’s absolutely increases versus using a captive IRA. Self-directed IRA’s are only for people who are responsible and wise, both legally and financially.
How Does The Process of Making Investments Work In a Self-Directed IRA?
That’s a great question, because it’s different than with captive IRA’s, where all you have to do is call your broker and enter an order.
With a self-directed IRA, investments are executed on behalf of your IRA by your custodian.
For example, if you want to buy real estate in your IRA, then technically it will be your custodian who purchases that real estate on behalf of your IRA.
You, personally, won’t be involved in the transaction. In fact, you can’t be involved in the transaction. That’s one of those rules that’s very important that you respect. (More about these rules in a bit.)
So if you find real estate you want to purchase in your IRA, what you’d do is get a purchase and sale agreement from the seller of the real estate, and send it to your custodian.
You’ll also have to fill out a form for your custodian called a “Direction of Investment” (or something similar). This gives the custodian the instructions they need to make the investment for you.
When the process is complete, your custodian will have sent money from your self-directed IRA to the owner of the real estate, and the owner of the real estate will have transferred ownership of the property to your IRA…
…and your custodian is responsible for facilitating the transaction for you.
What is a Self-Directed IRA Custodian?
When Congress created the IRA back in 1974, they decided that you and I weren't sufficiently competent to handle these accounts on our own. (Yes, I know it's a harsh viewpoint... but it's still true!)
So they decided that if you want to have an IRA, you'd need to go to a special type of financial company to set it up.
This type of company is called a "custodian". Custodians meet specific requirements established by the IRS.
To understand what a self-directed IRA custodian does, the easiest comparison is a stock brokerage like eTrade or Charles Schwab.
What do stock brokers - and IRA custodians - do?
- They execute transactions on behalf of their clients
- They keep some financial and accounting records for the account
- They report to the IRS about how the account holder is using the account.
That's the bottom line. Your IRA is required by law to have an IRS-approved custodian.
What is an IRA Administrator?
If you have an IRA of any type, you’ve got to have a custodian… the law requires it.
But some custodians don’t deal with the public directly. Instead, they just do the work of holding IRA accounts, but they don’t do any marketing or customer service themselves.
So if some custodians do no marketing, how do they find clients like you and me?
They partner with IRA administrators. IRA administrators are usually independent companies that serve as the marketing and customer service departments of custodians.
So while you’re evaluating IRA custodians, you’ll likely end up evaluating several IRA administrators, too, because sometimes the difference isn’t entirely obvious.
Some people try to make the case that you should never use an administrator, and you should only work directly with custodians who serve the public.
I don’t think that’s correct. So far, I’ve never encountered anyone who got better or worse service just because they chose a custodian over an administrator or vice versa.
At the end of the day, you will use an IRA custodian one way or the other. The law requires it…
…The only question is whether that custodian does their own marketing and customer service, or whether there’s an Administrator on the front end that handles that for them.
But remember this: If you do use an IRA administrator instead of using a custodian directly, you still must evaluate the financial health of the custodian that serves that administrator, because it’s the custodian who actually holds your money and assets.
Should I Use a Custodian or Administrator for My Self-Directed IRA?
It doesn't matter.
Some custodians try to make the argument that it's better for you to go "direct" to the custodian, but so far, I've never seen any evidence that it makes any difference.
You should choose the IRA company - whether custodian or administrator - that you feel meets your needs.
Speaking of which...
Which Custodian or Administrator Is Best For Setting Up Self-Directed IRA's?
This is actually a pretty complicated issue, but I’ll make it simple for you.
To choose the best custodian for you, I believe you should consider these things:
- Type of Assets You’ll Purchase: If you only want to buy stocks and mutual funds, then go with a custodian like eTrade or Charles Schwab who specializes in those. But if you want to invest in real estate or other non-Wall Street assets, you’ll need a truly self-directed IRA custodian.
- Customer Service Standards: How quickly will your custodian fund your investments? Will you have a dedicated account representative? Does your custodian have experience in the specific type of asset you’d like to purchase?
- Fees: Most IRA custodians charge an annual fee plus a flat fee for specific services or they charge on the basis of the size of your account. Usually, flat fee arrangements are less expensive.
- Financial Stability: Is your custodian financially strong? While it is very rare, sometimes custodians go out of business and cause huge problems. Note that merely having a large number of accounts or a lot of assets under management is not the same as being financially strong.
For your convenience, here's a list of every self-directed IRA custodian or administrator (and their contact information) known to us at SelfDirected.org:
Accuplan Benefits Services
406 S Jordan Pkwy #640
South Jordan, UT 84095
American Estate & Trust
6900 Westcliff Dr
Las Vegas, NV 89145
Bank of Utah
2605 Washington Blvd
Ogden, UT 84401
Central Bank of Utah
75 North University Avenue
Provo, UT 84601
555 12th Street
Oakland, CA 94607
First Midwest Bank
P.O. Box 30007
Albuquerque, New Mexico 87190
IRA Financial Group
1688 Meridian Ave #504
Miami Beach, FL 33139
100 Concourse Pkwy
Birmingham, AL 35244
IRA Services Trust
1160 Industrial Rd
San Carlos, CA 94070
Liberty Trust Company
Mainstar Trust Company
214 W 9th St,
Onaga, KS 66521
1520 Royal Palm Sq. Blvd #320
Fort Myers, FL 33919
Mountain West IRA
10096 W Fairview Ave
Boise, ID 83704
New Direction IRA
1070 W Century Dr
Louisville, CO 80027
280 S Ronald Reagan Blvd
Longwood, FL 32750
Polycomp Administrative Services
3000 Lava Ridge Court
Roseville, CA 95661
4465 S. Jones Blvd
Las Vegas, NV 89103
17171 Park Row Dr
Houston, TX 77084
STC Inc. (Security Trust Company)
223 N Prospect St
Hagerstown, MD 21740
Sovereign International Pension
1314 Alt 19
Palm Harbor, FL 34683
IMPORTANT: Summit Trust is in Receivership
8861 West Sahara Ave
Las Vegas, Nevada 89117
8 Corporate Park
Irvine, CA 92606
3525 Piedmont Rd NE
Building 8, #101
Atlanta, GA 30305
137 Broad Street
Asheville, NC 28801
122 East Butler Ave
Ambler, PA 19002
Community National Bank
225 Main St
Seneca, KS 66538
Equity Trust Company
1 Equity Way
Westlake, OH 44145
Goldstar Trust Company
1401 4th Ave
Canyon, TX 79015
74 N Main St
Cedar City, UT 84720
IRA Financial Trust Company
Sioux Falls, SD 57104
825 La Jolla Blvd
La Jolla, CA 92037
Kingdom Trust Company
1105 KY-121 b
Murray, KY 42071
Madison Trust Company
401 E 8th St
Sioux Falls, SD 57103
125 South Carroll Street
Frederick, MD 21701
Millennium Trust Company
2001 Spring Rd
Oak Brook, IL 60523
Nevada Trust Company
9130 W Russell Rd
Las Vegas, NV 89148
Next Generation Trust Services
75 Livingston Avenue
Roseland, NJ 07068
PENSCO Trust Company
Denver, CO 80202-3308
Preferred Trust Company
2471 W Horizon Ridge Pkwy
Henderson, NV 89052
Provident Trust Group
8880 W Sunset Rd
Las Vegas, NV 89148
Real Trust IRA Alternatives
312 East Trow Avenue
Chelan, WA 98816
Self Directed IRA Services
PO Box 23149
Waco, Texas 76702
Specialized IRA Services
6100 Indian School Rd NE
Albuquerque, NM 87110
10600 Menaul Blvd NE
Albuquerque, NM 87112
20860 N Tatum Blvd
Phoenix, AZ 85050
Will My Custodian (or Administrator) Find Investments For Me?
No. In fact, providing investment opportunities is expressly against the policy of every self-directed IRA custodian I’ve ever encountered.
Providing third-party investment advice is an entirely different business and requires entirely different licensing than is required to be an IRA custodian or IRA administrator.
Remember: Self-Directed IRA’s are self-directed, not custodian-directed, and that’s to your benefit. You get to call the shots.
What Kinds of Self-Directed IRA's are Available?
IRA’s come in many different configurations to match specific circumstances.
Here’s a quick list of each type, and the fundamental information about each (like qualification criteria, contribution limits, etc.):
- Traditional IRA: This is the original IRA which offers income tax deductions for contributions
- Roth IRA: Same as Traditional IRA, but offers tax-free withdrawals rather than deductions for contributions
- SEP IRA: Stands for “Simplified Employee Pension”. It’s a profit sharing plan so that self-employed people can save and invest some of their business profits
- Inherited IRA: If a loved one passes away and leave their IRA to you, you’ll need to set up an inherited IRA to hold the assets you’ve received
- Spousal IRA: If you are or have a non-working spouse who wants to have a separate retirement account, the Spousal IRA waives some requirements of the Traditional IRA to accommodate that
- Education IRA: Also known as a “CESA” (Coverdell Education Savings Account), this is taxed like a Roth IRA but allows for withdrawals for educational expenses rather than just for retirement
All of these types of IRA’s are available in both “captive” and “self-directed” varieties, depending entirely on whether the custodian you select allows for self-direction.
You may have also heard of other types of IRA’s, like:
- Checkbook IRA LLC
- Real Estate IRA
- Gold (Precious Metals) IRA
- Cryptocurrency IRA
These are not actually types of IRA’s, they’re just ways to use an IRA. If you look in the law that created IRA’s, you won’t see a single mention of any of these things. They’re all just marketing names.
But they are all important, so I’ll tell you about them, too.
What is a Checkbook IRA LLC?
The “Checkbook IRA LLC” is a very important strategy used by some investors who need to have instant access to their capital (like anyone who buys real estate or other assets at cash-only auctions).
Under normal circumstances, you have to take some extra steps for your IRA to purchase assets through a self-directed IRA custodian. Those extra steps can take time, and for many investors, time is money.
In essence, the Checkbook IRA LLC is a way to circumvent the direct involvement of your custodian in your day-to-day investment activity.
This can be a very good thing if you really need the additional speed… but it can also be a very dangerous thing. I’ll tell you why in a moment. But first, here are the steps you’d take to use this strategy:
- Step 1: Hire a lawyer to create a special type of LLC (company)
- Step 2: Appoint yourself as the manager (President/CEO) of the LLC
- Step 3: Transfer the money in your IRA to the LLC’s bank account in exchange for your IRA’s ownership of the LLC
- Step 4: Make investments on behalf of the LLC
With a Checkbook IRA LLC, any profits or losses you have in the LLC will actually flow up to the IRA itself, so you still get all of the tax benefits of the IRA along with instant access to your capital.
But here’s my advice: Only use a Checkbook IRA if you actually really need the added speed it offers.
Like every other case where you have greater authority, the Checkbook IRA also imposes much greater responsibility on you than if you circumvent the involvement of your custodian.
If you use the Checkbook IRA LLC, you must make every effort to become and remain well informed about the rules imposed on Self-Directed IRA’s by the IRS, because it’s very easy to unknowingly cross the line…
…and those kinds of errors can be both devastating and irreparable.
What are the Self-Directed IRA Rules I Must Follow?
Here’s rule #1: Get good legal advice before every single major transaction, because the cost of doing it wrong can be very, very high.
I’m no lawyer, so I can’t give you legal advice. But here’s what I can offer: Some good strategies to keep you from coming under the critical eye of the IRS.
- Rule #1: Consult an experienced attorney before every transaction. No exceptions.
- Rule #2: You can buy nearly anything in your Self-Directed IRA, but there are some types of assets that are strictly prohibited, including life insurance policies, collectibles, precious metals (except for those meeting certain purity standards) and S-Corporations.
- Rule #2: You can never use your IRA funds to benefit yourself in any way. This means you can’t borrow money from your IRA; you can’t pay yourself a salary to manage your IRA; you can’t even reimburse yourself for expenses you personally incur on behalf of your IRA. It’s not just about “direct” benefits, either. For example, if you get a loan from a bank, you can’t pledge your IRA as collateral for that loan.
- Rule #3: You can never use your IRA’s assets (like real estate). If you own a great beach house in San Diego or Miami, you can’t stay in that house yourself. If you own a fleet of heavy machinery in your self-directed IRA, you can never use those tools yourself in any way. Assets of your IRA are 100% off limits to you in every way.
- Rule #4: Just as you can’t use your IRA funds or assets to benefit yourself in any way, you also can’t use those funds or assets to benefit anyone who is related to you, or any businesses over which you exert control (including businesses you own, charities on which you’re a board member, etc.) This includes “indirect” benefits, such as allowing your granddaughter’s girl scout troop to sell cookies on a piece of real estate your IRA owners.
- Rule #5: Most of the time, your IRA won’t have to file a tax return or pay taxes year-to-year. But if you use your IRA to run an active business, or if you borrow money in your IRA, then your IRA will likely be obligated to file tax returns and pay taxes at a [very high] rate.
There are many more rules, but those 5 primary rules are very good guiding principles to keep you out of trouble.
But what happens if you accidentally (or otherwise) break one of the rules? Most of the time, the result is something called a “Prohibited Transaction”… and it’s a very, very serious issue…
What is a Prohibited Transaction?
“Prohibited Transaction” are the most vile words ever created, if you’re an IRA owner.
In general, to commit a “prohibited transaction” means you’ve misused your IRA in some substantial way.
Maybe you did something that’s clearly prohibited like “borrowing” money from your IRA or even using your IRA to buy the old family farm from your parents.
Or maybe you did something that’s more subtle, but wholly prohibited nevertheless, like using your IRA to buy up all of the land around your own home in order to drive up the value of your home.
Whatever the case, a prohibited transaction is a bad, bad thing. From the point of view of the IRS, a prohibited transaction is a fundamental abuse of the purpose of your IRA, and remember this:
The IRS is not friendly when it comes to prohibited transactions.
What is a Real Estate IRA?
The term “real estate IRA” is a marketing term that doesn’t appear anywhere in U.S. law.
It’s just a term created by some self-directed IRA custodians to suggest that their particular IRA is better for investing in real estate than IRA’s offered by other custodians.
In reality, all IRA’s have precisely the same investment capabilities under the law.
Some custodians are certainly more experienced with real estate investments than others, and that is a worthy consideration.
But at the core, all Self-Directed IRA’s – and all IRA’s in general – have precisely the same investment capabilities.
What is a Gold IRA (or Precious Metals IRA)?
The terms “Gold IRA” or “Precious Metals IRA” are marketing terms that do not appear anywhere in U.S. law.
Those are terms created by some self-directed IRA custodians to suggest that their particular IRA is better suited for investing in gold, silver or other Precious Metals than IRA’s offered by other custodians.
In reality, all IRA’s have precisely the same investment capabilities under the law, including where precious metals are concerned.
Some custodians are certainly more experienced with gold, silver or other precious metals investments than others, and that is a worthy consideration.
But at the core, all Self-Directed IRA’s – and all IRA’s in general – have precisely the same investment capabilities, including where investments in gold, silver and other precious metals are concerned.
What is a Cryptocurrency IRA?
The term “Cryptocurrency IRA” is a marketing term that doesn’t appear anywhere in U.S. law.
It’s just a term created by some self-directed IRA custodians to suggest that their particular IRA is better for investing in cryptocurrencies than IRA’s offered by other custodians.
In reality, all IRA’s have precisely the same investment capabilities under the law, including where cryptocurrencies are concerned.
Some custodians are certainly more experienced with cryptocurrency investments than others, and that is a worthy consideration.
But at the core, all Self-Directed IRA’s – and all IRA’s in general – have precisely the same investment capabilities, including cryptocurrencies.
What Tax Benefits Will I Receive From my Self-Directed IRA?
The tax benefits of an IRA depend on the type of IRA you’re using.
For example: Using a “Traditional IRA” has very different tax consequences than using a “Roth IRA”.
I’m not a CPA, so I’m not qualified to give you tax advice. But as a layman, I can tell you confidently that there are three primary tax benefits that come from using an IRA to save for your own retirement:
- Tax-Free Reinvestment of Profits
- Deductibility of Contributions
- Tax-Free Withdrawals during retirement
Tax-Free Reinvestment of Profits
Imagine you’ve made an investment, and that investment yields a profit of $1,000,000. Happy day!
If you did that transaction outside of an IRA, you’d immediately owe taxes on that profit. If your effective tax rate on that profit was 25%, you’d have to write a check to the IRS for $250,000.
The real pain there is that if you want to reinvest into another asset, you’d have $250,000 less capital to invest, because the taxes goes straight to Uncle Sam first.
Not so if you do the same investment in your self-directed IRA.
Your IRA has a great feature that means that as long as money stays inside of your IRA, you won’t pay taxes, no matter how much profit you make.
So in our example with the $1,000,000 profit, your IRA would receive that profit, and would then be able to re-invest the entire amount, rather than losing $250,000 to taxes…
…and that difference can be huge.
I believe that tax-free compounding of profits is the single biggest tax benefit offered by IRA’s.
Deductibility of Contributions
If you have an IRA that’s taxed under the “Traditional” (rather than the “Roth”) tax plan, then you get a wonderful immediate benefit in the form of a reduced income tax bill.
Here’s an example:
Let’s imagine that your effective income tax rate is 35%.
If you contribute $5,000 to a traditional IRA, then your income tax bill will be reduced by $1,750 (that’s $5,000 times 35%) for the year when you make the contribution!
That can really add up over time.
Important: There are some cases when you can not deduct contributions to a traditional IRA. Those cases usually hinge on whether you’ve got a retirement plan at your job and on how much you earn. Be sure to talk with a CPA about how this applies to you.
Tax-Free Withdrawals During Retirement
This particular benefit is, to me, nothing short of mind-blowing.
Imagine that you’ve dutifully contributed money to your IRA every year for the past 30 years, and you reach retirement age with a balance of $4,000,000.
First of all, congratulations!
But if you have been using a Traditional IRA, then you’re going to experience the big trade-off you accept for getting an income tax deduction for your contributions:
The big trade-off is: Every dollar you withdraw from a Traditional IRA is subject to income taxes.
But if you were using a Roth IRA instead, the picture would be very different.
While you would not have been receiving any tax deductions for you contributions during your working years, the Roth IRA gives you a benefit during retirement that’s almost unthinkably wonderful:
The big Roth IRA benefit is that you pay ZERO tax on the money you withdraw!
Zero. Zilch. Nada. Not a single penny!
So that $4,000,000 IRA you built up will be totally and completely yours to use, period. No income taxes at all, ever!
How Do I Deposit Money Into My Self-Directed IRA?
Before I answer this, note that in the IRA world, the word they use to describe depositing money into your IRA is “contribution”, so that’s the word we’ll use moving forward.
There are 2 ways to contribute capital to your self-directed IRA:
- Salary Deferral refers to contributing money that you’ve earned on your job. This is the most common way to add to your IRA principle balance.
- Profit Sharing refers to when your employer (or your own business, if you’re self-employed) contributes money to your IRA on your behalf from the profits of the business.
Most types of IRA’s only allow salary deferral-types of contributions. Conversely, if you use a SEP IRA, the only type of contribution it can accept is profit sharing contributions.
Can I Borrow Money To Do Bigger Deals In My Self-Directed IRA?
Maybe. There are a few [very important] factors you should consider.
First, if the money you’re borrowing is for the purpose of doing a deal in your IRA, then it must be your IRA that gets a loan, and not you. There are some lenders who specialize in IRA loans.
Second, you can’t be a co-signer or otherwise involved in the loan. In fact, if your name appears on the loan documents at all, there’s a good chance that you’re committing a prohibited transaction, and that’s a very negative thing.
Third, the loan you get must not place your IRA as collateral. The loan can be collateralized against a specific asset in your IRA, but not the IRA as a whole. That’s prohibited.
Fourth, the loan should not be made to your IRA by anyone who may be considered a “disqualified person”.
Fifth (and finally), be aware that using debt to finance a deal in your IRA will probably mean you’ve got to file tax returns and pay some taxes each year from your IRA.
It’s increasingly common for IRA owners to get loans in their self-directed IRA’s. But as always, before you do, the best advice is this: Seek good legal and tax counsel before you do it!
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