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The Self-Directed IRA FAQ I wish I'd had…

by | Feb 27, 2017

Personally, I'm sick of FAQ's that sound like they're written by and for robots.  This one is different.  Your retirement portfolio is profoundly important, and I'll not dishonor your time by giving you stock answers to all of these questions.  Granted, some of the questions are a little boring (there's nothing interesting about "What is the contribution limit a a SEP IRA for 2017?"...) but some of these issues are the financial equivalent of life-or-death important, and when that's the case, I'll tell you.

Is there a question you'd like to have answered here?  I'd love to answer it for you... just send it to me using the form at the end of the page, which you can reach by clicking here.  It's my goal for this to be the most exhaustive, reliable self-directed IRA FAQ anywhere, so don't hesitate to ask questions.

So let's get started...

Self-Directed IRA FAQ:  Fundamentals

A self-directed IRA is a special version of the retirement account known as the “Individual Retirement Arrangement”.  The distinguishing characteristic of Self-Directed IRA's versus non-Self-Directed (aka "Captive") IRA's is that there are almost no limits imposed on self-directed IRA's concerning the types of assets which the IRA is allowed to purchase.

What is a Self Directed IRA?

A self-directed IRA is a special version of the retirement account known as the “Individual Retirement Arrangement” that was created by the law called ERISA (Employee Retirement Income Security Act of 1974).

ERISA created a retirement account – the IRA – that encouraged saving for retirement by offering investors:

  • A tax deduction for contributing money to the account
  • Tax-free compounding of profits
  • Protection against claims from creditors
  • Easy bequeathment to future generations

ERISA gave investors another gift as well:  Extraordinary flexibility in terms of asset selection.  The new law specified only two assets that IRA’s would be prohibited from purchasing:  Life Insurance and Collectibles.  There were – and are – no other asset-type restrictions in ERISA.  There are other rules to consider – most notably, the rules concerning “disqualified persons” – but as a discreet matter, the only assets that are inherently prohibited inside of an IRA are Life Insurance and Collectibles.

What is a Captive IRA?

Any IRA that is not a self-directed IRA is a captive IRA.  I coined the term “captive IRA” to reflect how nearly all IRA custodians use the IRA to create a captive audience for that custodian’s investment products.

For example, consider the “conventional” type of IRA offered by a local bank, a big insurance company or even a stock brokerage.  In each case, those companies offer IRA’s to their clients, but there’s a catch:  The client must invest the funds contributed to that IRA exclusively in assets sold by the custodian.

…If you have a bank IRA, your IRA has to buy investments from the bank.

…if you have an insurance company IRA, your IRA must buy investments from the insurance company

…if you have a stock brokerage IRA, your IRA must buy investments from the stock brokerage

As a point of comparison, imagine a checking account that obligates you to spend all of the money you deposit into that account at your bank.  You’re forced to buy all of your groceries, clothing, and supplies at your bank.  Furthermore, anything that you need but that is not made available at your bank is simply not available to  you…

…That is the essence of a Captive IRA.

What determines if an IRA is Captive or Self-Directed?

Nearly all IRA’s are captive IRA’s.  If you have any doubt, ask your custodian these questions:

  • May I purchase real estate in my IRA?
  • May I purchase privately-traded companies in my IRA?
  • May I purchase a single-member LLC in my IRA?
  • May I borrow money in the name of my IRA to finance further IRA investments?

If the answer to any of those questions is “no”, then you have a captive IRA.  Some IRA’s are more captive than others, to be certain.  But an answer of “no” to any of those questions means that the custodian you’re questioning will not provide you with the full extent of authority available to your IRA under the law.

A final question to ask for ultimate clarification is this:

  • Will you ever restrict my IRA’s investment choices beyond insurance and collectibles?

If the answer to this is “yes”, then it’s a practical certainty that the custodian you’re dealing with offers (more or less) captive IRA’s.  For maximum flexibility, seek out a truly self-directed IRA custodian.

How did Corrupt Labor Unions and Poor Corporate Management lead to the Creation of IRA's?

I really enjoyed the story of the history behind how and why IRA's were created to begin with.  It's a lot like a soap opera.  But since I've recorded two podcasts that go into this topic rather deeply, I'll just let you have a look at those rather than rehashing it here:

What does S D IRA mean?

S D IRA is an abbreviation of the term "Self Directed IRA".

Frankly, I nearly skipped this entirely.  But when I was doing some research on Google, I found out that this is a common question.  Glad to be of service <g>...

Self-Directed IRA FAQ:  Law & Legal Issues

What is ERISA?

ERISA – the Employee Retirement Income Security Act of 1974 – is the law that created all IRA’s.

In the 1950’s and 1960’s, several very large companies went out of business due to a combination of corporate mismanagement and horrible abuse by labor unions.  In many cases, the demise of these companies also resulted in the total loss of the pensions that former employees were relying upon to fund their golden years.

This happened frequently enough that Congress responded with ERISA, which (among other things) created the IRA – “individual retirement arrangement” – which would make it possible for Americans to save for their own retirements in a tax-advantaged way.  But the IRA was unique because of the word “individual”…

…in other words, this retirement account would be connected exclusively to an individual person, and thus not subject to the risk that an employer pension would go bust.

More about What is ERISA?
How is an IRA structured legally?

IRA’s are a special type of “Trust” which is just a fancy term for an agreement in which one party (you, the investor) contributes money which is then held in safekeeping by another party (the “Custodian”) for your benefit.

If you’ve ever established an IRA, you’ll recall that you had to sign a large stack of papers.  Most of those papers were a “Custodial Agreement” that stipulates things like

  • Where will your money and assets be held?
  • Who makes investment decisions?
  • Who gets your account if you pass away?

In essence, the custodial agreement is nothing more than the terms under which your custodian is agreeing to be the trustee for your IRA.

The important thing to remember is that from a legal perspective, your IRA is a “Trust”.  This becomes important again later when we discuss protection from creditors and a dreadful pest known as UBIT.

Who is the best lawyer if I need Self-Directed IRA counsel?

We recommend Tim Berry.  Tim is a lawyer based in Phoenix, Arizona.  He has a vast amount of experience with self-directed IRA's, solo 401(k)'s and a number of related fields including high-net-worth asset protection and bankruptcy.  You can reach him here.

Much of the expertise shared here in the Self Directed IRA Ultimate Q&A comes directly from Tim, and we're grateful to him!

Self-Directed IRA FAQ: Investment Options

What assets am I allowed to buy in a Self-Directed IRA?

There are practically no limits on the types of assets you can purchase in your self-directed IRA.  In fact, the law that created the IRA – ERISA – stipulated only two types of assets that would be fundamentally prohibited in an IRA:

  • Life Insurance
  • Collectibles

These are the only assets specifically prohibited by the law for your IRA.

Can you hold real estate in an IRA?

Real estate can be held in some IRA's.

The law that established IRA's, ERISA (Employee Retirement Income Security Act of 1974) - does not prohibit IRA owners from buying real estate with their IRA funds.  Millions of Americans have bought real estate in their IRA's.

However, not all IRA custodians will allow for the purchase of real estate in the accounts they handle.

If your IRA custodian will not allow you to purchase real estate in your IRA, you should consider transferring your account to a fully self-directed IRA custodian who will give you all of the investment flexibility the law provides.

What things are considered to be “collectibles”?

Collectibles - one of only 2 specifically prohibited asset types for self-directed IRA's - is a rather vague term, so the IRS has provided this list to help clarify:

  • Artwork,
  • Rugs,
  • Antiques,
  • Metals - with exceptions for certain kinds of bullion,
  • Gems,
  • Stamps,
  • Coins - (but there are exceptions for certain coins),
  • Alcoholic beverages, and
  • Certain other tangible personal property

Please note the presence of the last item:  “Certain other tangible personal property.”  This is IRS code for:  “There are other things that should be on this list… we’ll let you know.”

Before using your IRA to purchase anything that has even the tiniest likelihood of being categorized as a “collectible”, please consult with an attorney with great expertise in ERISA.  I recommend Tim Berry, who can be reached here.

What happens if I buy a prohibited asset in my IRA anyway?

If you purchase either of the two prohibited asset types in your IRA, the money used to make that purchase will be classified as “distributed”.  The effects of this classification will be:

  • Your IRA balance will reduce by the amount of money you spent on the prohibited asset
  • You may be subject to taxes, penalties and interest

Always do your best to avoid buying insurance or collectibles in your IRA.

I’ve heard my IRA can’t buy S-Corporation stock. Is this true?

This is technically untrue, but is grounded in truth.

The law that created IRA’s – ERISA – stipulated only Life Insurance and Collectibles as prohibited assets.  As far as ERISA is concerned, everything else is on the table.

But there’s another law to consider, called 26 U.S. Code § 1361, which created a new taxation scheme for corporations called the “S” election.  Designed for small businesses with a low number of shareholders, this taxation structure can be very beneficial for some businesses.

Unfortunately, §1361 clearly established a limited group of people and entities who are eligible to own shares of a corporation that has elected “S” treatment.  Also unfortunately, IRA’s aren’t on that list.

However, that does not mean that S-Corporations are prohibited in IRA’s like insurance and collectibles.  An S-corporation is just a corporation, and corporations are totally kosher for IRA’s.

But there are penalties imposed by §1361 if an ineligible party – such as your IRA – becomes owner of shares in an S-Corporation.  The penalty is that the corporation immediately loses its “S” tax status, which can cause tremendously negative tax consequences for the corporation itself and any others who own shares in that corporation.

So technically, S-Corporations are not prohibited assets and can be owned in an IRA.  But practically, buying an S-corporation with IRA funds causes the corporation not to be an S-corporation any longer.

What is a Real Estate IRA?

The term “real estate IRA” is just a marketing term used by some custodians to describe their self-directed IRA’s that are capable of acquiring real estate.

Any truly self-directed IRA is capable of acquiring real estate.

What is a Gold IRA (aka “Precious Metals IRA”)?

The term “gold IRA” or “precious metals IRA” is just a marketing term used by some custodians to describe their self-directed IRA’s that are capable of acquiring gold or precious metals.

Any truly self-directed IRA is capable of acquiring gold or precious metals.

Self Directed IRA FAQ:  Traditional IRA's

What is a Traditional IRA?

A Traditional IRA is an IRA that front-loads the tax benefits of using an IRA.  Those benefits are:

  • Contributions to a Traditional IRA are deductible against income taxes
  • Profits in a Traditional IRA accrue tax-free while remaining inside the IRA

The impact of tax-deductible contributions can be significant over time.

Example:  Mary contributes an average of $5,500 per year to her Traditional IRA for 20 years.  During that time, her average effective tax rate was 20%.  Mary’s income tax burden is reduced by a total of $22,000 over 20 years.

The Traditional IRA has this name because this front-loaded tax benefit (in contrast to the back-loaded benefits of a “Roth” IRA) is how IRA taxation was established under the 1974 law that created IRA’s, ERISA.

Withdrawals from a Traditional IRA are taxed at income tax rates.  There’s also a 10% penalty if withdrawals are made before age 59 ½.

Am I eligible to have a Traditional IRA?

Traditional IRA eligibility is very simple.  To contribute to a Traditional IRA, you must meet two requirements:

  • You must have earned income (taxable compensation) for the year in which you're making a contribution
  • You must be younger than 70 1/2 years old

Earned income is generally the type of income that is reported on a W-2 or 1099 form.  It's the type of income that results from your direct labor.

Income such as rents, royalties, dividends, deferred compensation, annuity income and such are not active income.  If that is the only type of income you have, you'll not be eligible to contribute to a Traditional IRA.

Unlike the Roth IRA, there is no income ceiling that will prohibit you from making contributions to a Traditional IRA.  However, depending upon your income, the tax deductions available to you may decrease.

Remember:  The issue of "eligibility" for a Traditional IRA only concerns whether you are eligible to make new contributions.  But even if you are not eligible to contribute in a given year, you continue to own any Traditional IRA's that you owned in the past.  Eligibility does not affect ownership, only your right to make new contributions.

What are the taxes and penalties for early withdrawal from your traditional IRA account?

Question continued:  I would like to use some of the money in my traditional IRA to invest in a business. Would this be advisable?

It appears you may be confusing some issues…

To answer your question directly: Withdrawing money from a traditional IRA works like this:

  • Your withdrawal will be counted as income to you and taxed at income tax rates
  • If you’re younger than 59 1/2, you’ll also face a 10% early withdrawal penalty

You then ask whether it would be advisable to invest money in your traditional IRA in a business… and I’m not clear about the connection between that question and the question about taxes and penalties, so I’ll answer that from a couple of perspectives:

  • The most common type of investment for IRA’s is businesses in the form of publicly traded stock. Since that is so common and clearly easy to do with nearly any IRA, I’ll assume what you mean by “invest in a business” is “invest in a PRIVATE business (not traded on the stock market)”.
  • Whether it would be advisable to invest in a private business with your IRA funds is a function of the quality of the business and it’s suitability to your needs. It’s impossible to answer that question with the information you’ve provided. But there’s no reason that it is fundamentally unwise to invest in a private business with your IRA funds.
  • If you’re asking about withdrawals because you think it will be necessary to withdraw money in order to purchase a private business, I’ve got good news for you: You can absolutely invest in private businesses INSIDE of your IRA without making a withdrawal so you don’t take a tax hit. To do that, just transfer the necessary capital from your current IRA into an IRA at a self-directed IRA custodial company (for example: Equity Trust, PENSCO or Quest IRA) and direct them to make the investment using your IRA funds.
  • There are some circumstances under which it would be considered a prohibited transaction for your IRA to invest in a private business - such as in the instance when you own a controlling interest and receive a salary from the business - but it’s easy enough to clarify these issues ahead of time by consulting an excellent self directed IRA lawyer ahead of time.

Happy Investing!

Self-Directed IRA FAQ: Custodians & Administrators

What companies provide Self-Directed IRA’s?

Below you'll find a list of all known self-directed IRA custodians.  Each is linked to a page with their contact information and background information that may be of assistance to you in evaluating your choices.

Important Note:  This list is just a list.  It does not imply that I or the Self-Directed Investor Society are endorsing any of them.  Although there are a few on this list that we think do a really great job.

Also, just because a custodian appears on this list doesn’t mean that they offer fully self-directed IRA’s.  For example, some custodians now allow the purchase of any asset except for single-member LLC’s (aka the “Checkbook IRA LLC”… more on that later), which could be a very important issue for some of you.

Accuplan Benefit Services

Advanta IRA

American Estate & Trust

American IRA

Bank of Utah


Central Bank of Utah

Community National Bank

Entrust Group

Equity Trust Company

First Midwest Bank

GoldStar Trust Company

Horizon Trust Company

IRA Express, Inc.

IRA Financial Group

IRA Financial Trust Company

IRA Innovations

IRA Resources

IRA Services Trust

Kingdom Trust Company

Liberty Trust Company

Madison Trust Company

Mainstar Trust Company

MidAtlantic IRA

Midland IRA

Millennium Trust Company

Mountain West IRA

Nevada Trust Company

New Direction IRA

Next Generation Trust Services

NuView IRA

PENSCO Trust Company

Polycomp Administrative Services

Preferred Trust Company

Premier Trust

Provident Trust Group

Quest IRA

Real Trust IRA Alternatives

Security Trust Company

Self Directed IRA Services

Sovereign International Pension

Specialized IRA Services

Summit Trust

Sunwest Trust

uDirect IRA

Vantage IRA

Is there an excellent Self-Directed IRA Custodian that should be on this list?  Please click here to notify us.

What is a self-directed IRA custodian?

A self-directed IRA custodian is a financial institution that holds IRA assets on behalf of IRA owners.  IRA custodians are always either a bank or a non-bank trustee that meets the requirements set forth by the IRS.

Custodians are, as the name implies, charged with holding custody of assets.  In other words, when you make a deposit to your self directed IRA, it is your IRA custodian who receives and holds those funds, and it is your custodian who distributes those funds when you direct them to do so.  It is also generally your custodian's name that appears as the legal owner (for your IRA's benefit) of all assets purchased by your self directed IRA.

What is a self-directed IRA administrator?

A self-directed IRA administrator is a company performs marketing and customer services for self directed IRA account holders, but that does not directly provide IRA custodial services.  Instead, administrators serve a type of middle-man role that enables qualified custodians to focus on providing custodial services while the administrator provides front-line customer services and interactions.

Unlike custodians, there are no specific legal requirements for becoming an IRA administrator.

Your IRA provider is required to indicate to you whether they are a custodian or administrator, and if an administrator, they're required to specify which custodian is serving your acount.

Should I use a custodian or administrator for my self-directed IRA?

I don't think there's any fundamental superiority for custodians versus administrators.  A plausible argument can be made that speedier responses might be available if you work with a custodian directly rather than going through an administrator, but in practice I've not heard complaints about this.

An equally plausible argument could be made that administrators result in greater service speed by enabling custodians to focus on their core business of custodianship by offloading marketing and customer service to administrators.

So, I repeat:  It's my opinion that there's no fundamental superiority between using an IRA administrator to set up your self directed IRA versus going directly to a custodian.

If you're a custodian or administrator and you think I've missed something in this evaluation, I'd love to hear from you!

Self Directed IRA FAQ:  Prohibited Transactions

The single biggest risk of using a self-directed IRA is the potential for making errors which lead to prohibited transactions.  Pay careful attention to this section.

What is a prohibited transaction?

A prohibited transaction is any action involving your IRA that brings any kind of benefit (whether direct or indirect) to any "disqualified persons", including you.

A few simple examples of prohibited transactions include:

  • Buying property for personal use (present or future) with your IRA funds
  • Borrowing money from your IRA
  • Selling property to your IRA, or allowing any disqualified person to sell property to your IRA
  • Using your IRA as security for a loan or any other obligation

If you commit a prohibited transaction in your IRA, the ramifications can be very severe.  Prohibited transactions are, without a doubt, the single biggest risk of using a self-directed IRA, as the additional flexibility provided by self-directed IRA's also increases the potential for errors leading to prohibited transactions.

What is a disqualified person?

Broadly speaking, "disqualified persons" include:

  • You - the owner of the IRA
  • Family - your ancestors, descendants and their spouses
  • IRA Account Professionals - your account custodian or anyone providing services connected to the IRA
  • Related Entities - any business or organization on which you or a family member have substantive ownership or influence

"Disqualified Persons" is a critically important consideration. By engaging in a transaction that directly (or even indirectly) benefits a disqualified person, your entire IRA will be categorized as "Fully Distributed", which is catastrophic to your IRA and nearly always irreparable.

The IRS provides more guidance about Disqualified Persons here.

Alas, there’s more… FAR MORE… than meets the eye, and it’s all legally uncharted waters.

In moving forward, keep this little tidbit in mind: The IRS lists 10 groups of people who are DISQUALIFIED from doing business with your IRA. What’s #1? That honor goes to anyone who can be described as a FIDUCIARY of the plan. And SDI Society Legal Counsel Tim Berry – the Great One, we call him – tells us that Section 4975 of the tax code defines Fiduciary as anyone who has discretionary authority over a retirement plan.

Do YOU have discretionary authority over your retirement plan? Yes, you do. Remember, it’s *SELF* directed.

But that only prohibits the IRA from doing business directly with you, right? You’d think so, but… no.

According to Tim, the examples in that regulation (26 CFR 54.4975-6 a(5)) make it arguable that the disqualification extends not just to the fiduciary, but to anyone in whom the fiduciary has an “interest” that could sway the judgment of the fiduciary. Notice the use of the vague word “interest”. It doesn’t say bloodline. It doesn’t say family relationship. It doesn’t even say “personal relationship”. It just says “interest”.

Is it arguable that you have an interest in your siblings, your aunts, your uncles, your nieces or nephews? Sure it is.

So the bad news is this: The law says YOU are a fiduciary of your plan, and that you – and anyone in whom you’ve got an interest – are disqualified from doing business with your IRA. That’s a sobering thought.

The good news: Tim says he’s never seen this authority asserted by the IRS, so maybe their operating definition is narrower than what appears to be stipulated in law. Our advice: always, always, always consult qualified legal counsel before engaging in any transaction in your self directed ira. Our recommendation is to contact Tim Berry.

What happens when a prohibited transaction is committed in my IRA?

Prohibited transactions are, generally speaking, the very worst thing that can happen to an IRA.  The taxes, penalties and interest that can result are frequently enough to wipe out the entire IRA.  Clearly, this is a very serious issue.

When your IRA is guilty of committing a prohibited transaction, the IRS considers your IRA to be "fully distributed" as of January 1 of the year when the prohibited transaction took place.

To clarify this, let's break this down into these questions:

  1. What is a "distribution"?
  2. What does it mean to be "fully distributed"?

What Is A Distribution?

From the vantage point of the IRS, a "distribution" from your IRA means that a certain dollar-value in assets has been transitioned from being "in" your IRA (and subject to the IRA's tax benefits) to being "out" of your IRA.  The rules for distributions are (generally) pretty simple:

  • Traditional IRA:  Pay income tax on the amount of your distribution.  If you're under age 59 1/2, add 10% to that as an early withdrawal penalty
  • Roth IRA:  If you're under age 59 1/2, pay income taxes (plus a 10% early withdrawal penalty) on the amount of your distribution that's in excess of your total principal contributions.  After age 59 1/2, no taxes are due on distributions.

A distribution isn't a bad thing.  The point of your IRA is to provide you with distributions during retirement.  Of course, as you see, distributions taken prior to retirement may be subject to taxes and penalties.

What is a "Full Distribution"?

A "full distribution" simply means that 100% of the value of the IRA has been distributed.  In that case, the IRA has a zero balance and for all practical purposes, no longer exists.

So What's The Big Deal?

The problem with prohibited transactions is that you're quite likely not aware that you've committed the error.  Most people don't learn about prohibited transactions until they're discovered many years later during an audit.  As a result, it's common for a prohibited transaction to establish a tax liability that was payable many years ago.  This leads to a tax bill that includes a potentially huge amount of interest on what's likely already a substantial bill for taxes and penalties.

To further compound the situation, prohibited transactions cause a full distribution of your IRA.  This means that the distribution is not limited to the value of the specific asset on which you committed the transaction.  A prohibited transaction means your entire IRA is zeroed out, and your tax liability will be based on a combination of income taxes, penalties and interest on your entire IRA value as of January 1 in the year when the prohibited transaction was committed.

It is not an exaggeration to say that prohibited transactions can be cataclysmic for your self-directed IRA.  They can be avoided by great record keeping and excellent pre-emptive and on-going legal advice.

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Bryan Ellis is host of Self Directed Investor Talk, America's #1 radio show and podcast for affluent self-directed investors.  He's also an expert in self-directed IRA's, solo 401k's and turnkey rental property investing... at least, that's what his wife tells him 🙂  He's a contributor to well-respected publications like, Entrepreneur and ThinkRealty.  Bryan lives in metro Atlanta, Georgia with Carole Ellis - his wife, business partner and best friend - and his 4 children ranging in age from 2 to 19.