Using a Self-Directed IRA to Grow Your Retirement Nest Egg

For most people, an IRA is a “set it and forget it” portfolio item. Contributions to the account are usually automated, and the investments making up the IRA—typically stocks, bonds, CDs, and mutual funds—require little account holder oversight.

That’s all fine and good, but limited risk means limited returns. For those who want to take the reins and expand their retirement accounts to include more diverse investments with the potential for higher returns, a Self-Directed IRA might be the ideal choice.

What Is a Self-Directed IRA?

With regard to legal status and tax advantages, a self-directed IRA is no different from a traditional IRA. The account owner opens the IRA with the help of a custodian (usually a bank, broker, or licensed financial planner) and thereafter makes regular contributions to the account, subject to annual limits and other IRS rules.

However, whereas standard IRAs typically allow only a limited array of investments, self-directed IRAs give the account holder broad leeway to choose diverse and even unconventional investments. Bear in mind, though, that the custodian of any IRA maintains control of the account and has the authority to veto any proposed investment. It is therefore important to select a custodian who not only specializes in self-directed IRAs, but also shares the investor’s values and vision.

What Are the Benefits of a Self-Directed IRA?

Two words: control and flexibility. Someone with a deep knowledge of the regional real estate market or a keen eye for small businesses with extraordinary growth potential cannot act on that knowledge within the confines of a traditional IRA. Holders of self- directed IRAs, on the other hand, research investment opportunities and formulate portfolio strategies based on their own expertise and risk tolerance. The account holder thus has the power to cast a wider net over riskier waters, potentially hauling in far bigger fish.

Examples of Investment Types

The list of allowed investment types in a self-directed IRA is not infinite (life insurance and collectibles are excluded, for example), but it stretches well past the horizon of the average investor’s imagination. Savvy investors have realized impressive returns with such varied investments as:

• Gold and silver
• Business ventures and private placements
• Debt/loans/promissory notes
• Commercial real estate and residential rental property
• Tax lien certificates
• Cryptocurrencies

It is important to remember that the tax-advantaged status of an IRA stems from the idea that the account will benefit its holder only in retirement, not in the present day. Therefore, all investments must be structured so that returns enrich the IRA, staying beyond the account holder’s reach. Visualize an “arm’s length” relationship in which the IRA owns the investments and exists as a separate entity from the account holder.

Who Should Consider a Self-Directed IRA?

Risk-averse individuals without knowledge of non-mainstream investment opportunities will likely be better served by a traditional IRA. Self-directed IRAs are for the knowledgeable and the bold—those who are willing to take greater risks and do the research to manage those risks wisely. Even a seasoned investor should partner with an experienced financial planner to analyze the risks and potential of all investments under consideration.

What Are Prohibited “Self-Dealing” Transactions and “Disqualified” Persons? Like all tax-advantaged investments, self-directed IRAs are subject to pages of IRS rules. The strongest prohibition of all is “self-dealing,” which immediately nullifies an account’s status as an IRA. In simplest terms, the account owner cannot enter into deals with the IRA. Prohibited transactions include selling one’s own property to the IRA, borrowing funds from it, receiving services from it, or performing services for it.

For example, if the owner of a self-directed IRA instructs the custodian to invest in a golf course, the account holder cannot receive discounted greens fees or free lessons from the club pro. Nor can he or she volunteer to drive the ball picker on the driving range to save the golf course money (even though most of us would happily volunteer to do that just for kicks). These prohibitions also apply to “disqualified persons,” including the account holder’s spouse, parents, children, and grandchildren. Interestingly, deals with siblings, aunts, and uncles are allowed.

A single act of self-dealing disqualifies the entire IRA, even if the transgression applied to one small holding making up a tiny fraction of the investment portfolio. That could mean tens or even hundreds of thousands of dollars suddenly becoming subject to taxes, interest, and penalties.

Choose Investments, Custodians, and Administrators Carefully

Opening a self-directed IRA is a serious undertaking. Managed intelligently, the account will yield retirement savings growth that traditional IRAs can’t match. Approached carelessly, a self-directed IRA will become far more trouble than it’s worth. If in doubt, ask for help from someone who knows the territory. To paraphrase the great Casey Kasem, self-directed IRAs enable those who wish to grow their retirement wealth to reach for the stars, but only if they keep their feet firmly on the ground.