With the higher levels of unpredictability and volatility that we’ve seen in the investment markets over the past few years, it’s important that you have the highest degree of flexibility in choosing your investments. In fact, having flexibility in your retirement accounts may be even more important than flexibility in your other investment accounts, because the longer time frame that most people have for retirement investing gives nontraditional investment types more time to bear fruit.
Unfortunately, many IRA custodians – such as your bank or discount investment broker – won’t permit you to make all the investment types that are authorized under the rules governing IRAs. To take full advantage of the IRA savings vehicle, you’ll likely need to open a self-directed IRA with a custodian such as Quest Trust Company.
Traditional and Roth IRAs are actually quite flexible. You are legally permitted to buy and hold a wide range of asset classes, including real estate, private equity investments, tax liens, mortgage loans and certain types of precious metals. Unfortunately, many retirement savers are under the misimpression that these types of investments are prohibited, simply because most custodians won’t allow their clients to make them. A self-directed IRA with a custodian like Quest Trust Company opens up these investments.
But while you’ll have greater flexibility in a self-directed IRA, you’ll still need to make sure that you follow the rules that do apply. Your custodian can assist you in complying with the rules, but ultimately it’s your responsibility to know what is permitted and what is prohibited. For example, not every single type of investment is permitted within a self-directed IRA. For example, you can’t invest in collectibles (so while investments in gold bullion are generally permitted, investments in rare gold coins are not), artwork or life insurance policies.
Furthermore, the self-dealing rules governing IRAs still apply to self-directed accounts. This means that while you can’t hold real estate in an IRA for investment purposes, you can’t use that property yourself. So you can buy your future retirement home with a self-directed IRA, but you can’t actually use it until you retire and “distribute” the property to yourself.
Since self-directed IRAs are becoming more popular, you may have heard some custodians tout the concept of a “checkbook control” IRA account. These custodians claim that you can achieve an even greater degree of flexibility by setting up a limited liability company (in which you are the sole managing member), then having your self-directed IRA purchase all of the interests and that LLC. The supposed result being that your IRA holds all the economic interests in the LLC but you still control it personally through your managing member role (including the right to write checks to make investments using the LLC’s assets). The problem is that this structure has never been explicitly approved by the IRS, and there is much concern that it wouldn’t hold up upon closer inspection. The risks of pursuing this strategy are significant, because having it struck down would mean that you’ve taken an early distribution from your account, which would trigger immediate taxes and substantial penalties.