I’ve been learning a bit more about Individual Retirement Accounts and wanted to share a few things I’ve learned about how flexible IRAs actually are. Obviously talk to a qualified financial advisor before acting on anything you see here. If I got anything wrong, please let me know in the comments where everyone can read it.
Most people think of IRAs as being something you can invest in stocks, bonds, mutual funds and that is about it. If you really look at the law, it is much more generic than that. In fact the actual tax law only lists a handful of things that IRA can not be invested in. Here is the list:
- Life Insurance Contracts
- Alcoholic Beverages
- S Corporation Stock
Obviously that leaves a great number of things that you can invest IRAs in that most people don’t have access to. For example, you can invest your IRA funds in:
- Residential Real Estate
- Private Loans
- Tax certificates
- Automobile Loans
- Trust Deeds and Mortgages
- Private Stock
- Commercial Paper
And other investments. Most brokers however, aren’t interested in the paperwork and hassle of making these types of investments, so they restrict your account to stocks, bonds and mutual funds. If you are interested in making these types of investments with your retirement accounts, you need to look into something called a Self Directed IRA. A Self Directed IRA is setup where you can find pretty much any investment and have your broker cut a check to invest in it. The other IRA rules are all the same. It just opens up a bunch of different types of investments that you normally don’t have access to through your broker.
Obviously this is a lot more work for the broker, so you may need to find one that specializes in self directed IRA investments and you may have to pay much higher fees. Some brokers handle this through a Checkbook IRA LLC. The tax law says that you can’t just have the ability to write a check from your brokerage account for your retirement funds. However, your broker can start a limited liability company and fund it with your IRA funds. Then they can make you the manager of that company and give you the authority to write checks. Technically the LLC is owned by the brokerage who is holding it for your retirement account which you own.
This type of setup minimizes the hassle for your broker and gives you the ability to make investments without needing to go back to the broker every time you want to cut a check. Of course there are a lot of rules that go along with this type of setup. In general, you can’t invest money in ways that will benefit you or your relatives now. So you can’t invest in your spouse’s new business. However you can potentially invest your friends new restaurant or a small startup.
When you retire, the assets in your LLC can be withdrawn just like in a normal IRA. If it is a traditional IRA, you’ll have to pay taxes on the value of the assets. If it is a Roth IRA the assets are tax free. So what some people have done is create a Checkbook IRA LLC to get access to the IRA funds and then buy a home where they plan to retire. Then they rent out the home to generate some income. When they reach retirement age, they can move into the property as their own, with no taxable income (because it was a Roth IRA where the tax is paid up front).
In discussing this with my accountant he pointed out that the fees involved would eat away at any potential return. More importantly, he said you would need to provide a valuation of the selfdirected IRA annually, which in the case of property would require an appraisal (another $200-$500 down).
I don’t know if this is accurate or just an uneducated person trying steer me away. Interested in your thoughts.
Mark Shead says
I have seen some places offer to setup the Checkbook IRA LLC structure and run their end of things for $100 to $200 per year. As far as needing to do an appraisal each year, I’m not sure about that requirement. As far as I know the value of a traditional IRA doesn’t need to be reported, so I’m not aware of a requirement like that for a self directed IRA.
Now there are some special requirements if you use partial IRA funds and a mortgage. That type of arrangement might require some additional reporting because you have to pay some type of tax on the amounts attributed to income from the mortgaged portion of the investment.
Obviously this isn’t a good way to invest $5,000. But it could be a good way to invest $50,000 if you can find the right investment.
Also, if you have a 401k, it sounds like you can do the same thing, but there are less regulations because it doesn’t have to be held by a trustee like an IRA does.
Most of the CPA’s I’ve tried to work with seem very focused on doing their work and not very focused on keeping current on tax law changes, etc. I’m sure there are exceptions, but that has been my experience. This means if you want to do something that 90% of people aren’t already doing, your current CPA is probably not going to know much about it and you’ll need to check with someone else. Obviously, don’t completely dismiss what your current accountant is telling you, but don’t expect them to be experts on areas that they have never done any work in the past.
I have been researching the self-directed IRA also. I have found that while the value of the IRA is reported annually, in the instance of real estate, most companies that I have talked to only require a new value every three years as long as you do not take it out of the account. In addition, I have found at least one company,www.getmyra.com, that would accept a brokers price opinion, which would be cheaper than a full appraisal.
I am still researching the whole checkbook IRA LLC, to ensure that i understand the rules well enough. I do not want to mess up and enter into a transaction that ruins my IRA
Mark Shead says
From what I’ve read, a 401k can be invested in the same things, but you aren’t required to have it held by a trustee. If this is true a 401k might be even more flexible than an IRA for this type of investing. Some of the stuff I’ve read about Checkbook IRA LLCs suggest that there haven’t been a lot of court cases involving them so the one case where they came up make them look legal, there may still be some issues to iron out. However, if you are doing it with a Roth, the risk should be much lower because you’ve already paid taxes on the original investment.
Why there may not be the need for a trustee on the 401(k) would it still need a custodian to hold the assets? I have thought about a solo 401(k), but I was under the impression these would require a custodian also and I would still be in need of someone that would allow non traditional assets.