A self-directed IRA can be a powerful tool for doctors and business owners if used the right way, but there are very specific rules you must know and comply with. We’ve turned to an expert self-directed IRA administrator to help with some common questions and legal pitfalls to avoid.
As an asset protection attorney I like any financial strategy that also offers creditor protection by statute as the IRA does, to some degree in nearly every jurisdiction. Until recently, most IRA accounts held only conventional investments like stocks, bonds, and securities. Today, a growing number of clients and advisors are moving outside that narrow box to include a wider variety of alternative investments in their self-directed IRAs (SDI), including real estate, private placements, precious metals, and private placement deals. They are even using investments to purchase active businesses, including medical practices. While the widespread use of IRAs in this way is relatively recent, many of these options have been widely available for more than 30 years.
The IRS has specific rules on how you can do this and in most cases it is recommended that you use the help of a SDI administrator for required filings, legal structures, reporting, and compliance. One such professional is Alan Smalls, business development manager with Accuplan in Phoenix, Ariz., who works with variety of national clients to help them use their retirement savings more effectively. Smalls answered some key questions and shared specific techniques; I’ve summarized his valuable information below.
What is a Self Directed IRA (SDI)?
It is a formal structure that allows you to invest all of the conventional investments you are used to seeing in IRA (and 401K) structures plus many others including foreign currency, limited partnership deals, commercial paper, notes, active businesses, and precious metals. It can even facilitate loans to third parties. This great flexibility is achieved inside a managed structure that you control and make investment decisions for. The idea is that you can use your personal knowledge, connections, and network to help spread risk and increase the productivity of your investment account beyond just the conventional financial market options you are used to seeing.
What does the SDI administrator do for me?
While these plans are unbelievably flexible they do require specific compliance and in some cases, as in the purchase of a business, legal structures in order to fly with the IRS. A professional plan administrator is a third party that will advise you on these issues, help establish any required plan and structures, and completes the documents required for you to be inside the law. Without this ongoing guidance you could loose the tax-exempt or deferred status of the investment, have contribution deductions disallowed, and possibly even be subject to fines and penalties.
Why Hasn’t My Financial Advisor Told Me about This?
Many advisors typically don’t have a detailed knowledge of the intricacies of these programs and how flexible they can actually be beyond that fact that they exist. They simply have not been trained to advise you in the right way and avoid the discussion altogether. Second, based on the author’s experience, many advisors are limited in what they talk about by their advisory firms to a narrow universe of conventional investments that both limit their liability and focus on things they sell or can receive management fees on.
What Can’t I do with an SDI?
SDIs are meant to benefit you after you retire, not before, so transactions that provide immediate gain to you (or any “disqualified person”) as the account holder may be prohibited.
Some specific examples of things you can’t do include, but are not limited to:
• Borrowing money from the SDI
• Sell, exchange, or lease property to the SDI
• Use the SDI as collateral for a loan
• Transfer income or lend money to any disqualified person
• Receive “unreasonable” compensation for managing IRA assets
Who are “Disqualified Persons” in IRA and 401K language?
1. The SDI account holder and their spouse
2. The SDI account holder’s parents, children and their spouses
3. Plan investment managers and advisers
4. Any trust, partnership, or corporation in which you, the account holder, have a 50 percent or greater interest
5. Any trustee, custodian, or third party who provides services to the SDI
Now that you know the basics, we will continue the discussion next week with a look at how an SDI can be used to purchase real estate or a business.