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September 8, 2021

Choosing Your Own Investments with Self-Directed IRAs


A “self-directed” IRA may allow you to increase the benefits of a traditional IRA or Roth IRA—self-directed IRAs can hold nontraditional investments of your choosing and may offer greater returns. However, you should be aware of certain pitfalls that can sometimes result in unfavorable tax consequences.

Using IRAs for estate planning

Although IRAs were primarily designed to help secure retirement savings, a well-designed IRA can also serve as a tax-advantaged estate fund for your family. For instance, if a spouse is named as the beneficiary of your IRA, they’ll be able to roll the funds over into their own IRA after your death, which will allow the funds to continue to grow on a tax-deferred basis (or on a tax-free basis if the IRA is a Roth IRA).

Self-directed IRAs

Unlike other IRAs, self-directed IRAs allow you complete control over your investment decisions. 

While traditional IRAs usually offer a limited selection of investment types including stocks, bonds, and mutual funds, self-directed IRAs enable you to select from almost any type of investment—including real estate, closely held stock, loans, limited liability company and partnership interests, precious metals, and commodities like lumber, oil, and gas. 

Due to this added flexibility, self-directed IRAs may potentially offer you higher returns while still giving you the same estate planning benefits you’d receive through a traditional IRA. With a self-directed IRA, you’ll be able to transfer almost any type of asset to your heirs while retaining the tax advantages of an IRA. A self-directed Roth IRA can even allow you to secure tax-free investment growth for your assets.

Potential issues with prohibited transactions

When establishing a self-directed IRA, prohibited transaction rules are the biggest potential pitfalls to watch out for. Prohibited transaction rules are intended to limit dealings between the IRA and “disqualified persons,” such as account holders, businesses controlled by account holders or their families, certain service providers or IRA advisors, and certain members of account holders’ families.

Among other prohibitions, these persons are barred from receiving compensation from the IRA, personally using IRA assets, selling property or lending money to the IRA, buying property from the IRA, guaranteeing a loan to the IRA, pledging IRA assets as security for a loan, and providing goods or services to the IRA.

Engaging in a prohibited transaction carries a severe penalty: the IRA involved in the prohibited transaction is disqualified and all of the IRAs assets are deemed to have been distributed on the first day of the year that the prohibited transaction took place in, subject to income taxes and also potentially subject to penalties.

Because of these prohibited transaction rules, it’s almost impossible to manage a business or other investments that are held in a self-directed IRA. As such, forming a self-directed IRA isn’t recommended unless you intend to take a purely passive role toward the IRA’s assets.

Contact us today if you have questions or need help setting up a self-directed IRA.

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