The legal landscape surrounding specialized retirement accounts – like the self-directed IRA – seems to constantly be in flux. What’s important is that you know your rights.
Awareness of this unique individual retirement account is growing substantially, with recent press coverage from respected sources including:
This coverage – while frequently critical of the concept of self-managed retirement investing – is nevertheless fundamentally positive for the future of this booming financial niche.
What’s poorly understood, however, is the fact that these accounts are not a free-for-all for their owners. There are limitation, some clear and some wholly unclear, over which individual investors cannot run roughshod.
The Internal Revenue Service stipulates a group of activities known as prohibited transactions, which are actions that are prohibited to retirement account owners and rather severely punishable. The punishment for such activity isn’t set in stone, but is calculated as a function of taxes, penalties and interest on a case-by-case basis. It is rather common for a prohibited transaction to cost an account owner half or more of the value of their account.
- Borrowing money from your own account (certain withdrawals are allowable for emergency expenses)
- Personally occupying real estate that has been purchased in your self-directed account as an investment
- Using your retirement account to buy certain types of prohibited assets, like artwork or collectibles
- Allowing your account to buy from, sell to, lease from/to or otherwise conduct transactions with any disqualified person
These things are clear limits on your rights, but it’s far better to know your true rights rather than to violate the law in ignorance.
You may recall that committing a prohibited transaction can easily result in the loss of half or more of your self-directed IRA to taxes, penalties and interest. There are two reasons for this:
- When a prohibited transaction is committed, the account owner is quite certainly unaware of the error. As a result, it’s usually years before the error is discovered in audit, during which time taxes, penalties and interest are accruing at an alarming rate
- Committing a prohibited transaction with any asset in your self-directed IRA causes the entire account to be “downgraded” to non-IRA status and subject to penalization. In other words, any error with any asset renders the entire account punishable.
Nevertheless, the opportunity to full drive your own investment choices through this type of financial account with such tremendous tax advantages is, without a doubt, a huge opportunity.
The astute retirement planner will remember to always err on the side of caution and routinely seek the advice of highly qualified professionals when selecting and implementing investments in a self-directed IRA. Because while the potential in these tax-favored accounts is very high, the risk and cost of error is very high as well.