IRAs--They're Not Just for Stocks, Bonds, and Funds

Mention an IRA, and most investors probably think of a long-term savings vehicle that holds only securities such as stocks, bonds, and mutual funds. But the IRA wrapper also can be applied to many other investment types, including real estate, precious metals, and equity in privately held companies.

The vast majority of IRA assets are invested stocks and bonds but a small segment--estimated at about 2% of all IRA assets--are held in so-called self-directed IRAs, which may be established through a custodian or trustee and which can hold a much broader range of investment types.

What You Can and Can't Invest In - Tom Anderson, president of the Retirement Industry Trust Association, a trade group representing the self-directed retirement-plan industry, says that about 40% of the $50 billion in assets that the group's members manage is held in real estate--everything from income-producing properties to time-shares to co-ops. In fact, self-directed IRAs can be invested in just about anything with a few exceptions. Among these are collectibles, so forget about putting that Picasso original or '57 Chevy in your IRA. Life insurance also may not be put inside a self-directed IRA, nor can stock in an "S" corporation, which is a special type of corporate structure in which taxable income is passed on to shareholders.

Holding assets such as real estate or private equity within the IRA wrapper means enjoying tax-free growth and compounding, just as it does with stocks, bonds, and funds. A self-directed IRA also may use the traditional, Roth, or SEP IRA format, meaning that you could get a tax break during the contribution or distribution phase. For example, if you used money from a self-directed Roth IRA to invest in a rental property, not only would income be added to the account tax-free, but any proceeds from sale of the property would be tax-free, as well (once the account holder turned 59 1/2).

Rules Against Self-Dealing - Because they can hold such a wide array of asset types, self-directed IRAs tend to appeal to investors looking to diversify their retirement holdings and reduce correlation with stocks. The self-directed IRA is often used to complement, rather than replace, a more traditional IRA invested in stocks, bonds, and mutual funds. "Most of these IRAs are created as a result of someone working for 15-20 years, changing jobs, and rolling over [a piece of] their 401(k) into a self-directed IRA," Anderson says.

The rules governing self-directed IRAs can be tricky, however, so make sure you understand them before opening an account. For example, there are strict rules against so-called self-dealing, which means that IRA money may not be used to invest in a property that the account holder or a direct family member will use. Thus, buying a vacation home with an IRA and using it for trips with the kids or grandkids is not allowed. That's because the Internal Revenue Service requires that the investment be for the benefit of the IRA account exclusively--in other words, that its sole purpose is to potentially help the account increase in value as opposed to any ancillary benefit to the account holder or his family.

Before opening a self-directed IRA, you should think long and hard about whether it's the right choice for you. If you plan to invest funds in unregulated securities it's always best to get a second opinion from a trusted source such as your financial advisor if you have one. Aside from that, you'll need to keep in mind considerations such as fees charged by the custodian, how accessible the money will be if you need access to it in a hurry, and other factors.

A self-directed IRA can be an effective way to add diversification to your retirement portfolio, especially for wealthier investors concerned about having too many of their assets correlated to the stock market. But it's a strategy that takes careful planning and, most of all, due diligence.

Source:  Morningstar

Self Directed IRAs require a special self directed administration company.  D2 Capital Management uses the services of NuView IRA for those clients who desire to self direct their Individual Retirement Accounts.  D2 Capital Management may receive compensation for this.

The information contained in this article does not constitute a recommendation, solicitation, or offer by D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.

 

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