When you open an IRA at a bank or brokerage firm, you’re typically limited to choosing their investment products.
And your investment choices are pretty much limited to stocks, mutual funds and bonds.
But some investors want to do more with their IRAs and invest in nontraditional inves
tments such as real estate, hedge funds or limited partnerships.
That’s where a self-directed IRA comes in.
“People are seeking higher returns than what they’ve seen in their mutual fund accounts,” said Adam Bergman of the IRA Financial Group, which helps investors set up self-directed IRAs. “They’re also seeking to diversify so that their entire retirement doesn’t ebb and flow with just the stock market.”
So what is a self-directed IRA?
“The term self-directed does not actually have any legal connotation,” according to Pensco Trust Co. “It does not imply a different type of IRA or a separate set of IRS rules. Self-directed is simply an accepted industry term indicating that the IRA custodian is allowing the IRA owner greater control over their investment decisions.”
Firms that help investors set up self-directed IRAs say business has been growing.
Business at Pensco has doubled in the past five years, said Chief Executive Kelly Rodriques.
Before you venture into a self-directed IRA, make sure that you’re participating in your employer’s 401(k) plan — especially if it matches your contribution. Then look to an IRA if you have funds left over for savings.
Here’s what you need to consider:
Your knowledge level. How knowledgeable are you about the investments you want to put in your self-directed IRA? “If you have no comfort in real estate, then maybe you shouldn’t be using a good portion of your retirement funds to buy real estate,” Bergman said. “If you don’t feel (precious) metals are going to be a strong investment, maybe you don’t want to buy it.”
The long haul. Can you hold the asset in your IRA for the long haul?
You should be investing your retirement money for the long term anyway, but it’s especially critical with nontraditional investments.
Know the rules. It’s critical to know the rules because if you trip up here, the Internal Revenue Service could disqualify your IRA and you could end up paying income tax and a penalty that could jeopardize your funds.
For example, there are certain “prohibited transactions,” such as using IRA funds to buy collectibles or a life insurance policy or to lend to a family member.
Be prudent. “Sometimes an IRA is a great place to focus on that part of your portfolio where you don’t have to worry about capital gains and losses (because of tax deferral), so you can use that IRA as a place to do a little more active trading strategies,” said Wade Chessman, president of Chessman Wealth Strategies in Dallas.
Stay vigilant. Always investigate anyone who pitches you an investment.
“There are people who routinely set up investment scams to prey on the elderly,” Rodriques said. “If someone is approached with an investment that allows them to put retirement money into it, you need to scrutinize who that investment sponsor is.”
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