If you have a self-directed IRA, your investment choices are not restricted to just stocks, bonds, and CD’s. You can diversify your portfolio, reduce your risk and possibly increase your return by incorporating such investments as gold, real estate, foreign currency, structured settlements, oil and gas leases, etc. Your possibilities are almost endless…in fact, instead of listing the things that are allowed, the Tax Code only addresses those investments and activities which are prohibited, leaving everything else available to you.
Even though there are very few prohibited investments, custodians are free to allow whatever they want, so if yours says you can’t invest in, say, real estate, the only recourse you have is to move your funds to a more lenient custodian (and there are many of those).
We will be covering investment alternatives in future articles, but now I want to start with a discussion of what you can’t do in your IRA.
The restrictions imposed by the Tax Code fall into 2 categories: Prohibited Investments and Prohibited Transactions.
Prohibited Investments
The following investments are disallowed in an IRA:
- Life Insurance: This applies to any type (whole life, term, variable life, etc). No life insurance is allowed to be titled in the name of an IRA or qualified plan. There is one exception for a small policy that can be held in a qualified plan, but the amount of insurance must be negligible in relation to the size of the account.
- Certain types of derivative positons: The tax law prohibits the use of investments that have unlimited risk (such as the sale of naked call options). As well, some custodians do not allow investment in anything but selling covered call options. If you want to invest in other derivatives, you have to find a more liberal custodian, so be sure to check out their policies.
- Collectible coins: In order to be allowable in a retirement account, a coin must be pure in its mineral content and not be seen as a collectible. Some coins that are specifically allowed are: American Eagle coins (proof and non-proof), American Gold Buffalo coins (non-proof), American Silver Eagle (proof and non-proof), Austrian Gold Philharmonics coins, Canadian Maple Leaf coins. Krugerrands are specifically disallowed.
- Antiques/Collectibles: No antique or collectible is allowed as an investment in an IRA.
- Certain Real Estate: We will discuss this more in the section on Prohibited Transactions, but for now we will just say that you are not allowed to benefit directly from the real estate in your portfolio. For example, you cannot hold your primary residence in your IRA.
Other than that, all investments are allowed, which makes for a very large playing field.
The most common investment in IRA’s (other than stocks, bonds, and CD’s) is real estate (in all its many forms), and we will be discussing that in depth in future articles.
Prohibited Transactions:
Your IRA is meant as a way to save for retirement on a tax-deferred basis. It is not meant as a backup source of funding for your personal checking account. Therefore there are restrictions on what transactions can occur between your IRA and you and your immediate family
Your immediate family is made up of your spouse, children and their spouses, grandchildren and spouses, great-grandchildren and spouses, parents and spouses, grandparents and spouses, and great-grandparents and spouses. Also, the custodian of the account is treated as a fiduciary and therefore cannot transact directly with the account, either.
In essence, you and your family are not allowed to benefit personally from the IRA. Your IRA is a separate entity, and is meant for your future benefit, not a current asset. This would mean
- You cannot loan to or borrow from the account
- You cannot benefit personally from assets of the account. Therefore, you cannot buy a personal residence with IRA assets, but you can buy a home to rent to others.
- All revenue and expenses stay within the account. Therefore, any rental income goes into the account and all expenses of any property owned by the account must be paid from the account, not by you.
- You cannot use the account as collateral for a personal loan.
- The account cannot enter into any recourse debt (which means that you cannot sign a personal guarantee for a loan (ie mortgage) taken out by the IRA.
These are the major prohibitions, and apply to you and your “immediate family”.
It is important to understand this, even though your custodian has checks in place to assure that your transactions are all on the up-and-up. If there is a prohibited transaction, the funds involved are treated as a disbursement (or contribution) and are subject to any tax and penalties that would ensue if you had just withdrawn (or contributed) the same amount of money.
There are also some exclusions, exceptions, and other nuances outlined in the Tax Code, so don’t think that this is the last word on this subject. Your custodian can answer any questions regarding specific transactions that you may be contemplating.
In this article I am talking about IRA’s (Traditional and Roth). There are other types of retirements plans available to you that are not so restricted, and we will discuss them at a later time.
These rules are covered in the Tax Code sects. 408 and 4975 (in case you want some light reading or are having trouble getting to sleep some night). If you want something more reader-friendly, you can learn all you would ever want to know from IRS Publications 590 (IRA/Roth IRA) and 560 (SEP, SIMPLE and qualified plans).
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