Frequently Asked Questions of Self Directed IRA's
1) What is ERISA?
The Employee Retirement Income Security Act (ERISA) passed the
responsibility of retirement savings from the employer to the
employee. IRAs were created in 1975 to provide individuals a
chance to direct where their retirement funds were invested. Rather than distinguishing
which investments are allowed, the IRS code instead identifies
which investments are not permitted under these laws.
Only two types of investments are excluded under ERISA and IRS
Life Insurance Contracts Collectibles such as works of art,
rugs, jewelry, etc. IRS Code Sec. 401 IRC 408(a) (3)
2) Why haven't I heard about this?
Once ERISA was passed, the securities markets were responsible
for bringing the IRA and 401(k) to the mass market. The banks
and brokerage houses created a misconception that buying stocks,
bonds and mutual funds was all that was allowed through
retirement products such as an IRA. This is 100% false! Banks
and brokerage houses have a vested interest in having you invest
in stocks, bonds and mutual funds-not real estate, businesses
and other non-traditional investments. Do not let their
interests, or the lack of knowledge on the part of your
financial advisor limit your ability to maximize the investment
potential of your retirement accounts.
3) What kind of retirement funds am I able to use?
It is possible to use funds from most types of retirement
Traditional IRA Roth IRA SEP IRA Keogh 401(k) 403(b) And many
more! It must be noted that most employer sponsored plans such
as a 401(k) will not let you roll your account into a new
vehicle while you are still employed. However, some employers
will allow you to roll a portion of your funds. The only way to
be completely sure whether your funds are eligible for a
rollover is by contacting your current 401(k) provider.
4) How many people have self directed IRA accounts?
The self directed industry is growing at a rapid pace and is
expected to see upwards of $2 trillion enter the market over the
next two years. Some of the latest numbers show over 45 million
IRA holders in the U.S. and less than 4% of those funds are held
in non-traditional assets. This number is expected to increase
significantly over the next 5 years as more and more individuals
and their financial advisors attain a greater awareness of
5) Are there limits to the investments I can make?
Yes. As discussed previously, you cannot invest in Collectibles
or Life Insurance Contracts. In addition, there are certain
transactions in which you cannot participate when using IRA
funds. These are referred to as "prohibited transactions".
Prohibited Transactions are defined in IRC 4975(c)(1) and IRS
Publication 590. They were established to maintain that
everything the IRA engages in is for the exclusive benefit of
the retirement plan. Professionals often refer to these as
"self-dealing" transactions. Self-dealing occurs when an IRA
owner uses their individual retirement funds for their personal
benefit rather than to benefit the IRA. As an IRA owner, if you
violate these rules, your entire IRA could loose its
tax-deferred or tax-free status. It is very important that you
work with competent professionals to help avoid violating these
6) Specifically, what are prohibited transactions?
IRC 4975(c) (1), identifies prohibited transactions to include
any direct or indirect:
Selling, exchanging, or leasing, any property between a plan and
a disqualified person. For example, your IRA cannot buy property
you currently own from you. Lending money or other extension of
credit between a plan and a disqualified person. For example,
you cannot personally guarantee a loan for a real estate
purchase by your IRA. Furnishing goods, services, or facilities
between a plan and a disqualified person For example, you cannot use
personal furniture to furnish your IRAs rental property.
Transferring or using by or for the benefit of, a disqualified
person the income or assets of a plan. For example, your IRA
cannot buy a vacation property you or your family intends to
use. Dealing with income or assets of a plan by a disqualified
person who is a fiduciary acting in his own interest or for his
own account. For example, you should not loan money to your CPA.
Receiving any consideration for his or her personal account by a
disqualified person who is a fiduciary from any party dealing
with the plan in connection with a transaction involving the
income or assets of the plan. For example, you cannot pay
yourself income from profits generated from your IRAs rental
property. If you participate in a transaction which does not fit
SPECIFICALLY within these guidelines, the Department of Labor or
the IRS will analyze the specific facts and circumstances in
order to decide whether you have engaged in a prohibited
transaction. A Retirement Account Facilitator can help educate
you regarding how these may apply to investment you are
7) Who are disqualified parties?
Many of the prohibited transactions are the result of a very
Plan (or plan asset) + Disqualified person = Prohibited
A plan is defined to include tax-qualified plans, IRAs and other
tax favored arrangements. For the complete definition you can
reference IRC 4975(e) (1). A disqualified person (IRC 4975(e)
(2)) is defined as:
The IRA owner The IRA owner's spouse Ancestors (Mom, Dad,
Grandparents) Lineal Descendents (daughters, sons,
grandchildren) Spouses of Lineal Descendents (son or
daughter-in-law) Investment advisors Fiduciaries - those
providing services to the plan Any business entity i.e., LLC,
Corp, Trust or Partnership in which any of the disqualified
persons mentioned above has a 50% or greater interest.
8) Why are these rules considered to be complex?
These rules exist to ensure that your IRA does not engage in any
investment activity other than for the exclusive benefit of the
IRA. There are many types of investments which violate this law.
For example, buying a house and then letting your mother rent it
would potentially create a conflict of interests. If your
mother, who was making rent payments, all of a sudden could not
- you would be conflicted from evicting her and finding a more
reliable tenant You would
then have a conflict of interest between your relationship with
your mother and what is in the best interest of your IRA. These
rules were put in place to help avoid these sort scenarios. See
9) If my brother in not a disqualified party, then can I buy a
house and let him rent it from me?
Theoretically yes. Your brother is not a disqualified person.
However just like the scenario mentioned above, if he occupied a
rental property owned by your IRA and could not make the
payments, you could run afoul of the exclusive benefit rule.
This could cause your IRA to have participated in a prohibited
transaction. It is important that you treat every investment the
same - to benefit your IRA and only the IRA.
10) What is the consequence of a prohibited transaction?
If an IRA holder is found to have engaged in a prohibited
transaction with IRA funds, it will result in a distribution of
the IRA. The taxes and penalties are severe and are applicable
to all of the IRA's assets on the first day of the year in which
the prohibited transaction occurred.
11) How do I make sure that I am following the rules?
As mentioned previously, the IRS does not identify what
investments or transactions you can make in your IRA. They
instead state which investments are prohibited and what makes
certain transactions prohibited. Identifying, interpreting and
following these rules can be complicated, but not impossible.
Utilizing a Retirement Account Facilitator and other specially
trained professionals can help you follow Internal Revenue
guidelines and steer clear of prohibited transactions.
12) My CPA and Financial Advisors say this is illegal. Why?
It may be they are influenced by self interest or they are
simply uninformed. Often times an individual will ask their CPA,
Attorney or Financial Planner for advice and in turn are told:
"That's illegal." "You can't do that." "It is very risky."
Attorneys stick to their core competencies and rarely deviate
from them: Tax preparers are tught to do just that -
prepare taxes. Your financial advisor's company or agency may
either be disinterested in this type of business or have not
been educated regarding this type of investing format: A stock
broker makes money when they sell stocks, bonds and mutual funds
- not real estate or other types of investments..
13) What is a self directed IRA custodian?
The Custodian is a bank or savings and loan association, as
defined in IRC 408(n), or any other entity that has the approval
of the IRS to act as Custodian. In order to have a self-directed
IRA, it needs to be held with a Custodian who will allow
investments into non-traditional investments. There are very few
of these types of custodians.
A Retirement Account Facilitator, like the Guidant Financial
Group, sets up the legal structure such as an LLC or C
Corporation that allows for checkbook control of the funds. The
Facilitator, unlike the Custodian, does not hold the funds, but
usually contracts with a Custodian to hold the funds as part of
the services provided.
14) Why are there not more of these custodians across the
There are very few non-traditional IRA custodians simply because
the business is not as profitable as it is for the brokerage
houses. It requires many more hours to complete a real estate
transaction than to purchase stocks over an electronic system. Traditional banks do not
compete because it does not fit within their business
objectives. They make money by leveraging the dollars you have
sitting in their accounts.
15) Is my money safe?
A custodian must be a registered Trust Company. For one to
register as a Trust Company the institution must meet stringent
state requirements and have adequate reserves. Your money is
kept in a separate account for your benefit and not subject to
creditors of the custodian. Further, if your funds have been
placed into an LLC or C Corporation, the custodian never has
control of your money - YOU DO! You are ALWAYS in control.