Lawyers Journal

The truth about non-traditional investments in IRAs

Many consumers and professionals are not aware that the rules governing Individual Retirement Accounts permit a wide array of investment choices for IRA owners and investors. The knowledge of these opportunities is even more valuable in today's economic environment, where more traditional investments such as CDs, mutual funds and public stock have drastically dropped in value or in returns for IRAs.

As a legal professional, you should be aware of the alternatives for IRA investments, in order to assist your clients with their financial planning and retirement needs. First, you may be surprised to know that the regulations governing IRAs, under IRC 408 code, and summarized in IRS publication 590, only restrict investments in collectibles (e.g., artwork, antique cars) and insurance as prohibited investment types. In addition, certain transactions are prohibited, such as party-in-interest transactions (e.g. dealing with a disqualified party such as a trustee or a lineal ascendant/descendant of the IRA owner) as defined in IRC 4975, personal loans and using your IRA collateral for a loan. Therefore, by omission, all other investments are permitted.
Typically, institutions that are licensed to administer IRA accounts, such as banks, credit unions, trust companies or savings and loan institutions, are automatically qualified.
Others, however, such as broker/dealers and mutual fund companies, have to be separately, licensed by the Employee Plans Division of the IRS (Treasury Department) and restrict their IRA clients to a limited set of investments. They do so for several reasons.
First, if they offer investment advice, sell investment product, or have discretion over the management of investment assets, they will be concerned about the liability associated with the purchase and/or administration of any non-traditional investment. Second, their specific structure or license may restrict them from certain type of investments. Third, they may not be organized to profit from any investment other than their own proprietary investments (e.g., mutual fund companies). Consequently, the vast majority of institutions offering IRA servicing do not promote the fact that clients can choose from a variety of investment options for their IRAs.
Since most financial providers don't allow their clients to diversify their IRA holdings, how can a client take advantage of the regulations? It's simple — they must establish a "Self-directed IRA" with an institution that offers them and does not restrict the choice of investment. But they are only self-directed in the sense that clients make the investment decisions and choices independently (e.g. without advice or discretion by the provider). All of these institutions still restrict the type of investment to publicly traded investments.
True self-directed IRA custodians/trustees allow clients to select from any type of investment. Such investments as real estate, LLCs, partnerships, commercial property, and all forms of private placements are possible choices for clients of firms that are truly self-directed.
While clients can still include traditional investments such as stocks and mutual funds within their self-directed IRA, they also have the freedom to diversify their portfolio by adding a piece of real property or private stock. Such institutions serve as a vital source of funds to new and emerging companies by assisting individuals, including "angel" investors, to make capital and debt investments in such firms. In many cases, these investors have large sums of money accumulated in their retirement accounts, which they can now put to work in non-traditional investments through the services of self-directed IRA institutions.
The upshot is that when your client mentions a desire to invest in a friend's startup or to buy a retirement home using his or her IRA, be aware that both are quite possible through an established and experienced financial institution specializing in truly self-directed IRAs.For more information about IRAs and alternative investment options, call Tom Anderson, president & CEO, PENSCO Trust Company at (800) 969-4472, ext. 5608.

©2017 Massachusetts Bar Association