When starting a self-directed IRA, there are certain rules surrounding their creation and management that can trip up novice and experienced investors alike. Familiarizing yourself with some of the more common mistakes that investors make can save you money and the headache that comes with dealing with the repercussions. We’ve compiled a short list to help you get started on the right track.
- Allowable Investments — The IRS has a few limitations on the types of investments that you can make with your IRA, but they only describe what you cannot invest in. It helps that the list is fairly short and can be summed up easily. Collectibles of most types, life insurance, derivatives, and most coins. This still leaves a vast array of alternative asset types for an investor.
- Prohibited Transactions — Prohibited transactions are any transactions that can disqualify your IRA. It will be treated like a fund distribution, taxed, plus any penalties associated with an early distribution. In a worst case scenario, the entirety of your IRA can be disqualified, not just the amount involved with the prohibited transaction.
- Disqualified Persons — A disqualified person is anyone who cannot participate directly in your investment without triggering a prohibited transaction. Any family members to whom you are related through lineal descent or ascent and the fiduciary are all considered disqualified persons.
- Using LLCs Dishonestly — While LLCs are allowed in an IRA, some investors may imagine using one to avoid paying certain taxes. The best advice here: don’t. Even the most savvy of tax skirters can be caught. The penalties and risks aren’t worth any perceived reward. Uncle Sam can be harsh when he thinks you aren’t paying all of your taxes. There are legal ways to use an LLC in an IRA, and investors considering this route should consult closely with a tax professional to ensure they remain in the IRS’s good books.
- Withdrawing to Invest in Alternatives — Some investors who are still new to the idea of investing with an IRA make the mistake of taking an early distribution in order to invest in an alternative asset. They take an unnecessary penalty for their inexperience with IRAs and the types of investments allowed within them.
- Lacking Due Diligence — On the back of having the freedom to invest in the type of assets you want comes the responsibility to do the proper due diligence on that investment. Investors can be sold on an asset by a salesman and make investments without doing their due diligence. No investment is without risk, and potential investors should do extensive research on how and where they could potentially lose money on that investment.
The control afforded to investors when they choose a self-directed IRA can give a sense of freedom few other retirement options can match. Investors are free to invest in what they know but are also free to make mistakes. By educating yourself and consulting closely with a tax professional before making major investment decisions, you can confidently invest in alternative assets for your retirement portfolio.