But watch out for the pitfalls of self-directed IRAs. If you run afoul of tax laws, you could be in serious trouble.
By Kiplinger's Personal Finance Magazine
Stocks, bonds and mutual funds have a place in any IRA, but perhaps your retirement plan has room for a racehorse or a restaurant. Many individuals who are not satisfied with returns on conventional investments are plowing some of their IRA money into everything from commercial buildings to community banks using self-directed IRAs. (Read about "self-directed" IRAs in "Ground your retirement fund with real estate") Just about any investment is allowed except for life-insurance contracts and collectibles.
Vincent McCord is a convert. Three years ago, McCord, 59, invested the $250,000 in his IRA as a limited partner in two apartment complexes and a small shopping center in Las Vegas. When two of the ventures were sold, McCord, who runs a semiconductor startup in San Jose, Calif., rolled his profits into two real-estate properties in Phoenix. He's also invested in a commodities fund and a yearlong promissory note from a company offering him 20% in interest. The value of his IRA has doubled, he says.
Although only a small percentage of IRAs are self-directed, the numbers are growing, according to custodial firms that handle the record keeping for these accounts. Hugh Bromma, chief executive officer of Entrust Administration, based in Oakland, Calif., says his company has $2 billion in assets, up from $350 million five years ago. Assets under management at Pensco Trust Co., in San Francisco, have grown to $1.6 billion today, up from $758 million at the end of 2004, according to CEO Tom Anderson.
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But as with any investment, you can lose money. What's more, the rules governing these transactions are complex. Advisers warn not to place more than 25% of your IRA savings into alternative assets. "Self-directed IRAs are not for those who lack sophistication," says Franklin Federmann, a certified public accountant in Ronkakoma, N.Y. "There are substantial tax pitfalls if they're not set up correctly."
Danger in "self-dealing"
The biggest risk is "self dealing," using tax-deferred money for current personal use. If the IRS finds you're violating self-dealing prohibitions, it could disqualify your IRA's tax-deferred status and force you to pay income tax on the full value. Account owners younger than 59 would face early-withdrawal penalties.
You're not allowed to invest your IRA in a vacation house that you use, for instance, nor can you rent property to most family members. It's also tricky to use your IRA to invest in your own business. "You can't start a business with an IRA with the intent to employ yourself," Anderson says. But it may be okay if your IRA is a minority stakeholder, he says, and the other investors decide to hire you.
No matter what the investment, make sure you do your homework. "To do this right, you really need to spend the time," says Bromma. For example, if you want to invest in a restaurant, look at available capital, the chef's qualifications and local competition.
It's best to stick with something familiar -- a community bank may be an option if you're already in the banking field. And make sure a lawyer or accountant reviews any contract, especially if there's a risk of self-dealing. Also, some investments could require regular outlays from your IRA that could chip away at your retirement nest egg -- fix-up costs for some real estate holdings, for instance.
Consult an expert
When it comes to taking minimum required distributions at age 70, you'll have to sell off part of your investments if you don't have liquid assets in another IRA. If you can't sell it, you may have to retitle part of it outside your IRA. You'll have to pay taxes on the value of your titled share.
To set up such an IRA, you'll need to go to a specialist, such as Entrust, Pensco, Trust Administration Services and Sterling Trust. Pensco's charges, for example, are $50 to set up an account and then a yearly maintenance fee based on the amount of assets (say you have a $250,000 account, the fee would be $750).
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