An IRA can be a valuable tool in anyone's retirement and estate planning toolbox. But what if you're not satisfied with your investment options or portfolio performance? One option, particularly if you're a knowledgeable and experienced investor who wants broader diversification, is to set up a "self-directed" IRA.
Traditional IRAs typically offer investors a limited menu of stocks, bonds and mutual funds to choose from. Self-directed IRAs, on the other hand, can generally hold these, plus a variety of alternative investments that may offer the potential for higher returns, such as:
Note, however, that self-directed IRAs usually can't hold all types of assets. For example, S corporation stock, insurance contracts and collectibles, such as art or coin collections, are off-limits in most circumstances.
In addition to diversification advantages, self-directed IRAs have considerable estate planning appeal. Imagine transferring real estate or closely held stock with substantial earnings potential to a traditional or Roth IRA? Such transfers would allow these assets to grow on a tax-deferred or tax-free basis for the benefit of your heirs.
Before establishing a self-directed IRA, it's critical to understand the significant risks and tax traps involved with these tools. For example, prohibited transaction rules restrict dealings between an IRA and disqualified persons, including you, close family members, businesses that you control and your advisors. This makes it difficult, if not impossible, for you or your family to manage, work for, or have financial dealings with business or real estate interests held by the self-directed IRA without undoing its tax benefits and triggering IRS penalties.
In addition, IRAs that invest in operating companies may generate unrelated business income taxes, which are payable currently out of an IRA's funds. Further, IRAs that invest in debt-financed property may generate unrelated debt-financed income, creating a current tax liability.
You can certainly manage these risks if you choose a self-directed IRA. But for the best outcome, consider working with tax and estate planning advisors who can help you steer clear of tax traps and other threats.
Get in touch today and find out how we can help you meet your objectives.
