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Self-directed IRAs: Caveat Emptor

Chris Farrell Oct 27, 2011

I’ve noticed an increase in pitches from folks promoting the financial benefits of self-directed IRAs. It’s an IRA held by a trustee or custodian that permits investment in a broader set of assets than is the case with most IRAs. It’s a classic case of buyer beware.

The IRA most of use are familiar with–in its traditional or Roth form–have banks and broker-dealers as custodians. Investments in the IRA are limited to stocks, bonds, mutual funds and CDs. Think Fidelity and Vanguard.

However, with a self-directed IRA investors are allowed to put their money into other kinds of assets, such as real estate, promissory notes, tax lien certificates, and private placement securities.

I’ve never been a fan of putting IRA money–retirement money–into investments like these. The fees are high with self-directed IRAs. The securities are often hard to sell. The risks are disproportionate. I don’t like many of these investments anyway, but at the very least I would segregate speculations like these into taxable accounts. The latter strategy allows you to take advantage of the tax code if the bet goes wrong, as well as the ability to take advantage of depreciation with real estate investments and so on.

Self-directed IRAs have regulators worried. The SEC’s Office of Investor Education and Advocacy and the North American Securities Administrators Association issued “Investor Alert” about self-directed IRAs in September:

While self-directed IRAs may offer investors access to an array of private investment opportunities that are not available through other IRA providers, investments in these kinds of assets may have unique risks that investors should consider. Those risks can include a lack of disclosure and liquidity — as well as the risk of fraud> .

The IRA expert Ed Slott highlights the regulatory warning in the latest issue of his monthly newsletter, Ed Slott’s IRA Advisor.

Although the majority of IRA owners are content with the more traditional investment options offered by most conventional IRA trustees, self-directed IRAs still account for a sizable portion of IRA savings. According to the alert, self-directed IRAs currently account for roughly two percent, or $94 billion, of all IRA funds. It’s possible, however,
that the recent volatility and uncertainty surrounding the markets could help foster an increased “grass is greener” attitude with some clients, prompting additional funds to be allocated to self-directed accounts. >

I would add that the mistrust of established financial institutions is also playing a role.

The warning is timely. Of course, this isn’t to say that all self-directed IRAs are pushed by scamsters and fraudsters. Far from it. It’s to say that if you’re tempted to go the self-directed IRA route I would carefully read the Investor Alert. Caveat Emptor.

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