The initials IRA stand for Individual Retirement Arrangement. In this context therefore, what is a self-directed IRA? This is an arrangement where the owner, custodian, or trustee makes decisions on which investment vehicles are best suited for the IRA. Simply put, you are the director. The decisions are then communicated to the people who manage your retirement plan for appropriate action. In case your Self-directed IRA is in the hands of a professional custodian, he/she will keep all the relevant records. The custodian owes you other responsibilities like issuing statements, filing reports with the IRS as well as giving updates. Your custodian should also front ideas and suggestions on the assets you can choose to invest in.
Much as you would want to invest your IRA in ventures that will earn additional income, there are some restrictions. Prohibited investments include alcoholic beverages, gems, metals, artwork, and life insurance. Some metals are exempted as are coins. The IRS also prohibits some transactions and disqualifies certain categories of people from meddling in Self-directed IRAs. Examples of disqualified persons include spouses, children, IRA service providers, entities where you or the service provider holds 50% or more directly and your employer. The aim of such restrictions is to prevent any instances of self-dealing. It is important for you to note that your siblings, cousins, aunts, and uncles are not among the disqualified persons.
You may also wonder; what is a Self-directed IRA for if it has all these restrictions. The limitations are meant to safeguard your account from activities that can result in premature settlement of your account. Engaging in restricted transactions can result in heavy penalties. It is good to be aware of such dealings. Below are some of them:
The repercussion of prohibited transactions is that the IRS will treat that as a distribution at market value. It will then be subjected to penalties or taxes associated with early retirement distributions. On its part, self-dealing can take any of the forms below:
Purchase of real estate property that you will use at present or in future
Giving your child a mortgage to act as down payment for a house
Buying shares and stock from persons who are disqualified</LI> <LI>Acquiring shares in an entity where you hold controlling interest
As you will notice, self-dealing comes into play when you have a stake in the transactions in question or is dealing with disqualified people.
On the brighter side, there are many investment options for a Self-directed IRA. You could try precious metals, real estate, mortgage deeds, and energy investments or set up a company. The beauty about IRAs is that you are able to beat inflation as well as expand the portfolio of investments that will benefit you during retirement. Individual Retirement Arrangements are funded through rollovers. This means that whatever your employer has been putting aside for a pension plan can be used to fund your first IRA. Alternatively, you can make contributions on an annual basis.
The amount and mode of contributions depends on the plan you have selected. For instance, self-employed people can set up a SIMPLE, SEP or Solo 401(k) plan. Handling a Self-directed IRA is not difficult. You only need to find an honest and authorized trustee, know the rules regarding transactions, disqualified persons and the investments you are allowed to undertake. Next time someone asks, what is a Self-directed IRA? You will not start wondering what he/she is talking about.