Topel Forman News

Today’s Estate Tax Topic – August 19, 2021

With A Self-Directed IRA, You Choose Your Own Investments

If you’re the type who would rather order ala carte rather than a set entrée, you might prefer a “self-directed” IRA. With this option, you may be able to amp up the benefits of a traditional or Roth IRA by enabling them to hold nontraditional investments of your choosing that can potentially offer greater returns. However, self-directed IRAs present pitfalls that can lead to unfavorable tax consequences.

Estate planning benefits

IRAs are designed primarily as retirement-saving tools, but if you don’t need the funds for retirement, they can provide a tax-advantaged source of wealth for your family. For example, if you name your spouse as a beneficiary, your spouse can roll the funds over into his or her own IRA after you die, enabling the funds to continue growing on a tax-deferred basis (tax-free in the case of a Roth IRA).

You control the investments

A self-directed IRA is simply an IRA that gives you complete control over investment decisions. IRAs typically offer a selection of stocks, bonds, and mutual funds.

Self-directed IRAs (available at certain financial institutions) offer greater diversification and potentially higher returns by permitting you to select virtually any type of investment. The investment types include real estate, closely-held stock, limited liability company interests and partnership interests, loans, precious metals, and commodities (such as lumber and oil & gas).

Self-directed IRAs offer the same estate planning benefits as other IRAs, but they allow you to transfer virtually any type of asset to your heirs in a tax-advantaged manner. Self-directed Roth IRAs are particularly powerful estate planning tools because they offer tax-free investment growth.

Beware the prohibited transaction rules

The most dangerous traps for self-directed IRAs are the prohibited transaction rules. These rules are designed to limit dealings between an IRA and “disqualified persons,” including account holders, certain members of account holders’ families, businesses controlled by account holders or their families, and certain IRA advisors or service providers.

Among other things, disqualified persons may not sell property or lend money to the IRA, buy property from the IRA, provide goods or services to the IRA, guarantee a loan to the IRA, pledge IRA assets as security for a loan, receive compensation from the IRA, or personally use IRA assets.

The penalty for engaging in a prohibited transaction is severe: the IRA is disqualified and all of its assets are deemed to have been distributed on the first day of the year in which the transaction takes place, subject to income taxes and, potentially, penalties.

This makes it virtually impossible to manage a business, real estate, or other investments held in a self-directed IRA. So, unless you’re prepared to accept a purely passive role with respect to the IRA’s assets, this strategy isn’t for you,

© 2021

If you have questions, please reach out to your Topel Forman contact.

 

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