By J.P. Dahdah, Founder & CEO of Vantage
As we all take time on the 4th of July to celebrate our nation’s birthday, and the freedom our great country provides us, I felt it was appropriate to shine a light on the freedom that a truly Self-Directed IRA provides those who choose to establish and maintain one. Self-Directed IRAs are the most flexible and investor friendly retirement accounts available to Americans. But with freedom comes responsibility. IRA account owners must understand there are certain prohibited transactions between an IRA and disqualified persons, as defined by the Internal Revenue Code. Two key terms you’ll want to remember about Self-Directed IRA investing are ‘self-dealing’ and ‘prohibited transactions.’ In general terms, self-dealing refers to a transaction which can provide the account holder with a personal financial benefit, instead of your IRA, which is a no-no. A prohibited transaction is any improper use of your IRA by you or anyone the IRS has defined as a disqualified person (i.e. parties related to your IRA).
Anyone who begins the educational journey of learning how a truly Self-Directed IRA works, must get their arms around the minimal restrictions that do exist. This way, you can maximize the freedom they offer by creating an alternative investment strategy that is personally designed. Although it is common to feel overwhelmed with what appears to be a big learning curve on the IRA rules, they are actually quite simple. I always remind our clients to not be intimidated by the technical terms and Self-Directed IRA jargon that is many times mentioned when the regulations are explained. It is natural for investors to seek out validation and/or proof that the information they are now being introduced to is real. It goes against everything they have ever been told, taught or advised from their trusted advisors regarding what’s allowable within IRAs. The misinformation is a systemic problem in the financial industry. But now you know the truth about the alternative investment choices you do have with your retirement savings, it is important to take action in an informed way.
The IRA rules can be simplified into two primary restrictions, people restrictions and investment restrictions. Instead of creating rules about what we can do with our tax-favored IRA accounts, the IRS chose to provide us with the things we cannot do. As it relates to investment restrictions, there are only two types of investments that cannot be purchased within an IRA. The two limitations are life insurance contracts and collectibles. That’s it. As long as you don’t want to become financial independent by investing in those two asset categories with your IRA, you can invest in anything else your heart desires and your portfolio requires. Now, that’s what I call freedom! This truth can be validated by reading Publication 590, should you feel the itch for some super fun reading. Let’s move on to the people restrictions you must understand. The people restrictions focus keenly on the transactions that are prohibited within an IRA because they are deemed to create self-dealing, which is exactly what the IRS wants to prevent. Self-dealing is believed by the IRS to create opportunities for various types of tax payment avoidance and IRA account balance manipulation. Therefore, the IRS created a list of disqualified persons, also known as related parties to your IRA, which are meant to be avoided anytime your IRA is involved in a transaction. So the easiest way to stay within the IRA guidelines is to know exactly who is on your IRA’s related party list and stay clear of doing business with those people. The good news is that the “bad list” isn’t very long and it shouldn’t be hard for you to stay clear of your disqualified persons. I encourage you to take the time now to identify the people and entities your IRA must elude.
The three questions you must ask yourself to maximize the freedom your IRA provides go as follows: 1) Is my IRA purchasing a life insurance contract? 2) Is my IRA purchasing a collectible? 3) Is my IRA involved in any direct or indirect transaction with a disqualified party to my IRA? If you can answer NO to each of these questions, your IRA is free to be used in the exact way you think will help you obtain financial independence! Cheers to freedom!!