In the wake of the financial crisis, which left many Americans with a devastated nest egg, investors are looking for new and innovative ways to save for retirement. Self-directed IRAs are becoming more popular because they offer a new solution to retirement savers; the freedom and flexibility to explore alternative investments, such as private equity and real estate.
In order to benefit from a self-directed IRA, it is important that investors understand the rules that regulate these retirement savings vehicles. Similarly, it is important that financial professionals understand these rules so they can more effectively guide clients in a direction that will best meet their savings goals. If an investor asked you to help them navigate the world of self-directed IRAs, would you know where to start?
Take note of the following three self-directed IRA rules, and share them with your clients to ensure the most potential for successful investing:
1) Self-Dealing Rule
Retirement accounts in the US are structured in such a way as to not bring any immediate gain to the account owner. If a self-directed IRA owner is acting in a way that will bring him personal gain in the present, rather than upon retirement in the future, then this is called “self-dealing.” Self-dealing is not allowed within an IRA, and can lead to significant monetary penalties.
Some examples of self-dealing include:
- IRA owner lives in/works in real estate property owned by IRA.
- IRA owner uses retirement funds to invest in his/her own company.
- IRA owner takes physical possession of gold bullion owned by IRA.
2) Early Withdrawal Exceptions Rule
Most retirement accounts require that the account owner reach the age of 59.5 before taking any withdrawals. Withdrawals taken before that age would then be subject to applicable income taxes, as well as an additional penalty of 10 percent. There are some exceptions to this rule, however, that most people are not aware of.
Self-directed IRA funds can be withdrawn before the age of 59.5 in the following cases:
- IRA owner becomes disabled.
- Funds are used for qualified education expenses.
- Funds are used for a qualified first home purchase.
- Funds are used for a qualified domestic relations order.
- Payout to beneficiary upon premature death of IRA owner.
3) Disqualified Persons Rule
Similar to the reasoning behind the self-dealing rule, if retirement account transactions are seen to benefit certain people that are close to the plan or the plan-owner, then they are considered prohibited transactions. These people are called “disqualified persons,” and self-directed IRA owners should take particular care to avoid dealing with these people.
The following are examples of disqualified persons (see section 4975 of the Internal Revenue Code for a complete list):
- A person providing services to the plan.
- Any lineal ascendants/descendants of the IRA owner.
- IRA owner’s spouse.
Retirement planning can be hard enough without having to read through pages and pages of self-directed IRA rules. Hopefully, this simple break down of three important specifications can help you and your clients reach your respective saving and business goals. Remember, due diligence is the key to success, in any walk of life!