An individual retirement account is a sound investment for your retirement funds, so long as you comply with Internal Revenue Service requirements. One important requirement is that an IRA must have a third-party custodian for the funds, including an IRA for which you make the investment choices -- called a self-directed IRA. You can select the custodian for your IRA, which is determined in part by the type of investments you want to make.
IRA Custodian Basics
An IRA is a custodial account that gives you certain tax benefits for your retirement savings. The IRS requires that the custodian be a bank, federally insured credit union, savings and loan association or other business entity approved by the IRS to act as a custodian. In general, custodians invest IRA funds in bonds, mutual funds and CDs because of the low administrative burdens in managing these types of investments, as opposed to real estate investments that can require intensive management.
Although most IRA owners rely on their custodian's investment choices, this is not an IRS requirement. You're entitled to direct your IRA custodian regarding how your funds should be invested. You can choose to invest in nontraditional IRA investments, such as limited partnerships, real estate or certain precious metals. However, the key to this type of IRA investing is finding a custodian who will agree to follow your directions and accept your investment choices. Because the IRS permits custodians to impose their own restrictions on the type of investments for your IRA funds, a custodian can refuse to accept certain types of investments.
In September 2011, the Securities and Exchange Commission issued an investor alert warning of risks involving self-directed IRAs. The SEC alert stated that investors using self-directed IRAs should be aware that custodians for IRA accounts have limited duties to account holders. Custodians are not required to, and generally do not, evaluate the legitimacy of an investment or the people promoting it. The SEC warned that fraudulent promoters either state or suggest that self-directed IRA custodians investigate and validate investments used in a self-directed IRA. The SEC alert cited several cases involving promoters of fraudulent schemes for self-directed IRA investments in which the investors were steered to specific custodians to handle the investments. The IRS also warns that it does not pre-approve any investments for IRA accounts.
IRS rules place limits on the type of investments permissible for IRA funds. For example, IRA funds invested in collectibles such as artwork, coins and alcoholic beverages are considered as distributed to you in the year invested, which can result in early distribution penalties, depending on your age. A few exceptions exists for investments in gold and silver coins issued by the Treasury Department and other precious coins and bullion. The IRS also prohibits transactions involving your IRA funds that are particularly applicable to self-directed IRAs, such as the rule against using your IRA funds to benefit you or your family members. For example, although you can invest your IRA funds in real estate, you cannot use this property for your personal residence or vacation home.
Joe Stone is a freelance writer in California who has been writing professionally since 2005. His articles have been published on LIVESTRONG.COM, SFgate.com and Chron.com. He also has experience in background investigations and spent almost two decades in legal practice. Stone received his law degree from Southwestern University School of Law and a Bachelor of Arts in philosophy from California State University, Los Angeles.