Self-directed IRAs provide many benefits for investors, including index funds for ease of maintenance and the opportunity to invest in a variety of industries ranging from real estate to precious metals. Yet despite the higher rewards, the risks of self-directed IRAs remain incredibly high for many experienced investors. By familiarizing yourself with the industry and learning how to vet companies, investors can better make the necessary decisions that a self-directed IRA requires.
While there’s nothing wrong with opening an IRA with a bank or brokerage firm, your investment options are limited to the products they carry. With a self-directed IRA, the opportunities expand dramatically to include nontraditional investments, offshore funds, or even limited partnerships.
Still, despite increased opportunity, self-directed IRAs also become a potential source of trouble. Investors should be aware of the major pitfalls a self-directed IRA can create.
Investors Must Avoid “Self-Dealing”
One of the main priorities for self-directed IRA investors is to familiarize themselves with the investments and transactions prohibited by the IRAs. In other words, if you (or anyone benefited from the IRA) is considered a “disqualified person,” then the transaction is illegal. Investing in such prohibited transactions are illegal and referred to as “self-dealing.”
So what exactly qualifies one as a disqualified person? According to the IRS, the IRA owner, spouses, custodians, brokers, and descendents are disqualified persons. Furthermore, you can’t use these funds to purchase life insurance for yourself. By failing to follow these guidelines, your entire account may become taxable and wiped out if the IRS ever discovers the violation.
Remain Cautious of Investment Fraud
When investing in a self-directed IRA, perhaps the greatest threat is a fraudulent scheme. While banks and brokerages have reliable products and insurance, investors who approach IRAs alone must be diligent to safely invest retirement funds. By staying aware of potential fraudulent schemes and evaluating the legitimacy of investment opportunities, investors can better ensure that they are protected from fraud.
To do this, investors must verfiy all information. While it can be difficult to value and evaluate an investment, investors who are pro-active in verifying information are more likely to spot fraud before their peers. Furthermore, it’s best to skip all unsolicited offers. The reality is that fraud promoters use unsolicited offers to spread their schemes and lure investors into moving their money.
By being cautious about solication and verifying all information, investors can remain realistic about their self-directed IRA. Of course, every investment will have a degree of risk, but investors can minimize unnecessary ones.