A self-directed IRA is a type of Traditional or Roth IRA in which you’re allowed to invest in things other than stocks, bonds, or mutual funds – such as investing directly in a hot new biotechnology or traditional technology startup. In fact, it’s the only way you’d be able to invest your IRA dollars into anything non-traditional to include but not limited to real estate, race horses, and basically anything else (as long as you follow a few rules).
Disqualification
The biggest rule is that you can’t do anything that makes it appear as if you’re using deferred funds for current use. The biggest example is in real estate investing. If you use your IRA funds to “invest” in a property that you end up using and the IRS finds out, then your entire IRA could be disqualified, considered distributed, and you’ll have to pay any associated taxes and withdrawal penalties if you’re under 59 1/2. The disqualification aspect is the biggest danger associated with self-directed IRAs because it can sink you.
There are some categories that are explicitly not allowed and the two biggest are life insurance and collectibles. The “current use” rule regarding life insurance is clear, you’re technically always using it, right? With collectibles, it appears that the rule exists simply because there’s no way to enforce the “current use” rule otherwise. If the IRS ever asks, you could simply give your cousin the piece of art and say they were using it.
How To
This part is pretty simple, just head on over to your bank’s trust department or open an account with a custodial firm (many traditional brokerages, such as Vanguard, also handle self-directed IRAs). They handle all the accounting from disbursing the funds to collecting the profits but they stay mum on all other issues, they are not allowed to give advice. The fees are typically higher than your normal IRA account but that’s because they do a lot more work handling all those esoteric investments you’re thinking about.