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Get To Know Your Custodian

UNDERSTANDING THE ROLE OF A CUSTODIAN

Federal law requires that all IRA accounts be held by a custodian or trustee, which may be a bank, trust company or other entity which the IRS has approved to act in this capacity. Federal rules also make many types of investment permissible in an IRA, unless the investment is a prohibited transaction. Some examples of transactions prohibited in IRA accounts include life insurance policies and collectibles (art, antiques, rugs, gemstones, stamps, alcoholic beverages as well as certain metals and coins).

 

WHAT MAKES SELF-DIRECTED IRAS DIFFERENT

Aside from the assets which are disallowed by law, it is up to each custodian to determine which types of assets it will hold in custody in an IRA account on behalf of an accountholder. By way of comparison, most banks and brokerage firms only allow an investor to hold publicly-traded mutual funds, stocks and other public securities in IRAs; however, custodians of self-directed IRAs typically permit you to invest in private, non-exchange traded investments, such as private equity or real estate. But, keep in mind, these assets usually carry higher risks and may require more hands-on involvement by the IRA accountholder. For this reason, it’s important for investors to understand the limited role of an IRA custodian.

A Custodian's Limited Role

As an initial matter, a self-directed IRA custodian has a limited role as it relates to evaluating any investment. A custodian will only determine whether the investment is administratively feasible –simply stated, whether the investment fits within the custodian’s operating systems and procedures and whether the custodian can fulfill its government reporting obligations (i.e., to report the IRA’s fair market value or good-faith estimate of fair market value). For its own internal purposes, a custodian may choose to – but is not required to – investigate the validity of an investment, the background of any investment promoter or the accuracy of any financial information provided by the investment promoter.

Custodial Responsibilities

Once a custodian determines it will custody an investment, a custodian’s obligations are limited to:

  • Accepting, documenting, and recording contributions, transfers and rollovers from other IRAs/retirement plans
  • Implementing technology and procedures to protect the privacy of the accountholder and account data
  • Executing accountholders’ investment instructions as directed by sending funds from the IRA to the client selected investments
  • Gathering, executing, and holding documents such as subscription agreements, operating agreements, offering memorandum, promissory notes, certificates, and other evidences of ownership of investments by the IRA
  • Receiving and recording income from the assets held in the IRA
  • Executing accountholders’ instructions to sell, withdraw from or liquidate investments held in the IRA
  • Coordinating with investment sponsors the purchase and sale/liquidation of investments as directed by accountholder
  • Facilitating, as directed by the accountholder, distributions from the IRA to the accountholder or transfers to other IRAs or retirement plans
  • Performing tax reporting of IRS Forms 1099-R and 5498 as required by the IRS
  • Providing IRA statements to the accountholder which includes transactions and cash and assets held in the account
  • Complying with all applicable state and/or federal regulations

WHAT A CUSTODIAN DOES NOT DO

Now that you understand what a custodian is responsible for, it is important to know what a custodian does not do. Custodians do not:

  • Act as an investment advisor, tax advisor or legal advisor
  • Provide investment, tax or legal advice
  • Recommend or endorse investments
  • Recommend or endorse investment advisors
  • Determine the fair market value of account investments
  • Perform due diligence for the account owner on any investment or investment sponsor
  • Determine the merits or suitability of any investment for the IRA or the accountholder
  • Determine whether a transaction would be deemed a Prohibited Transaction (i.e., transactions that are prohibited by the IRS). Refer to IRS Publication 590 or Code section 4975 for more information).

SELF-DIRECTING AN IRA

When it comes to a self-directed IRA, it is exactly as the name implies: “self-directed” – the accountholder has the sole responsibility for doing the due diligence and vetting of any investment before directing their custodian to invest. The accountholder bears the full risk if the investment fails or does not perform in a manner consistent with the accountholder’s expectations.

A self-directed IRA accountholder should have a complete understanding of the service fees being charged by their custodian. They should also keep a close watch for, and notify their custodian if they see unusual or unexplained investment activity in your account and delays in receiving payments or information promised by an investment sponsor.


Self-Directed IRA Accountholder Responsibilities

Direct their own investment(s);

Understand the Prohibited Transaction rules and how to avoid them;

Complete their own thorough due diligence of any investment and the investment promoter(s);

Monitor the account carefully, including the performance of all investments made within the account on an ongoing basis;

Understand the risks related to their investment(s);

Seek help from legal, tax and financial advisors since important financial and tax decisions are involved;

Ensure they can provide annual valuations for all self-directed IRA assets;

Be aware that certain investments in operating companies and debt-financed real estate may generate Unrelated Business Taxable Income (UBTI) or Unrelated Debt-Financed Income (UDFI), and the accountholder should follow their custodian’s guidelines for any tax that may be owed and for the preparation of Form 990-T.

Get to Know Your Custodian

It’s critical to have a custodian with in-depth knowledge of alternative investments to guide you through the rules and regulations to avoid potential pitfalls. Download our Get to Know Your Custodian guide to learn more about what sets STRATA apart from other IRA service providers, custodial and accountholder responsibilities.

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Talk to a self-directed IRA professional.

If you have questions about self-directed IRAs and private equity or if you’re ready to open an account — don’t hesitate to reach out.

866-979-1522

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