Many financial professionals agree that alternative investments can potentially generate additional risk management and returns for investors, given their often-low correlation to traditional indices. Certain alternatives can also add a layer of diversification to your client’s portfolio to help endure market volatility. After the S&P 500’s correction in February 2018, the potential for rising interest rates and an uptick in market volatility, an alternative tool to help manage risk in retirement and IRA accounts may be a powerful and timely strategy.
Self-directed IRAs, or alternative IRAs, offer the best of both worlds to you and your clients. The aforementioned total return and diversification benefits from alternative investments can be more attractive when coupled with the tax advantages of an IRA account. If done right, your clients can potentially collect interest, dividends and capital appreciation in a tax-deferred vehicle. Like any investment, self-directed IRAs should be approached prudently, as there are common pitfalls to avoid for your clients.
Here are common mistakes in self-directed IRA investments that investors and financial advisors should avoid.
1. Not knowing the breadth of your investment options
Your self-directed IRA can go much farther than you think. There are many investment types which were unavailable at conventional brokerages are now easily accessible—especially opportunities beyond Wall Street. With the right custodian, your self-directed IRAs can house a broad range of different alternative investments, including:
• Directly-owned real estate (raw land, residential or commercial)
• Private equity or debt investments
• Trust deeds or mortgage notes
• Promissory notes or corporate debt
• Closely-held stocks
• Equity or debt crowdfunding
• Public or private LPs or LLCs
• Precious metals
• Brokerage accounts for publicly-traded stocks, mutual funds or ETFs
• Other alternative investments
With additional investment options from an alternative investment IRA custodian, you can give your clients much more flexibility and control of their portfolio’s potential. Many IRA custodians only offer a fraction of the investment options available, which can limit your client’s investment and diversification potential.
2. Engaging in prohibited transactions
The wide array of investment options available to your clients may seem appealing but not if the transaction is considered prohibited by the IRS. Therefore, choosing a knowledgeable alternative investment IRA custodian who can help you steer clear of infringements and navigate the IRS rules is a must. Investing in prohibited transactions in an IRA can strip the tax-deferred status of the account and result in penalties.
In simplified terms, prohibited transactions revolve around intent. Any transaction that is intended for immediate personal financial gain rather than for your future retirement is considered prohibited. Generally speaking, a prohibited transaction is defined by the IRS as any improper use of an IRA account or annuity by the IRA owner, which can involve:
• A disqualified person’s transfer of plan income or assets to, or use of them by or for his or her benefit
• A fiduciary’s act by which he or she deals with plan income or assets in his or her own interest
• A fiduciary’s receipt of consideration for his or her own account in a transaction that involves plan income or assets from any party dealing with the plan
• Any of the following acts between the plan and a disqualified person:
· Selling, exchanging or leasing property
· Lending money or extending credit
Typically, most prohibited transactions involve a disqualified person, which includes family members (spouse, ancestor, lineal descendant and any spouse of a lineal descendant) and fiduciaries (likely you). To avoid this major pitfall, it’s important your client talk with their tax or legal advisor, as well as self-directed alternative IRA custody experts like STRATA.
3. Skimping alternative investment due diligence
Warren Buffet once said, “Don’t invest in something you don’t understand.” This applies to any investment, whether it’s a stock, bond or an alternative investment in a self-directed IRA. It’s important for clients to work in unison with their professional team of tax and legal advisors to help them make more informed investment decisions. Thorough vetting of an investment is needed to understand the risk, expected return and the people backing or promoting an alternative investment. Careful and thorough due diligence is what separates sophisticated investors from the novices.
The need for transparency has steadily risen over the past decade for all investment professionals. In light of the new DOL Fiduciary Rule which was partially implemented last year, advisors must be more stringent regarding investment suitability documentation. When it comes to the risk, reward and reporting of alternative IRA investments, clarity should be provided to clients. Most alternative investments that clients would invest in with their disposable income are likely eligible in a self-directed IRA.
Before investing in an alternative investment with a self-directed IRA, invest the time and effort to understand the expected return, the risk and the people behind the investment before handing over your retirement money. It’s important for clients and their professional advisors to vet an investment prior to purchase and to conduct periodic checkups throughout the life of the investment. The role of your self-directed IRA custodian is limited to providing the administrative support necessary to fulfill the IRS reporting requirements, asset titling and recordkeeping for your IRA.
4. Choosing the wrong custodian
The personal financial plan and asset allocation strategy you put together for your clients already require a strong attention to detail. The last thing you want for your clients is poor customer service, inaccurate IRS reporting or incorrect account statements. So, choosing a self-directed IRA custodian is critical. For starters, it’s important that clients receive clear, easy-to-understand account statements and accurate IRS tax form filings.
Should you or your client have a question, your alternative IRA custodian should be easy to access by phone or email, and provide prompt support when needed.
With STRATA, you can focus on building and managing the optimal portfolio for clients, while leaving the self-directed IRA custody top-shelf customer support to us. We can custody a full suite of alternatives for your clients in a variety of retirement account types.
By following our best practices, and avoiding these common alternative IRA pitfalls, you’ll be on your way to helping your clients build a clear path to retirement and secure their financial futures.
Learn more about the benefits of self-directed IRAs online at StrataTrust.com or speak to one of our self-directed IRA experts at 866-928-9394.
About STRATA Trust Company
When alternative IRA custody is this easy, the possibilities are endless.
Founded in 2008, the STRATA Trust Company has built a reputation delivering streamlined and straightforward custody. Our service-driven team has helped thousands of investors and investment professionals unlock opportunities in their self-directed retirement accounts across a wide range of alternative investments. Formerly known as Self Directed IRA Services, Inc., STRATA has strategically realigned to support a broad range of investment professional partners in growing their IRA assets – always with an eye on the future.
With offices in Austin and Waco, Texas, STRATA operates as a Texas-chartered trust company with direct oversight by the Texas Department of Banking. Led by a seasoned team with over 350 years of combined experience, 35,000+ investors empowered and over $1.8 billion in assets under custody, our customers experience a clear difference in our approach to IRA custody.