No one wants to draw the ire of the Internal Revenue Service. It just isn’t a pleasing prospect to have to deal with the IRS if you’ve done something wrong. For this reason, if you have a self-directed IRA, it is necessary to know the self-directed IRA rules, which are different from the rules relating to other types of investment accounts.
Traditional IRAs are accounts that allow contributions from the account holder with the purpose of saving for retirement. The decision on where to invest these funds are made by banks and brokerage firms or by the mutual funds chosen by the account owner. There is very little direct management responsibilities on the account owner’s part.
Self-directed IRA’s, on the other hand, require much more hands-on management on the part of the account owner. He or she decides where the funds should go and offer a variety of avenues for investment. There is a lot of responsibility that goes along with owning a self-directed IRA as compared to a traditional IRA.
However, if you know what you are doing, there is more potential for earnings as well. The IRS does require the funds in a self-directed IRA to be held by a trustee or custodian that does not have an interest in the performance of the funds. The trustee is required to maintain transaction records, help the account owner stay in compliance with the IRS and provide investment advice. Having a trustee, though, does not mean you don’t have to know the self-directed IRA rules. You are still ultimately responsible for the decisions you make with your funds.
General Self-Directed IRA Rules:
People who do not have pension plans through their employers are eligible to have an IRA. In addition, those who do have pension plans are able to establish IRAs if they meet specific criteria. There are many types of IRAs available with different contribution limits and tax implications. To find out if you are eligible to open an IRA, see the rules here.
Once you have an IRA, you can withdraw your funds without paying a 10 percent penalty when you turn 59 1/2 years old. Depending on the type of IRA you have, you may pay taxes on the funds before they are deposited into the account or after you start taking withdrawals for retirement. You are not able to take loans out on the balance of your IRA, as you may be able to do with a 401k. Once the money is in there, it is designed to stay there until you reach retirement age.
More Specific IRA Rules to Observe:
As mentioned earlier, there are some rules that apply only to self-directed IRA accounts. These rules have been put in place to avoid conflicts of interest and the self-dealing that can be an issue if account holders were allowed to do whatever they wanted with their account. Essentially, the funds in the account should only be used to invest in precious metals, private equity, real estate, mortgage deeds, trust deeds, oil, gas and private debt. You cannot use the funds for any of the following reasons:
- Lending money. This allows the account holder to benefit from the interest on the loan.
- Collateral to secure a loan for any disqualified person.
- The exchange, lease or sale of property to any disqualified person. This means the account holder cannot live in a house purchased by the funds in the self-directed IRA. Nor can it be rented at a discount to a third party if that person is providing an indirect benefit to the account holder in exchange for that discount.
- The purchase of services or goods for personal use.
- The purchase of life insurance.
As you can see, there are quite a few self-directed IRA rules that you have to follow. In addition to what you can do with your money, you also have to make sure you avoid dealings with disqualified persons who cannot benefit from your funds. These people include:
- You and your spouse. You are supposed to be generating funds for your retirement, not using them to enjoy the present.
- Your direct ancestors including your parents and grandparents.
- Your direct descendants including your children and grandchildren.
- The spouses of your direct descendants including a son-in-law, daughter-in-law, granddaughter-in-law, grandson-in-law.
- Any person who provides paid advice for how your self-directed IRA should be administered, including your trustee or custodian.
- Any business of which a disqualified person owns 50 percent or more.
In general, the self-directed IRA rules are designed to ensure you put the money away for retirement. You can’t use it for personal needs until then, unless you want to pay the 10 percent early-withdrawal fee. If you have any question as to whether or not a rule applies to a transaction you want to make with the funds in your self-directed IRA, talk to your trustee. He or she is bound by the law to advise you and keep you compliant. After all, you are paying them to help you, so use it.
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