By Peter Mastrantuono
Since the creation of Individual Retirement Accounts (IRAs) in 1974, the list of permitted investments has expanded to exclude only life insurance, shares in S-corporations, and a range of collectibles.
Interest in nontraditional assets is growing. According to one survey, four out of five investors earning $200,000 or more annually expressed interest in adding nontraditional investments to their IRA portfolios, though fewer than 10% actually own such investments.
There may be compelling reasons to invest in nontraditional assets, but should you, just because you can?
Permitted Nontraditional Investments
Nontraditional (also sometimes referred to as “alternative” or “unconventional”) assets include real estate (commercial and residential rental property), hedge funds, private loans, bullion, certain gold and silver coins, private equity, and cryptocurrency.
There are restrictions, however. An IRA cannot transact with “disqualified persons,” i.e., the IRA owner, the beneficiaries on his or her IRA, family members, service providers of the IRA, an entity that is owned 50% or more by a disqualified person, or an officer or director, a 10% or more shareholder, or highly compensated employee of a disqualified person.
Certain transactions are prohibited, as well. An IRA cannot sell, exchange, or lease property already owned by the IRA owner, transfer IRA income, assets or investments to a disqualified person, lend money or supply goods, services or facilities to a disqualified person, or allow a fiduciary to obtain or use an IRA’s income or investments for its own interest.
Watch for the Sand Traps
When owning nontraditional assets investors need to be mindful of the rules of prohibited transactions, unrelated business income tax and asset valuation.
In the case of engaging in a prohibited transaction, the penalty is the disqualification of the IRA in its entirety, which has the effect of distributing all the IRA’s assets to the IRA owner as a taxable distribution (plus any early withdrawal penalties).
Investments in certain unconventional assets may trigger a tax liability, regardless that it may be held in a tax-deferred IRA.
Finally, arriving at a fair market value for nontraditional assets can be problematic, which may mean that IRA owners will need to obtain independent appraisals or other evidence to substantiate an asset’s value.
Investors considering adding nontraditional investments to their IRA accounts should start by discussing it with their financial advisor. He or she can be helpful in better understanding the risk/reward trade-offs and what unconventional assets may be most appropriate in light of individual investment objectives, risk tolerance and time horizon.
Investing in nontraditional assets requires an IRA custodian that permits holding such assets—many do not. Even among those that allow such investments, some may not permit all types of unconventional asset types. Fees to service and hold nontraditional assets tend to be higher than conventional self-directed IRA accounts. Your advisor may be able to help you with identifying a custodian that can accommodate these unconventional investments and also offer good ongoing servicing at a fair cost.
Peter Mastrantuono is a contributing writer to MyPerfectFinancialAdvisor, the premier matchmaker between investors and advisors. Peter worked for over 30 years in the wealth management industry, focusing on retirement planning, investing, asset allocation and financial planning.