Tax Tips
The Do's and Don'ts of IRA Investing - May 2004
Richard Scrivanich - Partner
Investors today have almost an infinite number of investment options available to choose from, ranging from the stock, bond, and mutual fund offerings of Wall Street to gold coins, real estate, and derivatives. However, your investment decisions can be even more complicated when deciding where to invest your IRA funds, because the law restricts the types of investment vehicles you can use for an IRA.
Deciding how to invest your IRA assets can be a landmine. You need to avoid prohibited investments completely, while making choices that will enhance the growth of your retirement funds. Although the decision of how to invest your IRA assets is one that is best done with professional advice, it is helpful to know the basics.
What works; what doesn’t
Following are some of the rules that apply to specific investments you might use in IRAs as well as some important limitations:
“Traditional” investments: These include some of the most commonly used assets for IRA investments: publicly traded stocks, mutual funds, bonds, Treasury instruments, and certificates of deposit.
Life insurance: IRAs cannot invest in life insurance.
Collectibles: Collectibles are not allowed within an IRA. Collectibles include the following items: art works, rugs or antiques, metals or gems, stamps and coins, and any alcoholic beverage. However, certain silver and gold (such as American Eagle) coins and any coins issued by a state are allowed.
Foreign investments: In general, an IRA cannot be used to transfer funds overseas. However, American depository receipts (ADRs) and domestically sponsored mutual funds that make overseas investments are allowed.
Real estate: Subject to certain restrictions, individuals can invest IRA funds in real estate. For instance, rental property may be permissible as long as neither the IRA owner nor certain family members use the properties involved. However, for many real estate transactions, it may be advisable to obtain an advance ruling from the IRS.
Nontraditional investments may have risks and complications
While you are not restricted to “traditional” assets within an IRA account, making other choices will be more complicated, and can put your IRA at risk if you are not careful.
If you choose to invest in nontraditional assets, you may find that many traditional IRA custodians (banks, brokerage houses, and mutual funds) will not act as custodians for nontraditional investments. This means that you must locate an independent trustee (for example, to hold title to the real estate or to collect rent).
In all IRA investing, it is crucial to avoid “self-dealing” – when the IRA owner uses the account for personal enrichment or to satisfy financial objectives in a way that goes beyond the intent of the tax law. Here are just a few examples of possible self-dealing activities with IRA funds:
- Purchasing stock in a closely held corporation in which the IRA owner is an officer or has a controlling equity position
- Using IRA funds to buy a vacation home the IRA owner or his or her family will use
- Purchasing restricted stock from a relative
If a taxpayer violates the IRA rules, he or she jeopardizes the IRA’s tax-free status. The entire IRA may even become taxable. A 10% early withdrawal penalty also may apply. With certain investments, IRA owners face other risks as well. For example, a special tax on “unrelated business income” may apply in certain real estate arrangements.
Sensible investing
The intent of the IRA rules is clear: the government wants IRA money used for retirement and invested sensibly so it will be there when needed. Your goals should be the same. Circumventing this reasoning is inviting trouble as well as jeopardizing your retirement security. Many taxpayers find that sticking to traditional investments is the best course to follow. However, if you are considering other options, ensure you are steering clear of problems before you make a decision.
If you have any questions on the do’s and don’ts of IRA investing or any other tax matter, please give me a call at (562) 698-9891.
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