April 07, 2020

Alt Assets in an IRA? Assess Suitability with your Advisor

By: Christopher Orr, CISP®, SDIP

Tags: Financial Professionals Other Alternatives Private Equity Investing Real Estate Investing

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Alt Assets in an IRA? Assess Suitability with your Advisor

Self-directed IRAs and the alternative assets they invest in have done a lot of good for many retirement investors. ;Self-directed IRAs allow investors to build their nest eggs by investing in alternatives like real estate, private equity, and gold. In turn, these alternative investments provide IRA owners with portfolio diversification and ballast against the whims of the stock market.

But not every investment is suitable for your self-directed IRA, and your IRA administrator or custodian cannot provide financial advice and tell you if an investment is suitable for you. With a self-directed IRA, you are in charge of your investment decisions. That’s why conducting ample due diligence before pursuing an opportunity—and working with a trusted financial professional—is one of the keys to self-directed investment success.

While there are many factors to consider when determining an investment’s suitability, you and/or your financial professional can get started with these five questions to review an opportunity to determine if it’s a suitable investment for your self-directed IRA. These are not the only questions to consider. In this time of market turmoil, the Financial Industry Regulatory Authority is seeking to address changes in suitability rules. For additional information, you can visit FINRA’s site*.

1. Do you meet the financial requirements for the investment?

One of the benefits of a self-directed IRA is that it can hold alternative assets. Yet, many alternative asset opportunities are only open to “accredited investors” who meet certain net worth or income requirements. For instance, you must have an annual income above $200,000 (or joint income of $300,000 with a spouse) in each of the last two years. That same level of income must be expected to continue for the current year. If you don’t meet the accredited investor requirements, you most likely will not be able to participate in the deal.

In addition, many alternative assets require high investment minimums, which can be a barrier to entry if you don’t have the necessary amount of funds in your retirement accounts. Remember: The alternatives you own in your IRA must be purchased with your IRA’s funds. For instance, if your investment opportunity requires a $20,000 minimum, that $20,000 must come from your IRA—not a taxable account.

2. Will you need easy access to the money you are investing?

If the answer to this question is yes, certain alternative assets may not be suitable investments for your retirement portfolio.

While you can typically buy and sell stocks, bonds, and mutual funds daily, many alternatives—like timberland, shares in a private company, or a stake in a commercial real estate project—are illiquid. Some investments may have lock-up periods during which they cannot be sold, while others may not have a clear exit strategy or only attract a small number of potential buyers. That means alternative assets require more time and effort to be sold and converted into cash than traditional investments (in some cases that may not be an option at all).

Also, owners of traditional IRAs must start taking required minimum distributions at the age of 72. If your traditional self-directed IRA is the only IRA you own, you will need to take the distribution from that account, which may involve converting a portion of your IRA holdings into cash every year**.

3. Do you understand the risk/return profile of the investment?

This question applies to any investment, both traded assets and alternative assets. Unfortunately, a surprising number of investors neglect to conduct their due diligence when dealing with an investment category that’s new to them or even one that’s familiar. But due diligence is crucial—especially when it concerns your retirement funds.

Conducting due diligence requires legwork and can involve working with a financial professional and/or tax attorney. Or it can mean thoroughly researching the opportunity on your own. No matter how you undertake due diligence, understanding the nuances of the investment you are considering, and all of its risks is imperative. Some alternatives pursue high-risk investment strategies or, as I mentioned above, are highly illiquid. Don’t let the potential for above-market returns blind you to the risks you may be taking.

At the end of the day, it is your responsibility to understand the potential risk/return profile of the investment you’re vetting to ensure it is suitable for your portfolio.

4. Will the investment increase your concentration risk?

One of the advantages of investing in alternatives is that they provide portfolio diversification. While your brokerage account may be invested in stocks, bonds, and mutual funds, your self-directed IRA may be invested in those types of assets, but may also be invested in real estate, private equity, and promissory notes, helping to diversify your entire investment portfolio.

But many self-directed IRA investors invest in areas that they know and love—like real estate or precious metals. As a result, some self-directed IRAs may become allocated 100% to real estate-related investments or precious metals.

If this is the case, and you are considering another IRA investment in the same asset class, FINRA warns investors on concentration risk. Be sure you are comfortable having concentrated exposure in your self-directed IRA, and whether or not you prefer to balance that exposure with investments in other accounts—like a 401(k), non-self-directed IRA, or a brokerage account.

If your self-directed IRA is the only retirement fund you have, be sure you understand the risks involved in holding only one type of asset class.

5. Is the investment or transaction permissible in a self-directed IRA?

One “biggie” when it comes to alternative investing and determining investment suitability is whether the asset or transaction is permissible in an IRA. The IRS makes it very clear that neither life insurance nor collectibles are allowed in IRAs. Aside from those categories, some transactions are prohibited—meaning they’re a deal-breaker and, by law, you cannot own them in your IRA.

For example, you can own a rental or investment property in a self-directed IRA, but you can’t buy your own home using one. Similarly, you can invest in a company’s private stock, but it generally can’t be your own company.

Breaking the rules and conducting a prohibited transaction, even unintentionally, may result in your account losing its qualified tax-protected IRA status, and you may face taxes plus additional penalties.

Is an Investment Suitable? When in Doubt, Ask a Professional!

Self-directed IRAs give people more choice and control when it comes to retirement investing. But, as with anything, this approach requires that people choose investments based on their specific portfolios, risk tolerance, and return objectives.

A knowledgeable financial professional should be able to tell you the pros and cons of any investment you’re considering, while a self-directed IRA custodian (like Pacific Premier Trust) can help with the process and IRS requirements. By ensuring investment suitability, you can invest with more confidence. And that’s a good thing.

*There may be other important factors to consider when evaluating an investment. Please consult your financial professional for guidance.

**Some IRA owners who hold alternative assets may be able to take their RMD as a distribution in-kind.

This Blog does not provide investment, tax, or legal advice nor does it evaluate, recommend or endorse any advisory firm or investment vehicle. Investments are not FDIC insured and are subject to risk, including the loss of principal.

Pacific Premier Trust (formerly PENSCO Trust Company) performs the duties of an independent custodian of assets for self-directed individual and business retirement accounts and does not provide investment advice, sell investments or offer any tax or legal advice. Clients or potential clients are advised to perform their own due diligence in choosing any investment opportunity as well as selecting any professional to assist them with an investment opportunity. Alternative investments are not FDIC insured and are subject to risk, including loss of principal. Pacific Premier Trust is not affiliated with any financial professional, investment, investment sponsor, or investment, tax or legal advisor.


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