As part of retirement planning and investing, self-directed IRAs often come up in conversation, leaving some potential investors confused and uncertain of its legality. Let’s dive in further so we can determine whether a self-directed Individual Retirement Account (IRA) is illegal.
What Is a Self-Directed IRA?
An SDIRA (self-directed individual retirement account) enables account holders to invest in assets other than traditional stocks, bonds and mutual funds; including real estate investments, private companies, precious metals or cryptocurrency investments. One key attraction of an SDIRA is giving account holders greater control over their investment decisions for greater diversification and returns.
Self-Directed IRAs Are Legal Its At their core, self-directed IRAs are legal. Recognized by both the Internal Revenue Service (IRS) and many financial institutions that provide SDIRA services. However, their legality often remains clouded due to potential risks or pitfalls involved with opening one up.
However, as SDIRAs themselves are legal entities, their contents can have major ramifications on your investments:
Prohibited Transactions and Individuals: The IRS has set forth regulations regarding prohibited transactions and disqualified people, such as buying property with an SDIRA to then live there personally; lending out SDIRA funds or using them for personal gain can also constitute violations against IRS rules.
Due Diligence: SDIRA owners must perform due diligence when investing their IRA funds, in order to safeguard themselves and avoid scams and schemes that prey upon unknowing investors. A wider variety of investment choices means more complexity and, potentially, higher risks.
Tax Liabilities: As is true with other IRAs, SDIRA distributions may be subject to taxes; however due to their unique investment strategies they could incur further obligations, such as Unrelated Business Income Tax (UBIT).
Custodian Role: All IRAs, including SDIRAs, require a custodian. However, unlike with conventional IRAs where custodians typically provide investment advice or oversight of investments directly, an SDIRA custodian often takes an inactive role that involves providing administrative services rather than giving advice directly.
Self-Directed IRAs are legal investments; they’re an acceptable means of diversifying retirement portfolios. But as with all investments, self-directed IRAs carry unique complexities and obligations which prospective investors should understand prior to diving in. As with all investments, doing thorough research into all potential risks is necessary and consulting financial and legal advisors is always recommended before diving in headfirst.