Ask the Self-Directed IRA and Solo 401k Experts

Are all Self-Directed IRAs the Same?

Mark K., NC

Hi Mark,

Thanks for your question. A self-directed IRA is a type of IRA structure that allows the IRA holder (you) to have more control over your retirement funds. Unknown to some, not all self-directed IRAs are the same. It is well known that the IRS allows you to use your IRA to make traditional investments, such as stocks and mutual funds, it is not as well known that the IRS also allows you to use IRA funds to make real estate, precious metals, tax liens, private business and much more tax-free and penalty free! In fact, the IRS only prescribes a few restrictions on the type of investments that can made using IRA funds.

Types of Self-Directed IRA

There are essentially three types of Self-Directed IRAs:

1. Financial Institution Offered Self-Directed IRA

The most popular Self-Directed IRA account offered is the financial institution Self-Directed IRA. The reason that this type of Self-Directed IRA is so popular is because generally offered by the major financial institutions, such as Bank of America, Wells Fargo, Fidelity, Vanguard, etc. With this type of Self-Directed IRA, the IRA holder is generally able to only make IRA investments offered by the financial institution which typically only includes financial relates investments, such as stock, mutual funds, and ETFs. Even though these types of IRA accounts are called “Self-Directed IRA” accounts that are very limited in their investment scope and do not allow IRA investors to make any non-traditional investments, such as real estate.

Why do the financial institutions limits the investment options available?

A financial institution that offers IRA accounts is not required to offer its IRA investors with the opportunity to make all allowable types of IRA investments. For example, even though real estate is an IRS approved investment, an IRA custodian is not required or obligated to offer that investment option. Accordingly, most financial institutions offering IRA accounts will restrict the IRA investment option to financial products offered by the financial institution. The reason behind this is quite clear – a financial institution earns fees from the sale of financial products not by allowing its clients to pull money out of the IRA account to buy real estate from a third-party.

2. Custodian Controlled Self-Directed IRA

A custodian controlled self-directed IRA offers an IRA investor more investment options than a financial institution self-directed IRA. With a custodian controlled Self-Directed IRA, a special financial institution or IRA administrator will serve as the custodian of the IRA. Generally, all IRA custodians are FDIC insured. Unlike a typical financial institution, most IRA custodians generate fees simply by opening and maintaining IRA accounts and do not offer any financial investment products or platforms. With a custodian controlled Self-Directed IRA, the IRA funds are generally held with the IRA custodian and the IRA custodian, at the IRA holder’s direction, will then invest those IRA funds accordingly.

Until a 1996 court case, the custodian controlled Self-Directed IRA was the only way one was able to use IRA funds to make a non-traditional investment, such as real estate. In essence with a custodian controlled Self-Directed IRA, every step an IRA holder wanted to make had to be carried out through a custodian, which would involve high annual fees, transaction fees, and time delays. In other words, the IRA holder could not take direct control. Every time the IRA holder wanted to pay an IRA transaction expense, for example mowing the grass or pay the bills on a real estate IRA investment, the IRA holder had to pay a custodian to do it.

3. “Checkbook Control” Self-Directed IRA LLC

In the 1996 case of Swanson vs. Commissioner, 106 T.C. 76 (1996), the tax court gave its blessing to a new type of self-directed IRA structure — the Self-Directed IRA LLC also known as the checkbook IRA— that is much simpler than investing through a regular custodial controlled self-directed IRA account.

With a “checkbook control” Self Directed IRA, the IRA holder (you) will have total control over your IRA funds and you will no longer have to get each investment approved by the custodian of your account like in a custodian controlled Self-Directed IRA. Instead, all decisions are truly yours. When you find an investment that you want to make with your IRA funds, simply write a check or wire the funds straight from your Self Directed IRA LLC bank account to make the investment.

Under the checkbook IRA format, the IRA is set up as a self-directed account that's capitalized by funds rolled over from your current retirement account. Then, a limited liability company (“LLC”) is created in which your new IRA purchases all the membership units/interests. Now, your money is held in an LLC and you are ready to invest at your discretion. A “checkbook control” Self Directed IRA allows you to eliminate the delays associated with an IRA custodian, enabling you to act quickly when the right investment opportunity presents itself.

With a Self Directed IRA, when you find an investment that you want to make with your IRA funds, simply write a check or wire the funds straight from your Self Directed IRA LLC bank account to make the investment. The Self Directed IRA allows you to eliminate the delays associated with an IRA custodian, enabling you to act quickly when the right investment opportunity presents itself.

Please do not hesitate to follow-up with any questions.

The Self-Directed IRA Experts


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