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IRA Financial Blog

Alternative Investments in an IRA

Special IRA Custodian

Understanding Alternative Investments in an IRA

As an IRA investor, you know that you can only establish an IRA with a bank, financial institution or authorized trust company. These entities will establish and administer your individual retirement account. However, not all IRA custodians will allow you to invest in alternative assets, such as real estate.

You most likely know the essentials of an IRA. You know that:

  • It’s a retirement account by Congress to encourage people to save for retirement.
  • You can contribute some of your income each year to the IRA account for investments.

But do you understand the concept of tax-deferral and that retirement funds can invest in assets other than stocks or mutual funds? You can make alternative asset investments with a Self-Directed IRA. Income and gains from your investments are tax-deferred, meaning you only pay taxes once you make a distribution at the age of retirement.

Of course, if you choose a Self-Directed Roth IRA, you pay taxes before, therefore the income and gains on investments are completely tax-free.

Traditional IRA’s & Alternative Investments

At this point, you’re probably thinking: “I’m an IRA investor. Why don’t I know that I can make alternative asset investments with a Self-Directed IRA?” It’s not because you, or the majority of Americans are indifferent or incurious. It’s because most IRA custodians choose not to tell you about Self-Directed IRAs.

It isn’t in the financial interest of traditional IRA custodians to encourage you to use your retirement funds to make alternative asset investments. They make money when you invest in their financial products. With alternative investments, you’re essentially taking your money from the financial institution to invest in assets that don’t make IRA custodians money.

They want you to keep your money there for a long time, whether through highly profitable trading commissions or by leveraging the power of your savings. They don’t receive commissions if you use your retirement funds to invest in something like Bitcoin. Additionally, they lose access to your money.

Alternative Investments in a Self-Directed IRA

Alternative assets are investments outside of traditional investments. Common examples of alternative investments include real estateprivate equitycryptocurrenciesprecious metals, such as goldstructured settlements, and venture capital investments. Whereas traditional investments include stocks, bonds and bank CDs.  Alternative investments are more complex than traditional investments, which is why they appear to be better suited for “accredited” or “qualified” investors.

“[Alternative] investments…just do not trade like a simple stock and have much more complexities,” explains Gerald Hendrik, Director of New Business and Client Relations at International Management Corp (ICMC), a wealth management firm. “Alternative investments are geared to…investors who are considered high net-worth individuals with investment experience.”

Hendrik goes on to say that alternative investments generally have high minimum investment requirements. However, you do not need to be an experienced investor to purchase alternative assets with your retirement funds. It is important to understand the investment and preferably have background knowledge before making a commitment. It’s also important to know the benefits and the dangers of the investment(s) before putting money into it.

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What are the Benefits of Investing in Alternative Assets?

1. Diversification

In general, most Americans have an enormous amount of financial exposure to the equity markets. Whether it is through retirement investments, such as IRAs or 401(k) plans, or personal savings, many of us have most of our savings connected to the stock market. In fact, over 90% of retirement assets are invested in the financial markets. With over $30 trillion in retirement assets as of 2021, you can see the scope of that exposure. Investing in non-traditional assets offers a form of investment diversification from the equity markets.

Additionally, the more diverse your portfolio, the greater chance that your assets will offer lower correlation. In other words, they are less likely to move in the same direction. However, diversification does not assure profit or protect against loss. Nevertheless, the use of non-traditional asset classes can help protect your portfolio when the market is down. It can also help protect you from losing more than the market.

2. Invest in Something You Understand

Many Americans became frustrated with the buoyancy of the equity markets. Many Americans have yet to recover from the market swings and they aren’t 100% sure what goes on in Wall Street or how it all works. Real estate, for comparison, is often a more comfortable investment for the lower and middle classes. You may relate. You most likely grew up with the understanding of such investments. Whereas the upper classes learn about Wall Street and other securities during their younger years and college days.

We all hear talk about the importance of owning a home or the amount of money that you can make by owning real estate. Reality TV related real estate programming is growing in popularity, and this is contributing to real estate becoming a mainstream asset category. It’s also rising as one of the most trusted asset classes for Americans. Of course, it isn’t without risk, because there are no risk-free investments. However, many retirement investors feel more comfortable understanding the real estate market and buying and selling real estate than they do stocks.

3. Inflation Protection

Rising food and energy prices, along with high federal debt levels, have recently fueled new inflationary fears. As a result, some investors may look for ways to protect their portfolios from the ravages of inflation. It is a matter of guesswork to estimate whether these inflation risks are real. However, for some retirement investors, protecting retirement assets from inflation is a big concern. Inflation can have a negative impact on a retirement portfolio because it means a dollar today may not be worth a dollar tomorrow. It also increases the cost of necessities that are vital to live and enjoy life, such as bread, gas, shelter, clothing, medical services, etc. This decreases the value of money so that goods and services cost more.

For example, if someone has an IRA worth $150,000 at a time of high inflation, that $150,000 will be worth significantly less or have significantly less buying power. This can mean the difference between retiring and working the rest of your life. Buying hard assets are seen as one way of protecting your assets against inflation. Many investors recognize that investing in commercial real estate can provide a natural protection against inflation. As you may know, rent tends to increase when prices increase. This acts as a hedge against inflation.

4. Hard Assets

Many alternative assets, such as real estate and precious metals are tangible hard assets. In other words, you can see and touch them. With real estate, for example, you can drive by with your family, point out the window, and say, “My IRA owns that”. For some, that’s important psychologically. This is especially the case in times of financial instability, inflation, or political or global upheaval.

Non-traditional assets, like real estate and cryptocurrency are perfectly legal investments. The IRS has allowed investors to use their retirement funds to invest in such assets since 1974. And the best way to do this is through the Self-Directed IRA. A Self-Directed IRA allows you to invest in a wide-range of assets and diversify your portfolio. The most commonly held alternative investments in an IRA include:

  • Real Estate: Including commercial properties, residential properties, flipping houses, seller-financing, land, farmland and so much more!
  • Gold, Silver and Other Precious Metals
  • Hard Money Loans
  • Private Companies
  • Cryptocurrency
  • Traditional Assets such as Stocks, Bonds and Mutual Funds
  • Private Equity and Venture Capital Investments
  • I Bonds
  • Commodities
  • Crowdfunding Ventures, such as Loans
  • Venture Capital
  • Live Stock
  • Oil & Gas
  • Foreign Currencies (Forex)
  • Farm Animals
  • Vineyards
  • Pre IPO Companies
  • REITS
  • Partnerships
  • Startups
  • And so much more!

While some alternative investments are more common, with a Self-Directed IRA you can invest in just about anything.

*While IRA Financial allows customers to invest in an extensive range of alternative investments, some Self-Directed IRA Custodians only allow individuals to invest in precious metals and cryptos. Hence, it is important to do your research before deciding to open an account with a Self-Directed IRA Custodian. Furthermore, it is also important to ask Self-Directed IRA Custodians about their fee structure. Some Self-Directed IRA Custodians charge an asset valuation fee. At IRA Financial, we charge a flat annual fee, so you will never have to worry about paying an asset valuation fee.

Related: A Recent Case Shows the Importance of Selecting the Right IRA Custodian

Why should you invest your IRA in Alternative Assets?

The importance of investing in alternative assets comes down to investment diversification. Diversifying your retirement portfolio with US equities, as well as alternative assets is a risk mitigation strategy. For example, if the U.S. stock market takes a hit, you can fall back on your real estate, cryptocurrency or precious metal investments.

“Alternative investments are becoming very popular,” Hendrik says. “They offer the potential for higher returns and they have lower correlations to traditional investments.”

When your investments do not correlate, they can protect your portfolio from market volatility. Every investor should look into purchasing both traditional and alternative investments.

“Growing wealth is the goal,” says Hendrik, “but protecting it is just as important.”

Read More: What is a Self-Directed IRA LLC with Checkbook Control?

How can you invest in Alternative Assets in an IRA?

Investors who are interested in using their retirement funds to invest outside of “conventional” investments can do so with a self-directed retirement plan. Before establishing a self-directed account, such as the Self-Directed IRA, make sure you go through a custodian who allows for the purchase of alternative investments. For example, most banks and financial institutions will establish a “Self-Directed” plan and make investments on your behalf. However, the types of investments such institutions will make are restricted to the financial products they sell: conventional/traditional investments.

If you wish to you use your retirement funds to purchase real estate, cryptocurrency, tax liens or any other alternative asset, you would not be able to do so through a bank or financial institution. The reason for this is because banks and financial institutions do not make money when you purchase assets they do not sell. Unfortunately, they are completely within their right not to allow you to invest in such assets.

Read More: Beginners Guide to Alternative Investments

Passive Custodian

Even though the majority of banks and financial institutions do not allow investors to invest in alternative assets, you can still make alternative investments with a passive custodian.

By establishing a Self-Directed retirement plan through a passive custodian, also known as a Self-Directed IRA custodian, you will gain the freedom to make any type of investment. Passive custodians administer retirement accounts and offer custodial and administration services. They do not make money on the type of investments you purchase with your retirement funds because passive custodians do not sell financial products.

We will soon look at the retirement vehicles that allow you to make alternative asset investments.

Self-Directed IRA or Solo 401(k) Retirement Plans

At IRA Financial, we are the fastest growing provider of self-directed retirement plans. Our plans include the Self-Directed IRA and the Solo 401(k) plan that allow plan participants to invest in traditional and alternative assets tax-deferred or tax-free in the case of a Roth IRA or Roth 401(k). By establishing checkbook control, you can make investments without custodian consent, which eliminates custodial fees and delays.

Basics of a Self-Directed IRA Custodian:

  • IRS approved
  • Can hold and custody IRA and 401(k) plan assets
  • Subject to state regulation by the state division of banking
  • Performs administrative record-keeping regarding the Self-Directed IRA
  • Performs administrative review of the Self-Directed IRA assets
  • Assists in opening & funding your IRA account
  • Makes investment(s) on your behalf
  • Makes distributions & pays expenses per your request
  • Provides you with quarterly statements
  • Answers questions about your account and the IRA custodian’s procedures
  • Reports information the IRS and other governmental agencies require such as:
    • IRS Form 1099R – Distributions from your IRA
    • IRS Form 5498 – Contributions to and Fair Market Value of your IRA

Learn More: The Basics of Self-Directed IRA Custodians

Responsibilities of a Self-Directed IRA Custodian

The majority of all Self-Directed IRA custodians are non-bank trust companies. The Self-Directed IRA custodian or trust company will typically have a banking relationship with a bank who then holds the IRA funds in a special account, or omnibus account. It offers each Self-Directed IRA client FDIC protection of IRA funds up to $250,000 held in the account.

An example of this is IRA Financial Trust, a non-banking IRA custodian, that partners with Capital One Bank, one of the most respected private banks in the world to offer clients a safe and secure way to make Self-Directed IRA investments.

Self-Directed IRA Custodian vs. Third-Party Administrator

IRA custodians, banks, financial institutions and approved trust companies are regulated entities. Additionally, the IRS authorizes these entities to act as an IRA custodian. Because an IRA custodian is directly approved by the IRS, it is the only entity in this group that can physically hold retirement assets.

IRA custodians are necessary in order to make investments using IRA funds. As a result, they are regulated by federal and state banking authorities.

However, an IRA administrator cannot hold or custody IRA assets. Furthermore, IRA administrators are not approved or overseen by the IRS or any state banking regulators. An IRA administrator essentially acts as an intermediary between the IRA owner and a partner custodian.

Read More: How to Correctly Diversify Your Portfolio

What are the prohibited transaction rules?

You can engage in virtually any investment with a self-directed retirement plan, but IRS rules do exist. For example, you cannot use retirement funds to purchase life insurance or collectibles (works of art, stamps, some coins, etc.). Furthermore, you cannot engage in a transaction that involves a disqualified person, which includes yourself as the Self-Directed IRA owner/ Solo 401(k) trustee.

“You can possibly get tax advantages or sheltered cash flows with alternative investments if done properly,” says Hendrik. “However, if you invest in alternatives in the wrong account or incorrectly, it can have negative consequences.”

Hendrik advises that investors consult with a professional before investing. At IRA Financial, our team of tax and ERISA specialists are onboard to help you navigate the IRS prohibited transaction rules. By working with IRA Financial, we will ensure that your self-directed retirement plan remains IRS compliant. Unlike other custodians, IRA Financial has never had a client audited by the IRS for triggering a prohibited transaction.

Solo 401(k) for Bitcoin

The Importance of Working Directly with a Self-Directed IRA Custodian

IRA administrators are not subject to any IRS or state audit or reviews. Accordingly, they are not subject to ongoing oversight, especially in the area of prohibited transactions. This is very important in order to keep your Self-Directed IRA in full IRS compliance. Whereas, an IRA custodian is subject to quarterly state banking division audits and reviews, as well as IRS audits, which help to keep your IRA safe from prohibited transactions and fraud.

Get in Touch

Do you still have questions about an IRA custodian, and the importance of using a Self-Directed IRA custodian for alternative asset investments? Contact IRA Financial Group at 800-472-0646.

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