There are essentially two ways to make non-traditional investments, such as real estate with a self-directed IRA: (1) An IRA custodian controlled self-directed IRA, which typically involves a special financial institution or IRA administrator will serve as the custodian of the IRA. 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. The IRA custodian is involved in every facet of the self-directed IRA transaction from signing checks to documentation and the account fees are typically asset and transaction based. (2) A “checkbook control” self-directed IRA LLC that offers the IRA holder with more control and cost efficiency when making IRA investments.
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 LLC is created in which your new IRA purchases all the membership units/interests. At that point, the IRA funds are held in an LLC and you are ready to invest at your discretion. A “checkbook control” Self Directed IRA allows one the ability to eliminate the delays associated with an IRA custodian, enabling the IRA holder to act quickly when the right investment opportunity presents itself.
Recently the Securities and Exchange Commission (“SEC”) issued an investor alert to warn investors of the potential risks of fraud associated with investing through self-directed Individual Retirement Accounts (self-directed IRAs). The SEC notes that there has been a recent increase in reports or complaints of fraudulent investment schemes that utilized a self-directed IRA as a key feature. In some cases, the fraud involved the IRA custodian who was holding the clients IRA funds. For example, in April 2014, the U.S. Securities and Exchange Commission is alleging American Pension Services and owner Curtis L. DeYoung misappropriated funds, made unauthorized investments, forged customer letters and inflated asset values, according to the lawsuit. American Pension Services’ master cash accounts were short $22.7 million at the end of 2013, according to the lawsuit. Whereas, if the IRA holders used a “checkbook control” self-directed IRA LLC structure instead of a full service self-directed IRA custodian, the client’s IRA funds would have been at a local bank in the name of the LLC, providing the client with more control and security over their IRA assets.
To be clear, fraudulent activity and bad investments can occur when an individual uses a self-directed IRA with “checkbook control, however, the chance of an IRA custodian stealing ones funds is much less likely when the funds are held by the IRA holder at a local bank of their choosing instead of at a bank the IRA custodian has some connection to.