Pursuant to Section 408 of the Internal Revenue Code, an IRA must be established by a bank, financial institution, or authorized trust company. Thus, a bank such as Wells Fargo, financial institution such as Vanguard, or a trust company such as the IRA Financial Trust Company are authorized to establish and administer IRAs. The main difference is that not all IRA custodians allow the IRA to invest in alternative assets, such as real estate.
Individual Retirement Account is a term that most Americans have some understanding of. They are commonly aware that it is a type of retirement account that was designed by Congress to encourage people to save for retirement. They generally understand that one can contribute a certain amount of income each year to the IRA account for investment. However, most do not have a solid understanding of the concept of tax deferral and the fact that retirement funds can be invested in assets other than stocks or mutual funds through what has become known as a Self-Directed IRA.
So why don’t they know this? It’s not because the majority of Americans are uneducated, indifferent, or incurious – they simply have not been told. It’s not in the financial interests of the traditional institutional investment companies, such as Bank of America, Charles Schwab, or E-Trade, to encourage you to make alternative investments using retirement funds. They make money when you invest in their financial products and keep your money there for a long time, whether through highly profitable trading commissions or by leveraging the power of your savings. They make no money when you use your money to invest in alternative or nontraditional investments, such as a plot of land or a private business. They get no commissions as a result. They lose access to your money too. Why would they inform you that such a strategy was permissible and possibly even preferable depending on the circumstances?
Yet, such nontraditional or alternative retirement asset investments are perfectly legal. The IRS has permitted them since 1974. It says so right on the IRS website.
And the best way to make those investments is through the Self-Directed IRA.
What are the Responsibilities of a Self-Directed IRA Custodian?
The majority of all Self-Directed IRA custodians are non-bank trust companies for the reasons outlined above. The Self-Directed IRA custodian or trust company will typically have a banking relationship with a bank who will hold the IRA funds in a special account called an omnibus account, offering each Self-Directed IRA client FDIC protection of IRA funds up to $250,000 held in the account. For example, IRA Financial Trust is a non-banking IRA custodian. IRA Financial Trust has partnered with Northern Trust, one of the most respected private banks in the world, to offer their Self-Directed IRA clients a safe and secure way to make Self-Directed IRA investments.
The following are the primary roles and responsibilities of a Self-Directed IRA custodian:
- IRS approved
- Permitted to hold and custody IRA and 401(k) plan assets
- Subject to state regulation by the state division of banking
- Performance of administrative record-keeping regarding the Self-Directed IRA
- Perform administrative review of the Self-Directed IRA assets
- Assisting in opening & funding your IRA account
- Making the investment(s) on your behalf
- Making distributions & paying expenses per your request
- Providing you with quarterly statements
- Answering questions about your account and our procedures
- Reporting information required by the IRS and other governmental agencies
- IRS Form 1099R – Distributions from your IRA
- IRS Form 5498 – Contributions to and Fair Market Value of your IRA
What are the Differences Between a Self-Directed IRA Custodian and Third-Party Administrator?
All IRA custodians, banks, financial institutions, and approved trust companies are regulated entities that are authorized by the IRS to act as IRA custodians. Since custodians are directly approved by the IRS, they are the only entity in this group that’s allowed to physically hold retirement assets. IRA custodians are needed in order to make investments with IRA funds and, as a result, are regulated by federal and state banking authorities.
Whereas, an IRA administrator is not able to hold or custody IRA assets and is not approved or overseen by the IRS or any state banking regulators. IRA administrators essentially act as intermediaries between the IRA owner and a partner custodian.
Why Is It Important to Work Directly with an 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, which is 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, helping keep your IRA safe from prohibited transactions and fraud.