Self-directed IRAs offer greater choices and flexibility than traditional retirement accounts, but also carry their own set of risks.
As an example, it’s critical that investors carefully screen investments and avoid any transactions considered prohibited (like fixing the toilet at an investment property you own) that could incur IRS fines.
1. They’re too complicated
Self-directed IRAs allow you to invest outside the list approved by the IRS, such as real estate, promissory notes and tax lien certificates. But these alternative investments often carry higher risks and fees.
Researching and understanding this form of retirement account requires thorough investigation to ensure investments comply with IRS rules – specifically any prohibited transactions – in order to comply with it correctly and avoid tax debt or losing deferred tax status altogether. If any mistakes arise, any mistakes could result in you owing Uncle Sam money or losing its deferral status.
Alternative investments can be difficult to value and value accurately, which means you should make sure your custodian or promoter provides accurate pricing and asset valuation information to you in order to avoid creating an ineffective investment with less-than-desirable returns. It may be best to partner with someone familiar with these nontraditional assets who can ensure the accuracy of information provided to you from them.
2. They’re too risky
Self-directed IRAs allow investors to invest in alternative assets like real estate, precious metals and private equity within their retirement accounts. Unfortunately, however, these investments often lack clear pricing or valuation information like stocks and bonds do, leading to potential fraudulence by promoters claiming false prices or promising high returns in exchange for your money – the Securities and Exchange Commission warns against this type of scheme.
These investments may also be risky due to being illiquid, making it hard to access your money when needed – this can prove especially problematic during retirement when required minimum distributions must begin at age 72.
Rule-breaking can lead to costly IRS penalties. For example, living in property owned by an IRA and providing services like fixing broken toilets would both violate rules that must be strictly observed; any violation will constitute engaging in prohibited transactions and could see your IRA disqualified as an investment vehicle.
3. They’re too expensive
Self-directed IRAs allow investors to invest in alternative assets like real estate, precious metals, private equity and cryptocurrency with less government oversight compared to publicly traded stocks and bonds.
Self-directed IRAs may provide increased returns; however, their additional investment flexibility comes with additional risks that should be understood before deciding to open one.
Self-directed IRA investors will need to hire someone with expertise to conduct due diligence on each investment before making it in their account. While this can be costly, this due diligence must take place so as not to violate the IRS’s “self-dealing” rule – this prohibits IRAs from conducting business deals with disqualified parties like spouses or children of an IRA owner. Failure to do so could incur heavy fines as well as the loss of deferred tax status; ultimately making self-directed IRAs suitable only for experienced investors who are prepared to assume more responsibilities when investing outside traditional asset classes.
4. They’re too easy to scam
Unfortunately, self-directed IRAs aren’t protected against fraud like traditional IRAs are. No regulations or vetting process is conducted by their custodian, so fraudsters may take advantage of this lack of oversight to target vulnerable investors.
Scammers often promote investments in nonexistent or overpriced assets through psychological manipulation, using techniques such as affinity fraud to build trust between themselves and individuals with shared backgrounds or interests, which they target to gain access to IRA funds. They may even falsify custodial responsibilities by falsely guaranteeing investment losses – though often this doesn’t happen, although insurance may cover physical assets like gold and real estate assets.
IRS rules make it more challenging for an IRA to invest in certain properties or investments, and any breach could trigger a taxable event with accompanying taxes and penalties. To mitigate such risks, educate yourself about different alternative investments available and their risk profiles while staying abreast of industry trends.