Entrust Learning Center > IRA Insights > Considerations When Selecting An IRA Administrator/Custodian

Considerations When Selecting An IRA Administrator/Custodian

When you select an IRA custodian to handle your Self Directed IRA account, you have limited choices but need to carefully evaluate their ability to provide you the services that you need. Many IRA owners are unfamiliar with many of the rules related to I

By: Catherine Wynne

IRA Insights

When you select an IRA custodian to handle your self-directed IRA account, you have limited choices but need to carefully evaluate each company’s ability to provide you the services you need. Many IRA owners are unfamiliar with many of the rules related to IRAs and don’t spend much time following current developments with the IRS. Thus, those IRA owners tend to rely on the administrator to know and help provide education about the basic rules, particularly regarding prohibited transactions and disqualified persons.

They also count on the administrator to stay abreast of current developments. IRS § 4975, “Prohibited Transactions”, provides you with the big picture regarding operating your account legally and ensuring the rules are followed. However, the big picture is generally not sufficient, and many individuals turn to their administrator for assistance, relying on the experience and knowledge of their administrator with regard to their specific transaction.

For the purpose of this article, we are using the terms “trustee”, “custodian” and “administrator” synonymously.

You are ultimately responsible for following the IRS rules, so knowledge of the rules is critical. Some administrators are not as experienced and may inadvertently violate the rules. In most cases, it is a prohibited transaction that is in violation of the rules. Such a transaction may result in taxes and penalties not just for the administrator, but for you and your IRA account as well.

How do you know if your IRA administrator knows what they are doing? Inquire about their experience. How long have they been providing self-directed IRAs? Educational background? How do they keep track of new regulations and the implications of new court decisions?

We have seen administrators who have allowed certain types of transactions which a custodian should never be involved in or allow. For example, if your IRA custodian allows any of the following, consider looking elsewhere for custodial services:

• The custodian itself lending to your IRA
  
• Allowing you to transfer or sell anything you already own to your IRA
• Funding a transaction which involves a disqualified person such as a spouse, child or parent
  

Unfortunately, the first example above is being done by bank custodians who do not understand the rules. If a bank is your IRA custodian, that bank may not make a loan to your IRA. IRS § 4975 clearly states the following:

For purposes of this section, the term “prohibited transaction” means any direct or indirect—4975(c)(1)(B) lending of money or other extension of credit between a plan and a disqualified person; 4975(c)(1)(C) furnishing of goods, services, or facilities between a plan and a disqualified person;

What is a disqualified person? Specific to the bank custodian, 4975(e)(2) delineates the list of disqualified persons, among them:

4975(e)(2)(B) a person providing services to the plan;

In plain English, any IRA custodian who provides services to your IRA, such as custodial services, is automatically a disqualified person with regards to the law. Banks who lend money to IRAs for which they are the custodian or provide investments directly to the plan are participating in a prohibited transaction and, because it is your IRA, you are too.

It may be asserted that the function of a bank Trustee department that provides the custodial services is set up as a separate entity. If so, this entity must pass the same tests as your IRA when examining disqualified persons and the ownership of the entity providing the trust services. If the bank trustee entity is owned by the same companies or individuals as the bank providing the loan, it is still disqualified.

Recent state and federal bank audits have revealed and terminated the IRA custodial services of banks who are involved in lending to their IRA accounts, mainly because of the types of transactions listed above. As a result, many banks that are not fully versed in the rules have decided they should not be in the business of providing custodial services.

Before selecting a custodian for your IRA, know what their level of expertise is. Custodians who specialize in the area of self-directed IRAs are the best selection. Having a track record, experience with a variety of transactions and competent ERISA-based legal council are a must.

Remember, your custodian’s error will become your error in the event of an IRS inquiry. Ask your custodian the right questions in order to ensure you are getting the most experienced custodian for your IRA and be familiar with the Prohibited Transaction rules yourself in order to stay in compliance.

Catherine Wynne is President and Co-Founder of Entrust New Direction IRA, providing self-directed IRA administration, including real estate IRAs, in Colorado, Wyoming, and Montana. www.newdirectionira.com

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