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Self-Directed IRAs Can Offer - Variety but Have Complex Rules

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12-02-2006

Page B4

What are your thoughts on using companies like Entrust or Guidant as custodians for self-directed IRAs to purchase a business? Are there other companies besides these that set up such individual retirement accounts? Could I get an attorney to do it? --Ray Cobb, Atlanta

Unlike traditional IRAs, self-directed individual retirement accounts enable their owners to pursue a wide variety of investments, such as real estate, businesses or closely held stock. Essentially, you are allowed to invest IRA assets in anything except life insurance or collectibles.

Few large investment companies or banks will set up such accounts, but a handful of custodial and administration firms specialize in handling self-directed IRAs. Some of the larger firms are Entrust Group Inc. in Oakland, Calif.; Pensco Trust Co. of San Francisco, and Guidant Financial Group Inc. in Bellevue, Wash. Costs typically include an annual custodial fee and transaction fees, ranging from $50 to a few thousand dollars a year, depending on asset size and activity.

Some lawyers, accountants and IRA consultants will set up and maintain self-directed IRAs as well, often charging higher fees for more hand-holding. Be sure to seek out someone with extensive experience because the rules are complicated, involving both tax and labor regulations.

A self-directed IRA may make sense for people who want to invest in land that they don't plan to use in any personal way, or for an investor who wants to buy stock in a community bank, or some other conservative investment that isn't available through a traditional IRA.

But accountants and tax-law experts often warn that self-directed accounts can backfire. The biggest risk may be "self dealing": According to the Internal Revenue Service, an IRA is supposed to provide for your future retirement -- not your current needs or wishes. That means you aren't supposed to benefit from the investment before you start making withdrawals in retirement. If you start using the property, or taking profits from a business, that you bought through your IRA, the IRS could step in and disqualify the account, resulting in huge tax bills along with additional penalties for account holders who are younger than 59½ years old.

There are some steps you can take to make sure a self-directed IRA passes muster with the IRS. For any transaction that might be considered self-dealing, IRA consultant Ed Slott of Rockville Centre, N.Y., advises getting advance approval from the Labor Department, which helps to oversee such accounts because of its oversight of pension plans. Second, he suggests separating your self-directed IRA from the rest of your retirement accounts so you aren't putting all of your savings at risk.

And if you use a self-directed IRA to operate a small business, bringing in independent investors with a significant stake may cut down on potential self-dealing problems.