A minor story line of the 2012 presidential campaign was the revelation that candidate Mitt Romney's IRA account was worth $102 million. While details remain murky regarding exactly how he was able to amass such a sum, given the limitation on annual contributions, one fact is obvious: he didn't get there by owning a traditional mix of stocks and bonds in his IRA.
While Mr. Romney likely used some nontraditional investment choices that are unavailable to most investors (private equity available through his Bain Capital company), the fact is there are non-traditional IRA options available to everyday investors as well. In rare cases, they offer the potential of dramatic gains. In others, they can become complicated and expensive hassles.
Over the years we've heard from a small number of SMI readers interested in owning non-traditional assets within an IRA. Typically readers ask about owning precious metals within an IRA, with occasional questions about real estate, and a rare inquiry about holding private business ownership. We will focus primarily on precious metals in this article, but we'll touch on the other types as well.
Before we dive into the specifics, here are two general principles regarding owning non-traditional assets within an IRA:
- It's usually complicated, so do your homework.
- It's usually (relatively) expensive.
One of the key rules regarding these IRA assets is that you can't be directly involved with the investment in any way. The IRA owns the asset, not you. This means you typically can't hold it, work on it, benefit from it, or be involved with it in any capacity. We'll revisit what this means specifically for each group as we go.
One of the first implications of this rule is you're probably going to need a specialty firm to be the custodian of your IRA. Most of the traditional firms people use for IRAs (Fidelity, Schwab, etc.) won't allow these assets in their accounts because of the extra rules and hoops the custodian has to jump through — and you can't hold the assets yourself. Thankfully there are specialty firms that handle these types of IRAs, but as with specialty firms of any type, you're going to pay for the privilege.
Two of the better known custodians for these types of IRAs are The Entrust Group and Equity Trust. Both of these firms can handle precious metals, real estate, and private business interests. GoldStar Trust and Hard Assets Alliance are two additional firms worth investigating if you only want precious metals capability.
The simplest approach to owning precious metals in a retirement account is to simply invest in precious metals-related ETFs, stocks, or mutual funds. However, some investors want to own the physical metal itself rather than a paper investment. This means buying actual coins, bars, or "digital gold."
But how do you get the bullion into your IRA? The process is fairly straightforward, although it is more complicated than "normal" IRA investing. Check with your current IRA custodian first, but chances are you're going to need an account with one of the specialty custodians mentioned above.
Once you've chosen a custodian, three steps remain: (1) filling out the application; (2) funding the account; and (3) choosing the metals you want to buy (the IRS won't let you put metals you already own into an IRA). The paperwork for opening a precious metals IRA is similar to other retirement account applications; funding the account is accomplished as you would fund any other such account — i.e., making a direct contribution by check or wire, or by executing a transfer or rollover from another retirement account.
The third step, however, is unique to precious metals IRAs. In step three, you negotiate with a metals dealer to buy the gold you want to put in your IRA. (The law prohibits your custodian from choosing a dealer or negotiating the price.) Once the deal is set, you contact the custodian, who then issues the dealer a purchase order for the metals you've agreed to buy. (Hard Assets Alliance has a unique, and simpler, approach to this purchase process similar to that of digital gold, explained later. See their website for details.)
For coins and bars
After receiving the purchase order from the custodian, the dealer ships the coins or bars you've chosen to a certified depository that will store the metals on your behalf. (You're not allowed to hold the metals; neither is your custodian.) Knowing your investment is secure may offer peace of mind, but it comes at a cost. Some depositories charge a flat fee; others charge a percentage of your IRA's value. Of course, you'll also have custodial fees (a fixed fee or a percentage). Altogether, custodial and storage fees are likely to run somewhere between $150 and $400 a year. Some custodians also charge a transaction fee each time you add to your IRA.
Assuming you want gold, which form should you choose? There's no single "best" choice. Since 1998, Congress has allowed all legal tender gold coins that are at least .995 fine (99.5% pure) to be part of an IRA. That includes Canadian Maple Leafs and Austrian Philharmonics, but not the popular South African Krugerrand. (The one exception to the .995-fine rule is the American Gold Eagle, which is only .9167 fine but is also allowed.) Gold bars that meet the .995-fine standard are also okay. The law also allows IRA investments in silver, platinum, and palladium; some restrictions apply.
For "digital gold"
A recent innovation in precious metals retirement accounts is the ability to buy "digital gold" via GoldMoney.com based in the British Channel Islands. However, since U.S. law requires that precious metals IRA investments be made through a custodian, you can't open an IRA directly with GoldMoney. Instead, you must first set up an account with a custodian (The Entrust Group is the authorized custodian for GoldMoney), which will then — at your specific instruction — execute the purchase of digital gold for your IRA. (The corresponding physical gold will be held in one of several foreign depositories noted on the GoldMoney website.)
One advantage of a digital gold IRA is that once your account is set up, adding to your IRA is a simple process. Rather than having to negotiate the purchase of coins or bars from a metals dealer, additional purchases can be executed via online transfer (again, through the custodian, not directly with GoldMoney). Transaction fees will apply.
Although setting up a precious metals IRA does require jumping through a few hoops (the result of laws aimed at keeping custodians, dealers, and depositories separate), your custodian is there to guide you through the process. By law, custodians cannot give investment advice, but they can lay out the options and respond to your questions about what to do next.
One important question about precious metals IRAs is what happens when the time comes to start taking distributions? (By law, withdrawals from Traditional IRAs can begin as early as age 59½; they must begin by age 70½. Roth IRAs have no mandatory distribution requirements.) The process will vary, depending on whether you opted for a coins/bars IRA or digital gold account. With the former, you can either convert your metals to cash, or take distribution of the actual coins or bars and convert them to cash later. With digital gold, your options are (1) convert to cash, or (2) transfer your distributions to a separate non-IRA digital gold account.
If you have unusual real estate acumen, owning real property within an IRA could be a profitable move. For most people, though, direct ownership of real estate in an IRA eliminates several of the features that normally make property a popular investment. Here are a few:
- IRA rules make it difficult to buy property using a mortgage. This eliminates the leverage aspect of any gains you might eventually get. Normally, if you buy a property with 20%-50% down and sell it at a profit later, the mortgaged portion amplifies your gains. But an IRA doesn't allow its owner to be held liable for unpaid debt, meaning the only permissable loans are those that use the property itself as collateral. While available, such loans aren't always easy to find. Taxes also can become a pain, because any earnings on the mortgaged part of the property are no longer tax-exempt.
- No personal use. Forget the idea of buying a vacation property that you can use occasionally while renting it out most of the time. Or a building where you keep an office and rent the rest. Bottom-line: you can't use any IRA-owned property at all, and neither can any relative or related business. Violate this rule even once and your IRA can lose its tax-exempt status. And you can't buy a property from any related party either.
- No "sweat equity." You also can't pursue the time-honored path of fixing up a place yourself in order to resell it for a higher price. Any renovations or active management of an IRA property has to be done by an unrelated party.
- All costs must be paid by the IRA. This may not be a big deal in certain cases, such as if you own raw land. But it can be problematic for those owning rental property. For rentals, this may mean needing to have enough extra cash in the IRA to be able to pay ongoing expenses should the property be vacant at some point. That can lead to lower returns, since those extra funds will likely be in cash or other liquid/low-volatility assets. You can't pay any expenses from outside the IRA without significant repercussions.
Because of these restrictions, specifically the lack of easily available mortgage leverage, it's not unusual for IRAs with real estate to become concentrated in just a small number of properties. Owning real estate directly in an IRA can be a smart move for the right person, but it can be a perilous path for others. Most investors desiring real estate exposure in an IRA would likely be better served investigating REITs—an easy-to-own type of real estate mutual fund.
Owning shares of a privately-held business in an IRA is obviously a potentially lucrative investment if the business does well. Unfortunately, the strict restriction that neither an investor nor any family member can work at any company owned within an IRA limits the availability of this option dramatically, since the reason many people gain access to these shares is through their working relationship with the company.
A second dream-squasher arrives when they realize that any untaxed business income (as from an LLC) received by the IRA is still going to be taxed. Without getting into the details, this Unrelated Business Income Tax (UBIT) can take the wind out of the sails of many prospective private equity deals an IRA owner might engage in.
Advantages of a Roth IRA are huge
Many non-traditional assets are difficult and/or expensive to value (for example, a real estate investment might require a new appraisal each time a valuation is needed). Even if valuation is clear, incremental selling of investments that are often illiquid by nature can be problematic. That's why owning these assets in a Roth IRA, where required minimum distributions (RMDs) beginning at age 70½ are not required, is an extremely significant advantage vs. owning these assets in a traditional IRA. The Roth's "no tax on earnings, ever" feature obviously doesn't hurt either.
Yes, you can – but should you?
We've spent a lot of time covering the basic mechanics of owning non-traditional assets within an IRA. But what about the "strategic" question: Is it a good idea? For most investors, the answer is probably not. Because of the significant fees involved, such accounts aren't well suited for new IRAs (the expenses are too high as a percentage of the small initial balance). Nor are these asset types well suited to dollar-cost-averaging (i.e., month-by-month investing), as you might do with an IRA containing mutual funds. Instead, these non-traditional assets are most appropriate for those with sizeable, currently-existing IRA balances who wish to convert a portion (or all) of their IRA holdings.
Thankfully, competition and innovation continue to make these options available to more investors at realistic price-points. But most smaller accounts should likely pass due to expenses and complexity.