Buyer beware
While some investors may opt for self-directed IRAs, they are not for everyone. These investments come with risks that a prudent investor must weigh before taking the plunge.
Darrin Farrow, president of Pension Builders and Consultants of Westlake, Ohio,is not comfortable with these risks, and does not recommend self-directed IRAs for his clients.
"There are a lot a risks, particularly if investors are doing (it) on their own, or if they no experience with the investment, or don't have enough assets," Farrow says.
Self-directed IRAs are especially risky for people who don't have much money to invest, or who are depending on the IRA for retirement income in the near future.
A deal gone south can mean financial ruin for such an investor, Farrow says.
Michael Rubin, founder of the financial education company Total Candor, agrees that self-directed IRAs are not for the average investor. For starters, most of these investments require a significant amount of cash. Relatively few Americans have such a hefty balance of IRA funds, he says.
"Your annual $5,000 contribution isn't going to cut it," says Rubin, who is also author of the book "Beyond Paycheck to Paycheck."
Instead, Rubin urges most investors to stick with a more modest, tried-but-true approach.
"Boring as it may seem, the average investor is better suited focusing on good old low-cost index mutual funds," he says.
Certain types of self-directed IRA investments can actually worsen your tax situation. For example, investing in an entrepreneurial venture through a self-directed IRA prevents a business owner from writing off any losses in the year they were incurred.
Self-directed IRAs may be more appropriate for high-net worth individuals -- people with at least $1 million in net worth -- who have enough assets in their IRAs to risk putting a percentage of their money into alternative investments, Farrow says.
“There are a lot a risks, particularly if investors are doing (it) on their own.”
However, investors of all income groups can run into other types of trouble if they are careless -- or simply clueless -- when establishing their self-directed IRAs.
Laurie Bachelder is principal and chief compliance officer with Nua Advisors, based in Portland, Maine. She stresses that investors should seek professional advice before making investment decisions.
She especially warns investors to stay away from "do it yourself" kits available online.
"If these deals are not constructed properly, you could lose the tax-deferred status of your IRA," she says.
Garry Madaline, founder of the retirement planning company United Retirement Advisors Group based in Wayne, Pa., says the lack of transparency in some investments associated with self-directed IRAs can be a recipe for disaster for average investors.
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"Most investors can't afford the loss if it happens," says Madaline, who is the author of the book "Making the Most of Your Retirement." "Having to push your retirement back five to 10 years due to stock market losses is nothing compared to losing it all when a private deal goes bad."