Setting up a self-directed IRA
Despite these potential pitfalls, some people still decide that self-directed IRAs are the best option for at least a portion of their retirement dollars.
An IRA custodian is crucial to properly establishing a self-directed IRA. The custodial company is similar to brokerages and mutual fund companies that handle traditional IRAs. However, the IRA custodian offers investment choices that go beyond stocks, bonds and mutual funds.
The custodial firm purchases private equity or real estate investments and holds them on the IRA owner's behalf, a requirement necessary to maintain the investment's IRA status.
Just a handful of firms offer self-directed IRA custodian services, mainly because these investments require extensive research, paperwork and IRS reporting that many brokerage firms are not willing to undertake.
Expect to pay a lot more than a $10 yearly maintenance fee for this service. Costs can range anywhere from $100 to as much as $2,000 a year, depending on your investments.
Remember that custodians are only the keepers of your IRA -- they do not offer investment advice or conduct due diligence on investments. For that, you need to find a financial adviser, certified public accountant or a lawyer.
When choosing such experts, be sure to turn to someone with experience managing self-directed alternative investments for retirement. Many experts recommend working with a fee-based financial planner rather than an adviser who works on commission.
Hiring the right help is crucial to staying in compliance with IRS tax rules regarding self-directed IRAs.
For example, it's important to avoid what the IRS labels "prohibited transactions," including investments such as life insurance, stock of S corporations and collectibles.
Also, people who open self-directed IRAs cannot use the funds to buy an investment from or sell an investment to a disqualified person as defined by the IRS in Internal Revenue Code Section 4975.
Disqualified people include the IRA owner and family members such as spouses, parents, grandparents and great-grandparents, children and their spouses, and grandchildren and great-grandchildren and their spouses.
Investors who violate self-directed IRA rules are guilty of "self-dealing" and can lose the tax-deferred status on the entire IRA balance. In such instances, they face having to pay income taxes and being charged an additional 10 percent penalty if they are younger than 59½ years of age.
Reaping the rewards
With the right professional advice, careful investors can benefit from using self-directed IRAs to fund their retirement, Bachelder says. She contends that even investors without a lot of money can benefit from this investment option.
"Self-directed IRAs are not just for the very wealthy," she says.
For example, investors can lower their overall stake -- and the risk that comes with it -- by joining forces with others, Bachelder says.
"An investor can participate within a part of an investment, if it is correctly structured," she says.
“Our most successful clients are the ones that are investing in something they understand.”
Bachelder cites the example of two clients who each used $25,000 from their IRA to purchase a dressage horse that cost $50,000. After training, such a horse can be sold for as much as $70,000 to $100,000.