URL: http://www.entrepreneur.com/magazine/entrepreneur/2007/november/185588.html
Interested in a retirement-friendly, tax-deferred way to invest in, say, reality TV? How 'bout a beach house in Malibu or a burger franchise in Eastern Europe? Self-directed IRAs can help. Unlike traditional IRAs that limit investors to stocks, mutual funds and bonds, this alternative account allows for a broader, more creative range of assets, including real estate, private equity, foreign companies and even racehorses.
David Cole, a private developer in Fort Worth, Texas, uses a Solo 401(k) to invest in a reality television series and two real-estate development projects in his neighborhood. Now, he's investing in two real estate development projects and a reality TV series. "My purpose was two-fold," says Cole, 44. "I wanted to take advantage of opportunities in real estate and defer the taxes, [as well as] diversify away from the stock market."
The payoff from a self-directed IRA can be higher than an average mutual fund, but the related dangers may be greater as well, experts say, because it's not as diversified as a basket of stocks, funds and bonds. "The higher leveraged you are in any investment, the greater the risk," says Nora Peterson, author of Retire Rich With Your Self-Directed IRA. "For example, if you've only got $2,000 and you buy someone's tax lien, it could be great. But if you haven't done your homework, the [entire] IRA can be lost." What’s potentially more risky, says Jeff Nabers of the IRA Association of America, is that self-directed IRAs don’t have built-in advisors, like mutual funds do. “It’s almost like you’re the manager of your own little mutual fund,” says Nabers. “The whole thing can be dangerous for a variety of reasons…unless you find professional advisors to keep you safe.”
Getting Started
The
first step is pinpointing an alternative investment, and investors
should rely mostly on their own judgment. "There isn't a market where
you just look up [various] opportunities," says Tom Anderson, CEO of
Pensco Trust, a custodial firm for self-directed IRAs. "There's nobody
bringing [ideas] to the IRA owner and saying, ‘Choose A or B.' There's
no one driving the bus for you."
Cole, fortunately, has insight as an experienced property developer, and the two projects he's invested in are managed by fellow developers he trusts. The reality TV program seemed sound because it was already in production and needed additional bridge financing.
The next step for investors is to hook up with custodial firms, such as Pensco or Sunwest Trust Co., that facilitate the investment and keep the books for a fee. While all IRAs are required to be held by a custodian approved by the IRS, Cole wanted more control and opted for a Solo 401(k), which doesn’t require a custodian.
Don't Self-Deal
Individuals
are not allowed to get involved with or have any personal gain from an
investment before they begin making withdrawals in retirement. For
example, says Ed Slott, owner of Irahelp.com, "You can buy [a] house,
but you can't live in it or rent it to your mother." Otherwise, you've
engaged in "self-dealing," one of the worst violations in the tax code.
Self-dealing exposes the entire account to taxes and penalties. The
same goes for a business: Investors can't get involved in the
operations of a business if it's included in their self-directed IRA.
The Exceptions
The
IRS prohibits investing in collectibles like an antique pinball machine
or a Persian rug. Furniture, artwork and life insurance don't qualify
either.
Cole stored about 25 percent of his retirement money in his three investment choices, which is the maximum recommended by some IRA experts. "It's not like I want to go out and stick 75 percent of my [money in one piece of property]," he says. "Not any more than I would in one stock."
