Ever since the concept of individual retirement accounts (IRA’s) was introduced in 1974 there’s been a lot of misunderstanding about how they work and what an individual can do in terms of directing their own retirement account investments.
From a strictly legal perspective, very few things a private investor is prohibited from doing with their retirement account. However, because third-party custodians must hold such accounts, it didn’t take long for banks and stock brokerage companies to realize that if they acted as the custodians, they could effectively limit what was offered through such accounts to only those investments which generated profits for them. In fact, such firms often offer custodial services for free or for fees so small that they don’t even cover the related administrative costs.
In the wake of the dot com bust at the turn of the century, as investors sought alternatives and real estate began to attract considerable interest, independent custodial firms popped up to facilitate “non-traditional” (i.e., things other than stocks, bonds, mutual funds, and savings accounts). Being at a severe marketing disadvantage to the big banks and brokerage houses, these companies led with consumer education. The internet has made much of this valuable information readily available to investors who want to truly “self-direct” their retirement investing.
However, even with an independent custodian, self-direction can sometimes be too cumbersome to respond quickly to great non-traditional opportunities when they pop up. For example, if you are purchasing an investment at an auction, or you’re running a rehab project and need to pay a contractor, you may not have the time to go back and forth with the custodian to gain approvals or obtain funding. You need to be able to write a check on the spot. Even if you have the time, why go through all the hassles if it isn’t necessary?
The general concept of the Checkbook IRA is very simple. Rather than fund an account with your custodian and then go through the approval and funding drill on a transactional basis (one deal at a time), you set up an entity (typically an LLC) and direct your custodian to use all, or part, of your retirement funds to purchase the LLC.
Now all (or a portion) of the account money is in the LLC as its sole owner, and you, as the Manager of the LLC, effectively control and manage those funds. Whenever an attractive investment comes across your desk, you can sign the paperwork and write a check immediately. No more dealing with the custodian. No more waiting for the custodian to approve your investment.
Now, it is very important to note that you, personally, cannot benefit from any of these transactions and all profits (and losses) belong to your IRA. For this reason, you cannot charge any managerial fees for rendering the services to the LLC.
1. Remember: It’s still an Individual Retirement Account. Therefore, all of the I.R.S. rules and regulations still apply. So in addition to no current benefit to the owner (you), you still can’t engage in ‘Prohibited Transactions’ or deal with ‘Disqualified Persons’. It’s beyond the scope of this report to discuss these items in detail, but you should be very familiar with these restrictions before you start writing checks. If you violate one of these rules, you could be facing a hefty tax and penalty. This is why you should have a qualified advisor at the ready so you can get qualified advice quickly when you need it.
2. Gain Additional Asset Protection and Privacy. Though IRAs enjoy some level of preferential treatment when it comes to asset protection, having an LLC in front of your IRA adds an additional layer of both asset protection and privacy. You can name the LLC anything you want, and since it will be writing the checks and holding the investments, there isn’t necessarily anything in the public record that indicates that you are the owner. And if the LLC were to be sued, you may also be afforded ‘charging order’ protection. If you’re unfamiliar with the powerful concept of ‘charging orders’, be sure to consult with an entity specialist who can advise you where and how to set up your LLC to maximize both asset protection and privacy.
3. Be Cautious of Subsequent Transfers. Although Courts have ruled that the initial transfer of your retirement funds (the initial purchases of the LLC interests) into your LLC is not a Prohibited Transaction, the law is less clear when it comes to subsequent transfers. If you find you need to add additional capital to your LLC, you should consult a qualified advisor to be sure such a transaction doesn’t trigger a severe penalty.
The Checkbook IRA is an exciting and powerful tool that provides flexibility, greater speed, and control, plus additional privacy and asset protection features when compared to a standard self-directed IRA. With the proper structure and professional advisors, it is something every serious investor should consider.
This blog post is intended to provide general information and should not be construed as, and does not constitute legal advice on any specific matter, nor does this message create an attorney-client relationship with Premier Law Group.