IRA = Individual Retirement Account
In 1974 Congress passed ERISA legislation. IRA’s really came to life right after that.All IRA’s must have a custodian – that is an IRS stipulation. There are basically three types of custodians.
- One – you can only invest in the investment products they have to “sell”.
- Two – invest in what you wish but all transactions must go through them for a fee of course. This can be slow and expensive.
- Three – passive custodians, much less paperwork and fees and invest as you wish.
It is very important to choose the right type of custodian because any and all fees come right out of your IRA decreasing your rate of return!
IRA’s and Checkbook Control
IRA accounts held at a custodian generally do not have checkbook control. This suits many custodians just fine. These types of custodians want to review all investment paperwork, not in a fiduciary manner but merely in a custodial manner and of course charge their relevant fees.
To obtain checkbook control, we use a passive custodian create an underlying LLC for each of our IRA clients. LLC’s have managers and members. The LLC’s we create will be manager managed. The client will be the manager and the member of the LLC will be the custodian (FBO) for benefit of the IRA. We obtain an EIN for the new LLC and this combined with the articles of organization are what a financial institution requires to let the LLC have a checking account. The LLC checking account is funded by the custodian sending money from the IRA account to the LLC account. Now the client has checkbook control and can invest quickly without any permission needed from the custodian.
Benefits of Using an Underlying LLC
- One – Liability protection that comes with an LLC
- Two – Anonymity – you can name the LLC any name you wish – it is no one’s business who owns the investment
- Three – Clients can invest quickly and confidently
- Four – Most Realtors, Title Companies, Investment Firms are used to LLC’s – you don’t have to explain what a Self-Directed IRA is all the time
Five – Much lower fees – the client is doing the paperwork, due diligence etc. so the custodian really isn’t doing much at all.
Hint – use a passive custodian. Besides reviewing all investment paperwork, find out if the custodian you are investigating also wants to charge an asset fee. There are custodians who will allow an underlying LLC but then have a fee schedule based upon the assets inside the IRA – the LLC is considered an investment of the IRA – hence an asset!!
Self-Directed IRA LLC’s Rules
First Rule – Disqualified Persons.
A disqualified person is not allowed to extend any immediate credit nor receive any immediate benefit from the IRA.
Disqualified person are generally the IRA owner, spouse, children, grandchildren, parents, grandparents and their respective spouses. If the IRA benefits from a disqualified person or a disqualified person benefits from the IRA, it would be a prohibited transaction.
Examples of a Prohibited Transaction (PT)
Your IRA is allowed to purchase a rental property. Your daughter would like to pay rent and live there. She is a disqualified person and therefore it would be a prohibited transaction. However, your niece indicates she would like to live and pay rent. Since she is not a disqualified person, it is permissible and not a prohibited transaction.
Your son would like a loan from your Self Directed IRA to help with college expenses. Again, he is a disqualified person so your IRA should not make the loan. Your brother also asks for a loan – for any purpose – he is not disqualified therefore your IRA can make the loan.
Second Rule – Prohibited Investments
There are three types of investments not allowed inside your self-directed IRA.
- Life Insurance Contracts – Certain Annuities are allowed
- Collectibles – such as rugs, classic cars, stamp collections etc.
- Shares of an S Corporation – your plan is not a person but an entity