Setting Up a Self-Directed IRA is Not As Complicated As You Might Think

We are often asked, “How do I go about setting up a self-directed IRA?” Many people think it is a complicated process because the idea is sold on the Internet as “an IRS loophole” or “little-known IRS secret” by companies trying to promote self-directed IRAs.

The truth is that all IRAs are self-directed. Internal Revenue Code Section 4975 states that you can’t own collectibles or life insurance in your IRA, but it leaves every other investment open. It is up to the custodians to decide what they want to allow you to invest with their company.

Most custodians allow you to invest in stocks, bonds, mutual funds and certificates of deposit, but there are a few that act as passive custodians and allow you to invest in anything not prohibited by the IRS. Those have become known as “self-directed IRA custodians.”

Your first step in setting up a self-directed IRA is to find a custodian that will allow you to make an investment in assets with which you are familiar and want to invest. There are several custodians around the country, and I would recommend you do your own research to find the one that best suits the kind of investment you are considering.

Some great questions to ask are:

• Will they allow the exact investment you are considering?

• How does their fee structure work?

• How familiar are they with the type of investment you are making?

Once you have identified the custodian with whom you want to work, you can begin the actual account setup process. The account application will require your name, address, Social Security number, date of birth and maybe some other identifying information. You may be asked to fill out additional paperwork that may be required by the particular custodian you have chosen. Some of that documentation could include an account-holder disclosure form and a fee schedule. Your new custodian is required to “know the customer,” as defined by the Department of the Treasury, and will require that you provide a clear copy of a government-issued photo ID.

Next, you will have to decide how you are going to fund your account. Among the options are a direct rollover from a previous employer 401(k) or a transfer or rollover from an existing IRA. Because of the amount of cash usually required to make an investment, funding often comes as a direct rollover from an old 401(k). If you are going to fund your account in this way, you will need to contact the administrator for the existing 401(k) plan and ask how to go about making the direct rollover. Usually, the administrators have a form that will begin this process. This needs to be done shortly after you have begun the setup process with the self-directed IRA custodian. The actual time it takes to get your IRA funded will depend mainly on the 401(k) administrator, but I would plan on two to four weeks to complete the process and have money ready to invest from your self-directed IRA.

If you are moving money from as existing IRA, there are a couple options. I think the best option is a custodian-to-custodian transfer. You start this process with a “transfer form” instructing the new self-directed custodian to request that the old custodian “transfer” funds to them. This process will also take two to four weeks, but it is done strictly between the custodians, and there is no taxable or reported event.

A second option is a “rollover.” In that instance, you as the account holder will request a check from your existing custodian made payable to you. Once you have received it, you have 60 days to re-deposit that money into the new self-directed custodian account to avoid taxation of the amount taken out of your IRA. The old custodian will issue you a 1099 at year-end, and the new self-directed custodian will give the IRS a Form 5498 showing the “re-deposit” of the funds, which again must be within 60 days to avoid taxes and possible penalties. Something to note is that a “rollover” can only be done once in a given 12-month period, and the IRS seems to be very strict about the 60-day rule.

Once you have your account set up and funded, you are now ready to make your investment. Every custodian is slightly different, but generally, you will be required to complete a Direction of Investment form instructing the custodian to make the investment on behalf of your IRA account.

It seems like a complicated process, but it really is not as hard as you might think. Any self-directed custodian you choose will be happy to walk you through this process, and in a short time, you will be ready to take control of your own retirement account and begin investing on Main Street instead of letting Wall Street invest for you.

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  • Terry White

    Terry White, founder and CEO of Sunwest Trust Inc., has been involved in the self-directed industry for over 20 years and is the author of “When All You Have is a Hammer… An Informational Guide to Self-Directed IRAs.” White also serves on the Board of Directors for the Retirement Industry Trust Association. 800-642-7167

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