What Are You Telling Me?!?!
Many a blog and article have been written by this author and others about the benefits associated with a self-directed IRA and 401K. So, that being said, why would this post even begin to state that establishing a self-directed IRA might be the worst mistake you ever made?! Why would the ability to self-direct one’s own retirement assets be a bad thing…let alone the worst mistake an individual may have made?
First, let’s break this down a bit. In general, the title of this article reflects an opinion that most do not hold. The benefits of a well-structured, self-directed IRA account are many. However, here is the rub:
Do you really know what you are doing with your self-directed IRA? Have you, and how do you know, that your investment choices fit the stringent IRS rules regarding prohibited transactions?
As a result of this past tax season, we have seen a significant increase in the number of errors committed by self-directed IRA owners. As one should and most likely be aware, even one small mistake can cost a self-directed account owner thousands of dollars in possible taxes and penalties.
But wait….can it get worse (you know if the question is asked, the answer has to be yes!)? Acutally, much worse. If an individual has a Roth IRA, and that Roth IRA engages in a prohibited transaction, no matter the value of the Roth, the self-directed account could be easily liable for mandatory fines of $200,000. And these fines are not able to be waived. Yikes!
Why address this? What can be done about it? Well, first and foremost, education, education and, oh lastly, education. Many people believe that in retaining the services of a self-directed administrator, custodian or facilitator, that these entities or individuals will keep them from harms way. In reality, THINK AGAIN. In many cases, administrators and custodians are prohibited from providing advice on an investment. So, ultimately, the responsibility of knowing that the investment does not trigger a prohibited transaction lies with the IRA account holder.
In addition, most people do not realize that there are public databases which not only identifies that an individual has a self-directed IRA but what their IRA holds in assets. In many cases these databases can show if the IRA account entered into a prohibited transaction by the asset held in the IRA.
Individuals should not only become more knowledgeable about what they can and cannot invest in, but understanding that there are individuals who can assist them with these decisions….so they do not inadvertently violate IRS prohibited transactions regulations.
Just remember that, unfortunately, in the case of self-directed IRA’s, what you don’t know can hurt you…a lot!
BawldGuy Here: John very wisely points out the consequences of ignoring one of my favorite axioms: It’s not the answers to the questions you have that get us — it’s the answers to the questions you never knew to ask that bite us in the butt.
Back to John.
In the next post, we will break down why a self-directed 401K can escape these types of penalties and why individuals should strongly consider establishing a self-directed 401K. While one must qualify and “fit the box” in establishing a 401K, the benefits may just be to one’s liking.
John R. Park is President and Founder of PGI Agency, Inc. and PGI SelfDirected.