Choosing the right self-directed IRA Custodian or professional advisor to assist you with your IRA and its investments is an important decision. When searching for professionals to assist you in this area, you will fin many individuals and firms who claim to be experts in the field. This can make the selection process difficult, but with a little preparation you can create your own scorecard to help separate those “in the know” from those who might steer you down the wrong path.
To begin, you need to know that the term “self-directed” has taken on a life of its own. This term was once used to denote firms or individuals who specialized exclusively in the sale or administration of non-publically traded investments, such as real estate, tax liens, private equities, partnerships and limited liability companies. However, many advisors and IRA service providers now insert this phrase into their marketing literature, advertisements and websites simply because it generates phone calls and drives traffic to their websites.
When you contact the individual or firm, you might find that what they call "self-directed" is simply an attempt to repackage their traditional investments products, such as stocks, bonds and mutual funds. In other cases, you might find that they have created a limited selection of investments, such as hedge funds or non-publically traded REITs which they offer under their traditional commission arrangements. But do not despair: With a little time and effort, you can narrow your search to those who can really offer the investment flexibility and advice you seek.
First you will need to find an IRA Custodian that is willing to hold these non-traditional investments. If you have a particular area of interest, such as private equities or real estate, you will want to find a firm that has experience in administering these types of assets. To begin this process, search the internet using key words such as “IRA” and the investment product you are interested in, e.g., “IRA Trust Deed.” This should generate results of firms who specialize in this particular area. Once you have found possible custodians, create a list of questions and a scorecard to refine your selection process.
Here is a list of possible questions and reasons why you want to know the answers:
- What type of entity is the IRA Custodian? is it a bank, independent state chartered trust company, securities broker dealer or a privately owned business.
- Who, if anyone, regulates the firm? Examples: FDIC, OCC, SEC, state banking commission.
Reason: You will want to work with a regulated firm. Regulators typically audit such firms at least annually and can help ensure that your assets are safeguarded. Also, access to financial information and other relevant information will be easier to obtain from a public company as opposed to a private company which may not be willing to provide such information. Lastly, you will often find that independent state chartered trust companies, as well as some banks, provide the greatest investment flexibility.
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- How does the IRA Custodian invest idle cash? Are these funds available immediately for investment or distribution purposes?
Reason: Some IRA Custodians provide an in-house interest bearing account. Others may sweep the funds to a money market account at a mutual fund company. If the IRA Custodian uses an outside money market account, you will want to ensure you have same day availability of your funds. Also, you may want to ensure that the IRA Custodian you choose uses an interest bearing account that is FDIC insured. Effective April 1, 2006, the FDIC increased coverage for IRAs and other qualified retirement plans to $250,000, the first increase in deposit insurance since 1980.
- How will the IRA Custodian register your investments? Examples: individual registrations ("ABC trust custodian FBO client’s name"), or an omnibus arrangement where the custodian places all assets under the name of the firm.
Reason: In the unlikely situation where an IRA Custodian goes out of business, individual registration will make it easier for the regulators or successor organization to quickly identify your assets. This would improve the turnaround time associated with transferring your account to another firm.
- Does the IRA Custodian carry Errors and Omissions insurance coverage, and if so how much
Reason: In the event of losses, an E&O policy would help provide a safety net that might help offset losses sustained by processing errors by the IRA Custodian.
- What asset types does the IRA Custodian administer, and how long have they handled such assets?
Reason: You will want to make sure that the prospective IRA Custodian will not only administer the type of asset in which you plan to invest, but has experience as well. For example, a broker dealer may allow you to hold a private equity within your account that is transferred to them as an IRA rollover or transfer, but they may not allow you to make any additional investments into this category. Accordingly, you should find a firm that will allow you to actively invest in products that are of interest to you.
- What are the IRA Custodian’s fees for handling a self-directed account? Do they charge a percentage of assets under administration, or an a la carte fee schedule? Do they have account termination fees?
Reason: Typically, you will find that firms that utilize an a la carte fee approach have the best pricing. Under an a la carte fee schedule, you pay an annual administration fee plus transaction and asset holding fees for the work performed by the IRA Custodian. You must decide for yourself based on your situation who will provide the best pricing.
- What support, if any, will the IRA Custodian provide when you have questions relating to your investments?
Reason: Don’t be surprised if you find that most firms simply refer you to your legal or financial advisor (this is normal). On the other hand, some custodians are willing to discuss your proposed investments with you and point out any possible problems upfront. These firms will also tell you to discuss the proposed transaction with your outside advisor(s); however, they will let you know if what you want to do is possible and, if not, how it might be restructured.
Unlike many IRA Custodians who are familiar with both traditional and non-traditional investments, investment advisors tend to specialize in a specific field. Accordingly, investment advisors who work for broker dealers, mutual funds or insurance companies tend to have limited experience in non-traditional assets. A number of registered investment advisor firms across the country have started investing in non-traditional assets, and one of these may be an option if you are looking for someone to invest your funds for you, but if you want to be actively involved with the selection of your investment, you may have to find several different individuals to assist you specialized in the investment types that interest you.
Investment advisors will ideally have experience working with IRA investors. This is an important issue and will help keep you out of trouble. For example, if a realtor has a rental income property that is available and of interest to you, they may recommend that you put 20 percent down and have the IRA borrow the remainder of the funds. Although the investment may yield a positive return (even with the debt service) it could create taxable income to your IRA, known as unrelated business taxable income. This could affect your decision to invest in leverage property and should be discussed upfront.
Finding investment advisors
So how do you begin the process of finding an investment advisor who is familiar with the investments you wish to make? First, you may want to ask friends, acquaintances or business associates who share your investment interest. Once you have found a number of prospects, create your scorecard and begin. Here are some sample questions to get you started:
- What type of investments do you handle?
- Are you licensed? If so, by whom and how long have you held your license?
- How do I check to see if any complaints have been filed either against you or your firm?
- How are you compensated for your investment recommendations?
- Are you familiar with using IRA funds for investing in such assets?
- Do you already work with an IRA Custodian and, if so, who?
- Are you familiar with the prohibited transaction rules affecting IRAs?
This last question is of particular importance. While the IRS permits almost any investment within an IRA there are rules that must be followed to ensure there is no self-dealing. Simply stated, investments within your IRA must be at arm’s length and not involve you or a member of your family. Violation of these rules could disqualify your IRA. You will want to find a professional advisor who understands the “dos and don’ts” of IRA investing or, at least, find an IRA Custodian who is willing to answer such questions.
Whether you are trying to trying to find an IRA Custodian or a professional advisor, you will want to look for someone that is experienced, professional, credible and financially stable. With a little effort, you can compile the information necessary to help you with your selection process.