A self-directed IRA allows you to invest in things other than securities registered with state or federal authorities. For example, you can use the assets in a self-directed IRA to buy a rental property or as a down payment for a mortgage on a rental property. You can even invest in a small business. With self-directed IRAs, you have more investment options so there should be potential for a higher return on investment. Often, the elderly are disproportionately targeted.
So what are the drawbacks?
If you lose money, you can’t deduct your losses, and you won’t get capital gains treatment on profits when you make withdrawals.
Making certain that your investment choice is a good one is vital. Yes, investing in a small business can be lucrative, but do you fully understand the deal, will the business be a success and turn a profit?
You also need to make sure your investment is legitimate and secure. Your IRA trustee will not review your investment choices. It will only provide you with statements.
And the biggest potential problem with self-directed IRAs: the potential for fraud. Scams involving self-directed IRAs are increasing in number. The Securities and Exchange Commission went so far as to issue an investor alert on self-directed IRA fraud and discussed incidents that targeted senior citizens through free lunch investment seminars and several elaborate and fraudulent Ponzi schemes (www.sec.gov/investor/alerts/spiral.pdf).
If you are tempted to try out the self-directed IRA be cautious and informed. If someone is offering a guaranteed return, or a very high return, run in the other direction. Avoid those that are pushing you to invest and check out the person offering the investment with the Securities and Exchange Commission and your state securities administrator. In addition, there are self-dealing restrictions on certain types of investments so be sure to engage an investment professional or tax lawyer before investing.
With increased market volatility and an economy that has been in flux for several years, ┬ámany investors have been seeking an alternative to stocks, but before you turn to self-directed IRAs as a viable option be sure to do the research to protect yourself or don’t do it.
Black Enterprise Columnist Jennifer Streaks is a Financial Expert, Author and Pundit. Continue the conversation by following her on twitter @jstreaks or on her website www.JenniferStreaks.com.