As the President of a Self-Directed IRA custodian, it surprises me how often I am asked by clients, friends, and colleagues what is a Self-Directed IRA custodian and how it differs from a traditional bank or financial institution.
Pursuant to Internal Revenue Code (IRC) Section 408, an IRA can only be established and administered by a bank, financial institution, or authorized trust company under state law. An IRA trustee, also known as a custodian, is the institution that administers your retirement account. By law, every individual retirement account must have either a custodian or trustee.
Currently, the majority of approximately 50 million IRAs invest in traditional asset investments. This includes stocks, mutual funds, and ETFs. However, since the 2008 financial crisis, retirement account investors have become aware of the advantages of alternative assets. They’re beginning to see it can better diversify their retirement account investment portfolio and act as a hedge against inflation.
Other than life insurance, collectibles, and certain self-dealing and conflict-of-interest transactions outlined under Internal Revenue Code Section 4975, alternative assets are permitted for an IRA.
Most banks and financial institutions that offer IRAs only allow their IRA clients to invest in traditional assets, like stock and exchange-traded funds for one simple reason: this is how they earn their fees. The IRA custodian has a right to choose what types of IRS-approved investments it allows their clients to invest in.
What is an IRA Custodian?
On the other hand, a Self-Directed IRA custodian (also known as a passive custodian) allows IRA holders to engage in non-traditional investments and never offers investment advice or sells investment products. A Self-Directed IRA custodian earns its fees from the custody and administration of alternative asset investments the IRS approves and is owned by an IRA or other retirement plan.
In other words, to establish an individual retirement account, one must open an IRA at a bank, financial institution, or authorized trust company, such as IRA Financial Trust. The IRA custodian is responsible for maintaining and administering the IRA. The IRA custodian is tasked with the responsibility of complying with all IRS reporting requirements regarding the IRA. This includes filing IRS Forms 5498 and 1099-R.
For most IRA holders who have an IRA with a bank or financial institution and currently make traditional investments, the IRA custodian could have a fiduciary, or at least a “best interest” responsibility depending on whether a registered investment advisor is involved.
However, for IRA investors who wish to make alternative asset investments with their IRA, such as real estate, the IRA custodian is not considered a fiduciary because it does not provide investment advice. The primary responsibility of the self-directed IRA custodian is to facilitate transactions based on the direction of the IRA holder, as well as take custody of the IRA-owned alternative asset investment.
The Self-Directed IRA custodian is not responsible for reviewing the transaction or performing any due diligence. Hence the name “Self-Directed.”
If you are looking to invest in alternate assets, such as real estate, with your Individual Retirement Account (IRA), you will need to find the proper custodian. A Self Directed IRA custodian will safe-keep your IRA investments. Most, but not all, Self-Directed IRA custodians will allow for alternate investments. If you have a traditional IRA already through a bank, trust company, or credit union, you know what a custodian is. They hold the assets in your IRA account. However, most traditional financial institutions do not allow for alternate investments. This is why you will need a special custodian to do so.
Related: How to Choose the Best Self-Directed IRA Custodian
A Self-Directed IRA Custodian Has Less Responsibility
The Self-Directed IRA custodian is not treated as a fiduciary by the U.S. Securities and Exchange Commission (SEC), does not sell investment products, or provide any investment advisory services. Its sole responsibility is to facilitate non-prohibited alternative asset investments based on the exclusive direction of the IRA holder.
In other words, the self-directed retirement custodian serves the growing demand from retirement account holders who wish to make IRS-approved alternative asset investments, such as real estate, hedge funds, private equity, private placements, notes, etc. that are not being served by the traditional financial institutions.
The Self-Directed retirement custodian will make the alternative asset self-directed retirement investment on behalf of the IRA owner as well as provide custody services. In addition, a Self-Directed IRA custodian is not permitted to offer legal or tax advice.
Responsibilities of the Self-Directed IRA Custodian
The Self-Directed IRA custodian is responsible for taking care of all IRS reporting concerning the IRA, including filing IRS Form 5498 and 1099-R. In addition, a Self-Directed IRA custodian will also take care of paying all expenses, such as property taxes on a real estate investment, for the IRA transaction.
Related: Can I Contributed to a 401(k) and a Self-Directed IRA in the Same Year?
The Difference Between a Custodian and an Administrator
To invest with any kind of IRA, your account must be opened by a “qualified custodian” who will oversee the account. They must follow strict banking regulations set forth by the government. These rules are there to protect both you and your funds held at the custodian. Failure to have a qualified custodian may lead to serious tax consequences or the disqualification of your IRA.
A Custodian should not be confused with an Administrator. An IRA administrator is there to take off all the ins and outs of the account. These services can include tax reporting, quarterly statements, document processing, and IRS compliance services. You must have some type of administrator for your Self-Directed IRA since you are not legally allowed to perform these duties yourself. Oftentimes, administrators are not bound by banking laws. You will usually sign some type of contract with them, which you are then bound by.
Lastly, a qualified custodian may also offer administration services. IRA Financial Group (IRAFG) acts as a facilitator of Self-Directed IRAs (and an administrator). Our sister company, IRA Financial Trust (IRAFT), is both a qualified custodian and an administrator.
Open a Self-Directed IRA with a Self-Directed IRA Custodian
You must open a Self-Directed IRA with a special custodian called a passive custodian or Self-Directed IRA custodian that will allow for alternative asset investments, such as real estate.
The self-directed retirement industry was born in order to serve the need for retirement investors to have the ability to make IRS-approved alternative asset investments using their retirement funds. The reason for this is that not all IRA custodians allow their clients to make alternative investments. In fact, almost all banks and financial institutions, that are IRA custodians, do not allow their clients to use IRA funds to make alternative asset investments for the simple reason that they do not make any money from those investments.
Each IRA custodian is free to determine what IRS-approved investments will be available to their clients. In other words, because banks and financial institutions generate a good amount of their IRA-related revenues from investment-related fees, allowing their clients to invest in assets they do not earn fees on, such as real estate, just does not make much financial sense.
The Most Important Questions to Ask an IRA Custodian
1. Are you a custodian or an administrator? As we just touched upon, there’s a difference between a Self-Directed IRA custodian and administrator. Your IRA must be held with a custodian. However, an IRA administrator will work with a custodian as well. For example, before IRA Financial partner Adam Bergman started the IRA Financial Trust Company, IRA Financial Group acted as an administrator with ties to several custodian options for clients to choose from. So long as you have a good administrator, you should be well covered.
2. What types of investments can I make? If you are looking into opening a Self-Directed IRA, you probably want to invest in alternative assets, such as real estate, tax liens, and precious metals. The IRS allows for alternate investments, however, not all IRA custodians do. Many Self-Directed IRA Custodians only allow you to invest in precious metals or cryptocurrencies. With IRA Financial, you are not limited in what you are allowed to invest in.
3. What fees do you charge for your services and how are they charged? Different companies offer different fee schedules. Fees can vary based on account value, the number of transactions, and the specific services you need. For example, IRA Financial Trust charges one flat, annual fee, due at set-up and then billed quarterly each subsequent year.
4. Do I need permission to make an investment? Generally, there are two types of SDIRAs: Custodian Control and Checkbook Control. With a custodian-controlled IRA, you need to get permission to make an investment. This takes time and may come with transaction fees. When you have “checkbook control” of your IRA, you can invest without custodian consent. You simply write a check or wire funds directly from your IRA LLC account. There are no delays or transaction fees.
5. What types of accounts do you offer? Most IRA custodians and administrators offer traditional, as well as Roth IRA plans. However, you might be interested in another type of account. Self-employed individuals might seek a Solo 401(k), and small business owners may want a SEP or SIMPLE IRA. Other options include Health Savings Accounts, Coverdell, and ESOPs. Make sure the custodian you are interested in offers the plan(s) you need.
6. Tell me about your company. I know this is not a direct question, but you should know as much as you can about your custodian. These are some questions you should ask the company before entrusting them with your money: How long have you been in business? How many clients do you have? How much are the assets in which you control worth? How many employees do you have (i.e. will my needs be met in a timely matter)? How is your customer service? Are you BBB accredited? Are you regulated (and by whom)? Any information you can obtain about the custodian will help you make a more informed decision.
7. Do you provide educational materials? IRA custodians do not offer financial advice. However, it’s important they do provide educational materials to help you better understand the product, the process, and the rules. These may include an informative website (including a blog), podcasts and videos, an app or webinars. The more information you can garner, the more informed you will be about the entire process.
8. What is your coverage area? Since the start of the Internet, there’s no longer a need to do everything face-to-face. Nowadays, you don’t even need to be in the same state or country. However, certain custodians might have a small geographical area that they cover. This may be an issue for you, particularly if you are a real estate investor. IRA Financial Group offers their services world-wide. You can invest right in town, or around the globe.
9. Do you have references or testimonials? Lastly, it’s of vital importance to know just how experienced your custodian is. How do current clients rate their experiences? Is customer service friendly and efficient? Do you have a referral program? Were there any complaints filed against the company or an employee? These are all important questions to consider when signing up for a long-term financial commitment.
The Final Take
Control of your retirement funds is an important undertaking. You must find a trustworthy company to manage these funds. A Self-Directed IRA custodian should be fair and honest and make sure your assets are kept safe and available when you need them. If you’re looking for an all-in-one custodian and administrator, you can’t beat IRA Financial Trust. They are experienced, and affordable, and offer you the freedom to invest in whatever you see fit. On the other hand, IRA Financial can facilitate your Self-Directed IRA with a different custodian if you so choose. Either way, you’re in good hands with the entire IRA Financial team.
