Dangers of a Self-Directed IRA
The last decade has seen an explosion in the number of IRA rollovers into uniquely-structured investment accounts, including Self-Directed IRA LLCs and ROBS (rollover for business startups). While these structures create more flexibility and options for business owners, there are also enhanced risks associated with direct checkbook-control access to one’s retirement funds, from both a tax and investment perspective.
Digital Currency
Cryptocurrency is now the new self-directed IRA “belle of the ball.” I have read dozens of online posts outlining the possibility of massive tax-deferred or tax-free returns from using a self-directed IRA to invest in coins, tokens and cryptocurrency. However, there are increased risks to this type of a strategy that investors should consider. Other investments hold more downside risk protection. Consider for a moment:
- Cash is FDIC insured for each individual customer
- Marketable securities are in an SIPC insured account
- Real estate holds title insurance
- Private securities, business interests, partnership agreements and licenses are direct instruments with the issuer and held in our (street) name
Not only do cryptocurrencies hold greater inherent risk as a potential investment with a self-directed IRA, there is also little to no capital preservation protection and ultimate downside risk mitigation.
Control
The very thing the self-directed IRA promotes as the big opportunity for investors remains remains the greatest risk: total control. When IRA holders are less-restricted in what they can invest in, they can also be more flippant in their treatment of things like due diligence. In the case of more restricted retirement accounts, where investors can only invest in certain boring products, the investment opportunities often involve more diversification and investments in more secure, larger-cap companies, not things like individual real estate, private placements and digital currency.
Unfortunately, the self-directed structure of the IRA does not protect the investor from herself. It exposes investors to the irrationality, biases, risks and exogenous factors associated with
Alternative Investments
For the truly savvy accredited investor, a self-directed IRA can be a great means of funneling a smaller portion of one’s investments into higher-yield alternatives. However, the best products often involve some combination of capital preservation and return on investment. Unfortunately, many promoted investment options for self-directed IRA holders are outside the realm of alternative investment. I have seen investment banking clients (unscrupulously) pay investment banking engagement fees from monies obtained self-directed IRA holders. In such a scenario, there was no investment in equity or a securitized asset, only a promise to repay–a promise whose return is only as good as the integrity of the borrower.
Investment opportunities for self-directed IRAs abound, but investors should take extreme caution in their investment decisions. Figure out a good strategy to protect yourself from yourself.
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