Most people think of stocks, bonds, mutual funds and the like when deciding where to invest their individual retirement account, or IRA, funds. But you have many other choices.
You might want to try a nontraditional approach with at least some of your IRA assets. Saving for retirement can be done via a number of unusual investments, including real estate or a closely held business. Likewise, a physical stash of gold coins may appeal to you if you worry about financial calamity or runaway inflation.
Before using your IRA to dabble in investments that are out of the mainstream, however, be aware that along with potential rewards are, in some cases, higher-than-average risks. Nontraditional investments typically are done through what's known as self-directed IRAs. You'll need a custodian to handle the account, who may be tough to find because major IRA custodians like banks and mutual funds typically stick to basic offerings. So do your homework, don't rush -- and don't do anything that makes you uneasy.
Heads Up on Coins
You can buy these coins with your IRA: U.S. gold coins in 1-ounce, half-ounce, quarter-ounce and one-tenth-ounce denominations; and 1-ounce silver coins minted by the U.S. Treasury Department. Certain platinum coins are also allowed.
Gold and silver coins have been measurements of value for thousands of years. They tend to be stable or go up when stock markets crash or inflation soars. Gold and silver have shown their mettle in recent years.
But that doesn't necessarily mean they're good for every IRA. For one thing, they don't pay interest or dividends, so you won't be compounding returns between purchase and withdrawal. And a lot of mainstream IRA custodians like banks and mutual funds don't offer this IRA option.
That's two reasons they may be problematic, says Meg Green, founder of Meg Green & Associates, a wealth management firm in Miami. "Where are you going to find a custodian to keep them for you?" she asks. Internal Revenue Service regulations require storage be overseen by a custodian, but custodians don't have to offer the service.
The second problem is cash flow. "You need things that provide income," she says.
That's so Precious
Besides coins, since 1997 the IRS has allowed investors to use IRA funds to buy precious metals bullion such as silver or gold bars. Like coins, your bullion is stored for you, for a fee. Your custodian arranges it.
The following metals can be purchased with an IRA, subject to standards of purity: gold, silver, palladium and platinum.
Again, Green says she's not a fan, at least for IRAs. For one thing, once you reach age 70½, you're required to start taking required minimum distributions from a traditional IRA by April 1 of the following year. The distribution is a percentage of your IRA's value. If you're holding bullion "you'll have to get it valued every year" to compute your minimum distribution.
Another issue, in her opinion: "It doesn't perform over time. It's all peaks and valleys."
A private mortgage is another little-known IRA investment opportunity. When you buy a mortgage, you're the banker, at least for one property. A private mortgage company can match you to a borrower and handle the paperwork. Your IRA lends to the borrower, and the loan is secured by the property.
Because you don't own the property, if the value goes up, you don't participate in the profits. However, your investment is backed by a real asset -- although the foreclosure crisis proved that doesn't eliminate risk. The return can be lucrative, compared to other interest-based investments such as certificates of deposit.
But tread carefully, advises Harold Evensky, president of Evensky & Katz, a financial planning firm in Coral Gables, Fla. "You have to find a custodian to do it, and most of the major companies don't," he says.
The second caveat is that typically these mortgages are for above-market rates, which suggests creditworthiness issues. "If someone is paying you over the market, you need to ask why," Evensky says.
Cross the Property Line
Buying real estate directly with your IRA is tricky. You'll need enough money in your IRA to cover all expenses -- maintenance, taxes, etc. There's no commingling of non-IRA funds with your IRA investment. Many IRA administrators won't handle real estate. Finding lenders to help with the purchase has historically been challenging, because any mortgage must be nonrecourse: That is, you and your IRA are off-limits to the lender.
Another important caveat: Buying property for personal use is prohibited with a traditional IRA. There's an exception. You may withdraw $10,000 from an IRA for a home purchase if you qualify as a first-time homebuyer. You'll owe tax on the income, but not the penalty.
But in general, you lose many tax advantages of real estate investing by using an IRA. You can't deduct losses and unlike with, say, stocks, it's tough to cut your losses quickly if conditions turn sour.
Green is a fan of real estate for an IRA, but suggests a simpler route. "Do it through a REIT," she says. REIT is the acronym for real estate investment trust. REITs invest in real estate and mortgages. They're securities that trade like stocks. "They're acceptable and they're income-producing," Green says.
Mind Your Own Business
Say you've found a great business opportunity. If only you had money to buy it! Maybe you do -- but it's locked up in your retirement account.
You can buy a business -- or an interest in a business -- with your IRA. There's a catch, however. You cannot use your IRA in any way to benefit yourself before retirement. Nor can you or your close relatives make transactions with the IRA. There goes the idea of working for the closely held business, or even managing it yourself to save money.
"It's potentially even more risky" than investing in mortgages, says Evensky. The long-term value is likely the capital gain if the business rises in value. "That's not a very effective use of an IRA," he says.
The fact that you can only be a passive investor also is a concern. "You have to ask yourseIf, does this investment make sense, no matter where the money is coming from?" he says.
Check Out Collectibles First
Before doing anything exotic with your IRA, make sure it's allowed by the IRS -- many investments aren't. Generally, it bars investment in what's known as collectibles. These include artworks, antiques, stamps, gems and any coins that aren't specifically allowed. Forget investing in a vintage bottle of Bordeaux as well: Alcoholic beverages are excluded as an IRA investment.
If your traditional IRA invests in collectibles, "the amount invested is considered distributed to you in the year invested," according to IRS guidelines. Translation: It's taxable. Furthermore: "You may have to pay the 10% additional tax on early distributions," the IRS warns.
An authoritative source on IRA tax guidelines is IRS Publication 590.