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What does ‘self-directed’ mean?
The term ‘self-directed’ does not actually have any legal connotation. It does not imply a different type of IRA, or a separate set of IRS rules. ‘Self-directed’ is simply an accepted industry term indicating that the IRA custodian is allowing the IRA owner greater control over their investment decisions. When an IRA account is self-directed, the IRA owner makes all investment decisions and instructs the custodian to act. Even this control, however, can vary greatly in degree. For example, you might be offered - or have – a ‘self-directed’ IRA at a major broker dealer. This account, while offering more hands-on control, will still, in most cases, limit you to a range of publicly traded investment options such as stocks, bonds, and mutual funds.
The phenomenon of a self-directed IRA that still limits you to
a brokerage account has spawned the use of yet another industry
descriptive - the ‘truly self-directed’ IRA –
to mean the type of account that allows for non-publicly traded
assets like real estate or private placements (pre-IPO stock, Limited
Liability Company membership, Limited Partnerships, etc.).
Whatever the terminology, the facts remain the same: All IRAs must adhere to the same IRS rules. The investment options available within an IRA are determined solely by the capabilities of the custodian sponsoring the IRA.
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Why doesn’t my broker dealer allow me to buy real estate or private stock?
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It’s simply a matter of money and business model. Broker dealers are not structured in a way that would allow them to profit from transactions outside of the public stock market. If they could do so profitably, they would. Because of a high-degree of manual processing, and lower fees, self-directed IRAs are not attractive or profitable products for traditional IRA providers such as broker/dealers.
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Then how do self-directed IRA custodians make a profit?
First, they often barely do, and it often takes years and a high volume of accounts to break even. A custodian of self- directed IRAs typically makes a lot less profit per account then a securities broker dealer can. Because self-directed IRA custodians typically have no proprietary investment product, they must exist from maintenance fees. Maintenance fees could consist of a percentage of the account value, or be transaction-based. Usually, as with PENSCO Trust, the fees are a combination of transaction and asset based, including compensation for cash on deposit with other depository banks. PENSCO Trust’s fees are predominantly asset based; depending on the type of transaction, there is either no additional fee, or a nominal processing fee assessed to the account. You can see our fee schedule here: PENSCO Trust Unlimited Fee Schedule.
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What types of assets can one typically invest into with a self-directed IRA custodian?
PENSCO permits clients to invest in most IRS permitted investment types. Because the law governing the types of investments permitted within IRAs is exclusive rather than inclusive, there is a specific list of investments that are prohibited (See IRS Publication 590 for complete details). These are:
- Collectibles (e.g. art, antiques, jewelry etc.)
- Life insurance
- Coins (other than U.S. gold coins)
- "party-in-interest" transactions (These are transactions involving "disqualified" parties such as ascendants, descendants, fiduciaries etc. See Internal Revenue Code 4975 for details)
With these exclusions, the range of permitted investments is quite broad and includes mutual funds, stocks, bonds, certificates of deposit, private placements (LLC memberships, LP interests, private C-Corp stock, and in the case of certain banks, S-Corp stock, etc.), promissory notes, trust deeds or mortgages, real property, and more.
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