Self-directed IRAs

Good Read from USAToday

Investing: Are self-directed IRAs too good to be true?

Just because you can do something doesn't mean that you should. You may be perfectly capable of cross-breeding trout with electric eels, for example, but you probably shouldn't do it unless you're very angry at fishermen.

You can invest in a wide array of things via your individual retirement account, aside from the usual stocks, bonds and mutual funds. Office buildings? Sure. Small businesses? Check. Unregistered securities? Yep.

And you can invest in all of these through self-directed IRAs. Should you? For most people, no. But for a few people, it can make sense.

An IRA is simply a tax-deferred retirement account, and has very little to do with what you decide to put in that account. You can have an IRA stuffed with stocks or bulging with bonds. You can't put most collectibles in an IRA, or whole life insurance, or subchapter S corporations. (You can have U.S. gold coins in an IRA, but that's a story for another day.)

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 even as the down payment for a mortgage on a rental property.

There are restrictions, however, on self-dealing: You can't rent the place to yourself, for example. And you must have a qualified third-party custodian for the IRA.

Self-dealing restrictions on investing in small businesses — especially sole proprietorships — are also complex, and you should see a tax lawyer before you put IRA money into a small business. "Self-directed IRAs have helped fund thousands of small businesses that otherwise wouldn't be there," says Tom Anderson, president of the Retirement Industry Trust Association, a trade group.

So. You can put many types of investments into a self-directed IRA. What are the drawbacks?

The most obvious is that while the IRA will shelter gains on transactions inside the account, you'll lose other tax benefits. If you lose money, you can't deduct your losses , and you won't get capital gains treatment on profits when you make withdrawals.

Another problem is making sure you're putting your IRA in a good investment. Yes, owning an office building can be lucrative. Have you done it before, and do you understand the deal?

You also need to know if it's legit. Your IRA trustee won't check your investment for you. It will just give you statements.

And this brings us to the biggest problem with self-directed IRAs: the potential for fraud. The Securities and Exchange Commission and the North American Securities Administrators Association put out an investor alert on self-directed IRA fraud in September.

The alert makes for interesting, if sad, reading. The Missouri Securities Division, for example, filed orders against Stephen Gwin in 2007 for misleading senior citizens into investing in unregistered securities in self-directed IRAs he controlled. He sold them at — what else? — free lunch seminars. In 2010, the SEC shut a Ponzi scheme that took $9.2 million from self-directed IRAs.

Anderson points out that the regulated securities industry has seen more fraud, and that's true. The regulated securities industry is also far larger.

"Self-directed IRAs aren't bad, they aren't illegal," says Matt Kitzi, Missouri's Commissioner of Securities. But scams involving self-directed IRAs are becoming more common, he says.

So if you are tempted by a self-directed IRA, be wary. If someone offers a guaranteed return, or a very high return, run. Avoid anyone who pushes you to invest — or offers a free lunch, for that matter. Check the person offering the investment with the SEC and your state securities administrator. And notify your securities administrator the moment something seems awry: Your chances of getting money back in a scam decrease by the minute.

Lots of people are looking for alternatives to stocks, and that's understandable. But some investments don't deserve your money just because they're there. If you're not willing to spend time checking a self-directed IRA, don't do it.

John Waggoner is a personal finance columnist for USA TODAY. His Investing column appears Fridays. See an index of Waggoner's columns. His book,Bailout: What the Rescue of Bear Stearns and the Credit Crisis Mean for Your Investments, is available through John Wiley & Sons. John's e-mail is jwaggoner@usatoday.com. On Twitter: www.twitter.com/johnwaggoner.