Savers who see their individual retirement accounts as good places for investments in real estate, private debt and cryptocurrencies — alongside stocks and bonds — might think they're gaining an edge to building their long-term savings.
But many holders of self-directed IRAs don't realize that they're losing regulatory protections designed to shield them from questionable investments, tax complications and even fraud.
The Securities and Exchange Commission and other regulators
Sponsors of traditional retirement accounts are typically reluctant to direct savers' money into anything more exotic than stocks, bonds, mutual funds and certificates of deposit. By contrast, owners of self-directed IRAs gain
"Self-directed IRA custodians are only responsible for holding and administering the assets in the account," the SEC alert noted. "Furthermore, most custodial agreements between a self-directed IRA custodian and an investor explicitly state that the self-directed IRA custodian has no responsibility for investment performance."
The SEC, along with the Financial Industry Regulatory Authority and the North American Securities Administrators Association, stressed the legal protections that investors in self-directed IRAs receive from putting their money into standard retirement accounts. Managers of traditional IRAs, Roth IRAs and 401(k)s are bound by the Employee Retirement Income Security Act of 1974 to always act in a retirement saver's best interest when deciding how to invest their money. This guardrail obliges plan managers to review any stock, bond or mutual fund before deciding whether to include it in a plan's menu of investment options.
But with self-directed IRAs, that vetting responsibility falls entirely on the individual saver.
Self-directed IRAs date to 1974 and are often funded using rollovers from other tax-sheltered retirement accounts. The Retirement Industry Trust Association, a trade group for self-directed IRAs, estimates that these accounts have from 3% to 5% of the total $11.8 trillion in investments held in IRAs.
Self-directed accounts are either structured like standard IRAs — meaning taxes aren't owed until money is taken out by retirees — or like Roth IRAs, meaning taxes are paid on contributions upfront. The limits for adding to the accounts are also the same. This year, they're a maximum of $6,500 for anyone under 50 and $7,500 for anyone 50 or older.
Custodians of self-directed plans have been known to attract regulators' scrutiny. In 2016, the SEC brought
In their latest alert, the SEC and its fellow regulators acknowledge that custodians have little obligation to prevent such deceit. They also warn that unscrupulous parties will encourage investors to set up self-directed accounts for the sole purpose of directing their retirement savings into dodgy investments.
"Fraudsters may be more likely to exploit self-directed IRAs because custodians or trustees of these accounts may offer only limited protections," the joint alert warned.
At least one official at a self-directed IRA custodian said he agreed that investors need to know what they're getting themselves into. But John Paul Ruiz, the head of compliance at
"How can you mitigate your risks if you're all in securities?" he said.
Ruiz said that although The Entrust Group has no fiduciary duty to self-directed plan holders, it will advise investors to consult an accountant or lawyer when an investor seems intent on putting money into something sketchy.
"And we can even take that a step further and tell an investment fund: We aren't going to do business with you," Ruiz said.
Just as worrisome as fraud, said
Baker said many people who seek out his advice seem to think that no restrictions apply to self-directed accounts. After he's explained the ins and outs — including exemptions that make some investments in a self-directed account taxable even before money is taken out — some investors change their minds and opt not to open one.
"I'd say from an investment perspective, for every one person who knows what he's doing with these things, there are probably five to 10 who are only hoping they know what they are doing," Baker said.
The last time the SEC put out an investor alert about self-directed IRAs was in 2018. Karen Grajales, a NASAA spokesperson, said that regulators' latest notice was prompted by a desire to ensure that "investors, especially older investors, understand the risks involved with self-directed IRAs and have important and timely information they need to better protect their retirement savings."
NASAA, which represents securities state and provincial regulators in the U.S., Canada and Mexico, also included self-directed retirement accounts in its list of
Just like dollars put into a regular IRA, money put into a self-directed account is deductible from a saver's taxable income, and taxes aren't owed until the account is drawn on after retirement.
But certain alternative assets held in self-directed IRAs can come with their own tax implications. In a case
The couple, apparently unaware of IRS rules that require such investments to be kept in the custody of a third-party fiduciary, stored the coins in a safe-deposit box at home. Their decision to do that was likely encouraged by a series of
Self-directed IRAs also often have fees that are higher than those associated with standard retirement accounts. Those expenses can be justified, Baker said, because investing in alternative assets like real estate can sometimes require plan sponsors to do cost-intensive things like collect monthly rent.
Baker said with markets still in turmoil, he expected alternative investments to remain attractive in the coming year. So regulators' warning about self-directed IRAs, he said, comes at a good time.
"It always depends on which assets are hot," Baker said. "When crypto was hot, all of a sudden everyone was saying: how do I buy that? And when the market is doing poorly, people are naturally looking for alternatives. And all they need is a little push."
