The Risks of Self-directed IRAs

by InvestorLawyers on October 12, 2011

in IRAs,LPL Financial,SEC

The North American Securities Administrators Association Inc. and the Securities and Exchange Commission issued an investor alert on September 23, which warned of the risks of self-directed IRAs. According to InvestmentNews.com, this scrutiny by regulators will likely influence the implementation of tougher restrictions on self-directed IRAs by small- to mid-sized broker-dealers.

THE RISKS OF SELF-DIRECTED IRAs

According to Brad Borncamp, a certified public accountant, “IRAs have a specific purpose: long-term investment for retirement. It’s really easy to mess up these transactions, and there’s more than meets the eye.” Self-directed individual retirement accounts allow their owners to invest in more unusual investment vehicles such as raw real estate, limited partnerships, private placements and life settlements. This is in contrast to traditional IRAs, which are usually limited to mutual funds, stocks and bonds. According to NASAA, about 2 percent of the total IRAs, or $94 billion, is estimated to be self-directed.

Because self-directed IRAs’ owners are able to hold unregistered securities, due diligence is often neglected by custodians. In addition, early withdrawals come with a penalty that encourages money to remain tied up in them longer, making these investments a frequent vehicle for stock broker fraud. Although up until now, smaller broker-dealer firms have resisted giving up the higher profit margins associated with self-directed IRAs, they will soon be following in the footsteps of their larger counterparts because of recent developments.

There are many restriction options available to broker-dealers. For instance, LPL Financial doesn’t allow advisers to sell any self-directed IRAs. Commonwealth Financial Network allows self-directed IRAs but they are subjected to due diligence. Fidelity Investments allows self-directed IRAs but holders can only purchase non-traded real estate investment trusts. Other options that have been adopted by firms are aimed at disallowing nontraditional investments or ensuring that the firm can not be held liable for self-directed IRA investments that go bad.

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