A large number of clients express their appreciation for the level of freedom they have in selecting their investments when it comes to self-directing their IRA. The ability to choose among various options such as real estate assets, private company investments, or loan making, provides them with extensive flexibility and significant benefits.
Despite the abundance of freedom and choices available, there are restrictions that apply. Self-directed IRAs are subject to a set of regulations that investors need to be mindful of and adhere to. Furthermore, there are certain transactions that are prohibited in self-directed IRAs, as well as certain individuals with whom they are not permitted to engage in business. The focus of this blog post will be on these disqualified individuals.
Self-directed IRA disqualified persons
Initially, why do such disqualified transactions and individuals exist? Certain transactions go against the primary purpose of your self-directed IRA. It is crucial to bear in mind that your retirement plan is meant to benefit you solely after retirement, not beforehand. Transactions that may appear to provide immediate financial advantage to the account holder or any other disqualified individuals are prohibited.
When it comes to determining prohibited transactions through your self-directed IRA, who is considered a disqualified person? The following individuals are considered disqualified persons.
- You and your spouse
- Your employer
- Your lineal ascendants and descendants, as well as their spouses (children, parents, etc.)
- Any person providing plan-related services (custodians, advisors, fiduciaries, administrators, etc.)
- Any entity (business, corporation, partnership, etc.) of which you are at least 50% owner, whether directly or indirectly
- Any entity where any disqualified person has undue influence over the decision of that entity
If your IRA engages in “self dealing,” which refers to buying or selling investments with a disqualified person as defined by Internal Revenue Code Section 4975 Section 11 on Prohibited Transactions (4.72.11.3.1 Disqualified Person), it may result in substantial tax penalties.
These examples of disqualified persons may assist in determining who is and who isn’t a disqualified person, which can sometimes be challenging.
- If you hire your son to paint a real estate rental property owned by your self-directed IRA, your son is a disqualified person.
- If your own company is a contractor and you hire someone on staff to work on your property, that employee of the company is disqualified.
- If you rent a property owned by your self-directed IRA to your parents, your parents are disqualified.
The short lists consist of the rules regarding disqualified persons and prohibited transactions for self-directed IRAs, which are important. However, there are much longer lists specifying what you can do with your self-directed IRA and the individuals you can collaborate with.
How to Set Up a Self-Directed IRA
To gain a better understanding of how to establish your own Self-Directed IRA, we will examine each step in greater detail. Please note that Madison Trust will provide guidance throughout the account setup process. Although it may appear complex on paper, it primarily involves filling out forms. Typically, the entire process of setting up a Self-Directed IRA takes two to three weeks. Step 1: Open an Account with a Self-Directed IRA Custodian The initial step in opening a Self-Directed IRA is to contact a Self-Directed IRA custodian and complete an account application. The application will inquire about the type of IRA you are opening and how you plan to fund it. Step 2: Transfer Funds into the Self-Directed IRA There are two ways to fund a new Self-Directed IRA. You can directly make a new contribution or roll over funds from an existing retirement account. If you are transferring funds from an existing IRA, you will need to complete a transfer authorization form, instructing the Self-Directed IRA custodian to initiate the transfer. The form will then be forwarded to your current IRA custodian for processing. Subsequently, the current custodian will transfer your IRA funds, which will be deposited into your self-directed account. If you intend to roll over funds from a previous employer’s plan, such as a 401(k) or 403(b), you will need to contact your employer or plan administrator to request rollover paperwork. They will then issue a check or wire to the new Self-Directed IRA account. Before opening a Self-Directed IRA, it is crucial to familiarize yourself with the rules that apply to your current 401(k). Some employers restrict their employees to a specific 401(k) plan for the duration of their employment, which may prevent you from rolling over funds into a Self-Directed IRA. However, once you are no longer employed by the company, you are free to roll over your 401(k) funds at your discretion. Step 3: Direct the IRA Custodian to Invest Funds in Your Chosen Asset Complete an investment authorization form, instructing your Self-Directed IRA custodian to invest your IRA funds directly into your selected asset. This form will stipulate the investment amount and delivery instructions. As passive, non-discretionary custodians, Self-Directed IRA custodians are unable to offer investment or legal advice. It is recommended that investors conduct due diligence before making investments to ensure their suitability. While Self-Directed IRA custodians such as Madison Trust Company are available to address any queries or concerns regarding the investment process, they cannot dictate how you should invest your money.
What’s the Self-Directed IRA Setup Time Frame?
Setting up a Self-Directed IRA usually requires a total of two to three weeks from beginning to end. In case of a need for faster completion, expedited service can be availed.
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