What to look for when picking a custodian for self-direct IRA?

Question

I am getting started and building my team. I have read alot and ready to jump in.

What should I look for and what questions do I need to ask when choosing a custodian for my self-directed IRA?

Most important to me is keeping the transaction transparent and ease of access to cash to pay bills and vendors is important.

I am sure all financial firms aren't equal, but I don't know, what I don't know!

George Blower · Answer

@Kristopher J. Anderson

Welcome to BP!

I suggest that you interview a few providers and as you do so here are some issues to consider:

1. In order to have checkbook control, the IRA account will need to be at a trust company that will allow the IRA to invest in an LLC (where you will be the manager and your IRA will be member - an as manager you will have checkbook access to the LLC bank account). Therefore, you will want to confirm that the trust company allows for investing in an LLC and the associated fees and minimim balance that applies to the IRA account.

2. Confirm that the IRA LLC provider will prepare all of the documents needed to not only form the LLC (articles of organization, SS-4 to obtain an EIN) but also the documents needed by the trust company to process the investment of IRA funds in the LLC.

3. Confirm that the provider has experience with the particular investments in which you intend to invest your retirement funds as you very likely will have questions in terms of the mechanics (e.g. how do you invest in real estate, etc.).

4.  Confirm that the provider has a pristine reputation (e.g. Better Business Bureau reviews, etc.).

5. In addition, if you are self-employed with no full-time employees you may wish to consider opening a Solo 401k instead of a self-directed IRA as it has several advantages over an IRA LLCsuch as much higher contribution limits, direct checkbook control (i.e. no need to have the account at a speciality trust company), ability to take a 401k loan, exclusion from unrelated debt finance income tax with respect to investment in real estate acquired with non-recourse financing, etc.

Brian Eastman · Answer

@Kristopher J. Anderson

Self-directed IRA's come in several formats offered by different types of companies.  The type of self-directed IRA that will best suit your situation and goals will drive the process of identifying the right firm to work with.

A self-directed IRA custodian is a processing entity.  Think E*Trade or Fidelity with different paperwork.  All IRA based plans are required to have a custodian to administer and report on the account.  What makes a self-directed IRA custodian different is that they are not purely connected to the public exchanges and limited to investing in stocks, bonds and funds, but rather have the staff training and paperwork to document the IRA's investment in the more individualized transactions that occur when investing in real estate, notes and other non-traditional assets.  Such custodians will hold funds, sign documents, issue expenses and receive income on behalf of your IRA and act as your processing layer.  This works OK for relatively static and simple investments like a private placement or crowdfund, but can become rather cumbersome and expensive with a more time sensitive and transaction intensive asset such as a rental property.  You also need to be aware that custodians are passive in nature and simply process transactions at your direction.  They do not provide meaningful oversight or guidance with respect to tax code compliance.

A checkbook IRA LLC is an enhancement on the above structure that is generally more time and cost efficient for investors with a more diverse portfolio.  It starts with a self-directed IRA held by a custodian, but the IRA simply makes one investment into a specially designed LLC entity.  The IRA owns the LLC, but you can be the non-owner manager of the LLC and have signing authority.  This allows you to directly manage transactions via the LLC and eliminates the paperwork, processing delays and per-transaction fees of the custodian.  These plans typically cost a bit more to establish due to the legal work, but in most cases will save you considerably over the long term.  With a quality provider, such plans also come bundled with meaningful consulting guidance to help you get the most out of the program while staying inside the IRS guidelines.

A similar checkbook program is a Solo 401(k).  Such plans are available to those who have some form of self-employment  and no full time employees.  As an owner-only business retirement plan, the Solo 401(k) has higher contribution limits, allowing you to build your savings on the front end as well as providing investment flexibility.  The Solo 401(k) also has the advantage of being more favorable for real estate investments using debt-financing such as a mortgage - as the 401(k) is exempted from a small tax called UDFI that an IRA would pay on the percentage of income derived from the borrowed money.

So, as you continue your research and get feedback here on BP, think about what type of program will best suit you needs and be sure to ask questions along that line.  Get on the phone and speak with a few of the providers that are active here on BP.  You will pretty quickly be able to tell who is just selling something and who can become a valuable member of your team.