I’ve written about IRAs in the past. (See IRA is not a kid anymore and IRAs are becoming increasingly important, but rules can be confusing). But those discussions were in the context of tax planning for distributions. IRAs are, of course, also a tax-advantaged investment vehicle. And as retirement dollars start to increasingly become available, you”ll start hearing more about "self-directed" IRAs particularly as a way to invest in "alternative investments".
So before going any further, here is some background. Of course, all IRAs can be "self-directed". It simply means that the IRA account holder can choose his or her own investments. And that’s what most investment firms and banks offer, but they’re limited to so-called traditional investments. That is, stock, bonds, mutual funds, money market funds, etc. But many of the Boomers who are retiring want to diversify their retirement funds beyond these traditional investments.
And it’s axiomatic that if there is a need for specialized financial services, there will be service providers available to meet investors’ needs. There is now a small segment of the financial service industry that allows an IRA holder to invest in "alternative investments". Penso Trust Company, one of those service providers, estimates that that while the self-directed component of the IRA market is only 3%-4%, it’s the fastest growing segment at 25% annual growth versus 8% growth for the total IRA market.
What’s considered an "alternative investment" is usually framed as anything except what the IRS does not allow IRAs to invest in. The except is a short list and includes collectibles, life insurance contracts, or stock in an "S" Corporation.
The longer list includes what the approximately 20 companies in the marketplace who provide special asset custodial services do permit. They are usually regulated trust companies who will act as custodians for such assets as real estate in many of its forms, e.g., raw land, rental properties, commercial properties, and even real estate-related entities such as limited liability companies (LLCs) that invest in real estate. Some of these custodians also allow private placements that are used to fund a startup company, e.g., IRAs that are rollovers from an employer plan to start a new business.
Self-directed IRAs for alternative investments are not for all investors, of course, and should be established only with the help of experienced professionals. This is really one of those "kids, don’t try this at home" situations.