Most investors do not understand why they can’t manage, invest, transfer, and hold their IRA funds any way they want. After all, the money in the IRA is owned by the IRA owner isn’t it? The answer is yes and no. An IRA will be held by a financial institution for the benefit of the IRA owner. The IRA is not really held in the name of the IRA owner, but rather for the benefit of the IRA owner. It sounds like semantics but the rules are the rules.
One reason for this process is to provide a system that potentially reduces the chance that an IRA owner will do something improper with his/her IRA and subject themselves to unnecessary income taxes and possible penalties. Another potential reason for this lies in the potential taxation of the IRA proceeds. Upon any distribution the taxable IRA investor will receive a portion of the liquidated funds, and then pay a portion of the funds to the IRS.
IRA accounts, whether Standard IRAs or Self-Directed IRAs must be held and administered by a Custodian. IRA accounts can be held for the benefit of the IRA owner but the assets in the IRA must be held by the Custodian and titled properly.
According to Jason Helquist, MA, LL.M, and Chief Compliance Officer of Provident Group, a Self-Directed IRA Custodian located in Las Vegas Nevada:
"All IRA assets are required to be held by a Custodian/Trustee, which is normally a bank, trust company, credit union, or a custodian that has been approved by the IRS. Unlike a qualified plan with an employer in which the owner-employee can serve as plan trustee, the IRA owner cannot hold title to the assets in the IRA. Accordingly, when investing in alternative asset classes, the IRA owner should direct the custodian to purchase and hold the investment in the name of the account (e.g., Name of Custodian, for the benefit of John Smith’s IRA).
The IRS has issued Forms 5305 and 5305-A as model IRA agreements, which are used by many trustees and custodians. Form 5305-A provides that the IRA owner may direct investments and retain most "traditional" powers that would otherwise create a passive trust, and that such powers do not cause the IRA’s assets to be owned by the IRA owner. Any alterations to the Model IRA agreements must be submitted for IRS approval.
The Internal Revenue Code expressly holds that IRA custodial accounts are treated as IRA trusts as long as the assets are held by a bank, trust company, or other approved entity and that the IRA custodian is treated as the trustee for all statutory purposes. Since the owner of an IRA is the sole participant, the IRA is not a plan governed by ERISA. This is critical, as it means ERISA’s preemption of state law is not applicable. ERISA’s fiduciary rules regarding reasonable prudence and diversification do not apply to IRAs. However, the Internal Revenue Code does require that the IRA be for the exclusive benefit of the owner or his beneficiaries."
A Self-Directed IRA Custodian will typically provide the following services:
- Establish your Self-Directed IRA account
- Communicate with previous plan Custodian to enact transfer of funds to Self-Directed IRA
- Receive, document, and report all deposits into Self-Directed IRA account
- Distribute, document, and report all disbursements from Self-Directed IRA account
- Distribute all required minimum distributions – RMDs
- Review suitability and paperwork for proposed investments
- Send funds to invest in specific investments
- Receive income from investments
- Report account values
- Provide governmental filings – federal, state, local, etc
- Offer miscellaneous services
Mr. Helquist adds this data regarding the role of the Custodian:
"As mentioned above, the Internal Revenue Code requires a "bank" to serve as an IRA custodian or trustee. Among the institutions defined as "banks" are trust companies, credit unions, banks, corporations governed by a state agency which regulates state banking institutions, or an IRS approved company. The IRA owner cannot act as the trustee or custodian. Typically, a custodian of a Self-Directed IRA will act only at the direction of the IRA owner. The custodian retains no discretionary authority and generally will have the IRA owner acknowledge the non-discretionary nature of its role. The acknowledgements will typically include waivers of liability.
The prohibited transaction rules impose an excise tax penalty on a disqualified person who is a fiduciary. The fiduciary would be jointly and severally liable for applicable taxes. The role of the custodian in a Self-Directed IRA is critical is determining its liability for any potential prohibited transactions. Custodians of a Self-Directed IRA would assert that they are not fiduciaries, as they have no discretionary authority or control over the IRA." |
