Because of the current financial crisis, you may be wary of investing in stocks with retirement funds. However, now may be the best time to look at a brokerage account in your Self-Directed IRA. We always talk about the benefits of diversifying your portfolio. Generally, this means investing in alternative assets, such as real estate and precious metals. However, traditional assets, like stocks and mutual funds, are an important part of most people’s retirement plan. A brokerage account held in your IRA can help you buy and sell stocks.
The Brokerage Account
A brokerage account can be opened at a brokerage firm, which allows you to invest in stocks. It can be opened by an individual, or an entity, such as an LLC. That means, you Self-Directed IRA LLC can open an account. The five major brokerage firms are TD Ameritrade, E-Trade, Fidelity Investments, Vanguard, and Charles Schwab.
After creating a brokerage account, you can fund it with your IRA funds by simply writing a check or wiring money. This will allow you to purchase traditional equities, such as stocks, bonds, ETFs and mutual funds. You can open as many brokerage accounts as you want, and is generally the only way to invest in traditional securities.
You should be aware of the strength of your broker and the amount of its protection coverage. This insurance will compensate you in the event your brokerage house goes bankrupt. So long as you opt for a major company, your money should be secure. However, if you want a more personal experience with a smaller company, do your homework first!
Using Your Self-Directed IRA to Open a Brokerage Account
The most important thing to remember is that the LLC is the entity making the investment. The IRA is the owner of the LLC, which affords you the tax benefits of your assets. For income tax purposes, a single-member LLC is treated as a disregarded entity. The IRA is treated as the owner of the LLC. Therefore, since the IRA is the beneficial owner of the brokerage account, all gains made from your investments are tax exempt.
The number one reason for opening a brokerage account with your IRS is the tax benefits. When using regular funds, all gains from the stocks would be subject to tax. However, when held in an IRA, all taxes are deferred until you withdraw from the plan. In the case of a Roth IRA, all qualified distributions are tax free! That’s the power of investing with a retirement plan!
One brokerage firm stands out from the rest in our opinion – TD Ameritrade. It is the only brokerage firm that has a specific application for Self-Directed IRA investors. Tax reporting on your account is repressed. TD Ameritrade is knowledgeable about the tax treatment of an IRA LLC-owned brokerage account.
Know the IRS Rules
As you may know, there are only a handful of assets prohibited by the IRS. These include life insurance, collectibles and, most importantly, transactions involving a disqualified person. Remember, only the IRA can benefit from your investments. A disqualified person includes yourself (the IRA owner), your spouse, lineal ascendants and descendants (parents, children, etc.) and entities controlled by these people.
This prohibited transaction rule can be best related using a real estate investment example. If you invest in a rental property with your Self-Directed IRA, you cannot rent it out to your parent, child, or use it personally. When looking at a brokerage account, you cannot hire a disqualified person as your broker. However, so long as the IRA receives the full benefit of an investment, you are in the clear!
Remember, you already have the tax advantages of the retirement plan. The IRS feels that’s enough. You are never allowed to use retirement funds to receive more benefits. Then again, the ability to defer taxes (or cut them completely) is an outstanding benefit.
Opening a Brokerage Account with Your IRA
First, you need to establish your Self-Directed IRA with a custodian or trust company, such as IRA Financial. Next, you need to fund the account. This can be a rollover or transfer of funds from another plan, or via direct contribution. An LLC will then be created, which will be owned by the IRA.
Now, it’s time to open a brokerage account. Remember, you need to open the account in the name of the LLC and not the IRA. For example, you name your LLC John Smith Inc. LLC, that that’s what should open up the account. Not John Smith, the individual, or the IRA itself. You will need the LLC article of formation, a Tax ID#, and the Self-Directed IRA LLC operating agreement. TD Ameritrade has a special account (pdf version) for Self-Directed IRA investors.
Next, you need to tell your IRA custodian to send the funds to your new brokerage account. The funds will be transferred tax free, in exchange for a 100% interest in the LLC. Since you are the manager of the LLC, you will have total control of the funds. This is known as checkbook control.
To reiterate, the LLC is treated as a disregarded entity and will not be required to file a tax return. All gains from your brokerage account will flow back into the IRA with no tax.
There’s no time like the present to get started and open a brokerage account. The markets seemed to have bottomed out and have shown some signs of recovery. Now is the time to see what’s out there. Lastly, be sure to work with a financial planner if you need help deciding on your investments.
Remember, portfolio diversity is paramount to a long and happy retirement. If you have any questions about opening a brokerage account with your Self-Directed IRA, please contact us today!