Fundamentals of Alternative Assets and
Self-Directed Retirement Accounts

What you'll find on this page:

What is a self-directed IRA or self-directed retirement account?

The term "self-directed" is not a technical or legal term, but a descriptive term about how the IRA is managed. "Self-directed" essentially means that the IRA owner or someone appointed by the IRA owner makes all the investment choices and decisions for the IRA. You can open a self-directed IRA at a brokerage firm or with an alternative asset custodian like PENSCO Trust Company. The primary difference is that brokerage firms and traditional banks that offer self-directed IRA services generally restrict investments to exchange-traded assets.

What is an alternative asset or investment?

An alternative asset is an asset which is not bought and sold (i.e., traded) through the various market exchanges. You probably know exchange-traded assets more commonly as stocks, bonds, options and mutual or exchange-traded funds (ETFs). Alternative assets are just about anything else you can invest in as long as they're not prohibited by IRS tax regulations (we'll cover that later). With PENSCO Trust Company as your custodian, you can invest in real estate, private placements, promissory notes, precious metals, commodities, and many other alternative assets, even cattle or restaurant franchises.

Private placements

Private placement is a non-public offering of an investment vehicle that acts as a way to raise capital. Securities regulations allow exemption for selected types of private placements. Smaller private offerings can be done where there are less than 35 investors and when the public is not solicited (e.g., friends and family rounds of financing). The most common type of private placements are those involving closely-held private companies. It has been estimated that 75% of new businesses formed in the United States are funded through such private placements.

Promissory notes

A promissory note is an extension of credit from one or more individuals or entities to another individual, individuals, or entities. A qualified retirement account, such as an IRA, is able to extend a loan to any party (including corporations) as long as the party is not considered a "disqualified person". Such notes can be either secured or unsecured. If they are secured, it means that the borrower has supplied collateral (such as real estate they own) and in the event the borrower defaults on the loan from the lender, the borrower agrees to supply the lender with the collateral or security in lieu of the principal balance of the loan. With unsecured notes, the borrower doesn't supply collateral. This makes unsecured notes generally riskier than secured notes. See more about promissory notes.

Why invest in alternative assets in an IRA or retirement account?

There are clear benefits to investing in real estate, private placements, promissory notes, and other alternative assets in a retirement account.

Tax deferral

Alternative assets in your IRA get the same tax treatment as "traditional" assets. In other words, these investments grow tax-deferred. If held in a Roth IRA, your capital gains and interest earned are tax free. Because in most cases, you are not taxed until retirement in a tax-deferred account, your return on investment can accumulate faster, and that accumulated return may be reinvested tax deferred.

Diversification

Diversification is a way to reduce risk in your investment portfolio (as in the saying "don't put all your eggs in one basket"). Alternative assets can provide greater diversification because your investment choices are nearly limitless and may not be tied to the market cycles of exchange-traded investments such as stocks, bonds, and mutual funds.

You're in control

As the term "self-directed" suggests, you or someone you appoint makes all of the investing decisions - what to buy, how to buy it, when to sell, and so on - as long as the investments are not prohibited by the rules and regulations governing tax-advantaged retirement accounts.

What are prohibited transactions?

There are some investment types and transactions which the IRS prohibits in tax-deferred retirement accounts or plans. It's important that you know these rules prior to investing.

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