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Self-Directed IRAs Are Risky, But For Whom?

By Bryan Ellis

In 2011, when the SEC published a notice concerning the risk of fraud in self-directed IRAs, conventional financial professionals were quick to choose sides.

“I have a special warning for you about doing weird things with your IRA," states a video published by one well-known consumer advocate. "There's a new warning from the Securities and Exchange Commission letting investors know that a lot of times, you're just going to be separated from your money by a scamster."

Is there a risk of loss in self-directed IRAs through fraud? Of course there is -- as is true in literally every single investment opportunity.

Yet what this consumer advocate failed to reveal was that the SEC notice he cited explicitly endorsed the legitimacy of self-directed IRAs ("self-directed IRAs can be a safe way to invest retirement funds") and that the total amount of monetary loss cited in the SEC notice (about $52 million across six different cases and hundreds of investors) was equivalent to the loss in market cap that occurs when Apple stock declines by a single penny.

This negative assessment of self-directed IRAs is correct in one way: self-directed IRAs are risky. But, as the knee-jerk reaction from conventional financial professionals clearly indicates, these powerful retirement accounts are much riskier for the status quo of the financial industry than for investors who use these powerful, versatile financial tools.

Are self-directed IRAs a gateway to investment fraud?

As CEO of the Self-Directed Investor Society, I regularly encounter conventional financial professionals attempting to connect alternative investment tools -- like self-directed IRAs and solo 401(k)s -- with fraudulent investment activities.

Their motivation is clear: the conventional financial industry has a vested interest in keeping Americans narrowly focused on the retail assets offered by Wall Street rather than considering any competitive alternatives, such as real estate, precious metals or privately-owned businesses.

Yet these claims are falling hard when faced with legal scrutiny, as recently happened when a major self-directed IRA custodian (Equity Trust) handed the SEC a decisive legal defeat when the SEC attempted to equate fraudulent investment schemes with self-directed IRAs provided by Equity Trust.

Equity Trust's legal victory was a victory for users of self-directed IRAs and a clear and embarrassing defeat for conventional financial professionals, who attack self-directed IRAs as a means of maintaining the status quo.

Are self-directed IRAs too complex to be used safely?

Another approach I’ve seen used by conventional financial professionals to dissuade Americans from self-directed IRAs is to overemphasize the complexity of maintaining legal and tax compliance.

“Experts warn of pitfalls extending beyond investment risk, such as costly tax penalties, that should temper such choices for most investors” proclaims a recent article (registration required) in InvestmentNews.

It's certainly true that there are experts willing to warn of increased risks connected with self-directed IRAs. But, invariably, the experts cited are conventional investment experts whose expertise ends long before the rules concerning self-directed IRAs begin.

Another wealth adviser cited in the InvestmentNews article points out the “unique complexities” of self-directed IRAs, including leveraged investments, unrelated business income tax and asset valuations.

Again, these issues are, in fact, real complexities involved in alternative asset investing through self-directed IRAs. But it's precisely those complexities that create extraordinary potential in self-directed IRAs that cannot otherwise be replicated.

Tim Berry, a leading attorney with expertise in self-directed IRAs and a guest on the Self Directed Investor Talk podcast, recently told me: “It amazes me to see how willing many so-called experts are to criticize some of the complexities that can exist with self-directed IRAs. I'm frequently able to save my clients truly substantial amounts of money they'd otherwise have to pay if those complexities didn't exist. It's those complexities that present opportunities for savvy investors to create exceptional results."

Self-directed IRAs are spreading like wildfire.

Despite the drumbeat of negativity about self-directed IRAs from conventional financial professionals, investors on Main Street are pouring into this powerful investment vehicle in droves.

PENSCO Trust Company, a self-directed IRA provider based in San Francisco, is a great example of the explosive growth in the industry. In just over a year, PENSCO's client base has increased by 17% with assets under custody jumping an even more impressive 40%, from $10.75 billion to $15 billion.

The conventional financial world is taking notice, too. In May, PENSCO announced an agreement with financial advisory behemoth Merrill Lynch for Pensco to provide custodial services for the alternative assets of Merrill’s client base, who are demanding access to assets classes beyond Wall Street’s retail offerings.

One thing is certain: self-directed IRAs are here to stay and are being adopted at an extraordinary pace, creating opportunities not just for savvy individual investors, but also for conventional advisers who wisely choose to expand their service offerings to include real estate, precious metals and other alternative assets that are booming in public demand.

 

To read this article on Forbes' website, click here.