Tuesday, May 15, 2007

The Best Self Directed IRA

I've been doing a lot of research recently about the best company to use for a Self Directed IRA, so I thought I'd better share my knowledge.
What is a Self Directed IRA?
A Self Directed IRA is an IRA that allows you to choose your own investments. Your current IRA provider will probably tell you that you can choose your own investments -- "Oh sure, you can choose between the Janus Fund and the Fidelity Fund." No, that's not what I'm talking about. With a real Self Directed IRA, you can invest in not only stocks and mutual funds but also real estate, businesses, notes, and just about anything you want, as long as you avoid certain prohibited transactions. Prohibited transactions are simply transactions where you use the money to benefit yourself instead of your IRA, but it's important to read and understand the details.

So if you're tired of losing money in the stock market and getting jerked around by self serving mutual fund managers, a Self Directed IRA is the way to go.

You can easily convert a non Self Directed IRA into a Self Directed IRA. You can also convert a 401K, if you have one sitting around from a former employer. If you have a 401K with a current employer, you probably don't want to convert it to an IRA, since you would no longer get matching funds.
Downsides of a Self Directed IRA
While Self Directed IRAs offer a lot of advantages, there are also some downsides to be aware of. For one thing, you can't just go out and invest the money. You have to have a custodian company (i.e. babysitter) that actually does all the investing. So, for example, let's say you want your IRA to invest in a house. Rather than writing a check to buy a house, you have to request that your custodian send a check. And instead of managing the property yourself (not that you'd want to), you have to hire a property management company and the custodian has to pay them out of the IRA. There are a few little tasks like this that the custodian has to carry out, and they all seem to cost money.

Self Directed IRAs also have issues when buying property using leverage.

But the upsides definitely outweigh the downsides.
Selecting a Custodian
I looked at all sorts of custodians. Some really nickel and dime you for every little thing, (Pensco and Sterling Trust for example). No thanks.

A lot of real estate gurus promote Equity Trust for some reason. Equity Trust doesn't nickel and dime you as much, but their annual fees get really high (up to $1850 per year) if you have a lot of money in your account. And I for one plan to have a lot of money in my account! So no thanks.

Entrust offers a pretty good deal. But the best one I found was Sunwest Trust. They charge a $50 setup and then a flat $190 per year if you go with the IRA LLC option.
IRA LLC
The best way to go when setting up your Self Directed IRAs is to set up an IRA LLC. "IRA LLC" is not a legal entity type. It just refers to an LLC that your IRA invests in. The operating agreement will have some verbage relating to the fact that the LLC is set up for your IRA. If you're only going to have your own IRA investing in the LLC, then you would set it up with the IRA as the sole member of the LLC, and you as the manager of the LLC.

Setting up an IRA LLC provides the following benefits:
  1. Checkbook control. Once the LLC is funded, you no longer need the custodian to write the checks. The LLC can write its own checks, and since you're the manager, you have control.
  2. No nickels and dimes. Since the custodian is only managing one asset, you pay a flat $190 per year, if you go with Sunwest Trust's Single Asset Account plan. Entrust has a similar plan for $250 per year.
Options for Setting up the LLC
Now you need to set up your IRA LLC. How should you go about it?
  1. You can have your lawyer set it up. He will probably charge you $3,000 to $5,000. And he may not know much about Self Directed IRAs. Not the best way to go.
  2. There are companies such as Guidant Financial, which provide the LLC and also administrate the IRA. Guidant is not a custodian, but they have an agreement with an unnamed custodian to only charge $130 per year for the annual fee. But setting up the LLC costs a whopping $4,000.
  3. You can have a less expensive lawyer do it. You should be able to find someone in the $500 to $1000 range. In Arizona, Richard Keyt is a good option. He's very experienced at creating LLCs, and he gives a $50 discount for AZREIA members. His cost for an IRA LLC is $949, which includes filing the articles and publishing.
  4. If you google "IRA LLC kits" you'll find a few inexpensive options such as this one, which costs $195. I'm not sure how worthwhile these kits are.
  5. I bought a CD on ebay which had some good stuff, including an operating agreement for an IRA LLC. Cost: $32. Search for "IRA LLC" on ebay and you'll probably find it.
I am not a lawyer, but my guess is that the operating agreement content is probably not as important as the lawyers say it is. You'll probably be fine setting up your own. But the important thing is that you avoid prohibited transactions, and file the proper paperwork with the IRS. For the LLC you need to file an informational return each year, which basically just tells how much the LLC is worth. For the IRA your custodian should handle the needed forms.
A Better Solution
I decided that Sunwest Trust had the best deal, but I may not end up using them. "Why not?", you ask, (no doubt recoiling in dismay). The answer is that I found a better solution: It's called an Individual K, or Solo 401K.

I'll tell you all about it in my next post...