The Dos and Don'ts of IRA Investing
Preston, Robert, Journal of Accountancy
Some investments work better than others.
IRA investors today have literally hundreds of investment options available to them ranging from the stock, bond and mutual fund offerings of Wall Street to gold coins, real estate and derivatives. The decision to purchase one or more of them is one an investor often makes with the advice of his or her CPA. Investment decisions can be more complicated when the client intends to hold the investment in an IRA. The law does not allow taxpayers to put certain investments in an IRA; despite such limitations, there remain some attractive, little-publicized and less-known investment opportunities. CPAs should be familiar with them so they can give clients the best possible advice on a confusing, and potentially risky, subject.
KEEPING WITH TRADITION
Most CPAs are aware of the traditional IRA investments--publicly traded stocks, bonds, treasury instruments, cash. But what about investments outside the United States or in private placements and real estate? Are these viable options for an IRA? How about limited partnerships or options? Can a client make these investments legally? Are commodities, personal loans or mortgages acceptable alternatives?
Unfortunately, there isn't extensive guidance from federal regulators that answers these questions and provides a thorough overview of what investments are allowed in IRAs. CPAs, however, will find considerable guidance on IRA deduction limits and minimum distributions. The rationale for that is fairly obvious--Congress and other agencies put a priority on rules affecting revenue collection.
While the Department of Labor (DOL) is the principal authority responsible for prudent, allowable investments and overseeing prohibited transactions in qualified plans, its interest in IRAs is minimal. In most instances, the DOL does not consider an IRA a pension plan and consequently it is not covered by Title I of ERISA; for the exceptions, see DOL regulation 2510.3-2(d). However, the DOL has principal authority for prohibited transaction issues (and granting exemptions) involving IRAs under IRC section 4975(e).
ERISA initiated the concept of asset guidelines as they apply to qualified plans (principally ERISA sections 404 and 406-408), but there are no asset diversification guidelines for IRAs similar to those in ERISA section 407 for qualified pension plans. Government agencies and the courts have provided follow-up guidance. IRAs originated with ERISA in 1974, but the Economic recovery Act of 1981 gave them a big boost by relaxing the eligibility rules, allowing more individuals to participate, including those covered by employer-sponsored pension plans. While the Tax reform Act (TRA) of 1986 added some restrictions, the 1997 TRA continued the liberalizing trend of the early 1980s. With the proliferation of large pension distributions being rolled over into IRAs, assets have mushroomed.
IRA INVESTMENT RESTRICTIONS
While Congress put strict prohibitions on some IRA investments (for example, insurance), it did not pay similar attention to other asset classifications. Because the account owner generally manages IRA assets, Congress and the enforcement agencies probably did not foresee the same need for supervision and guidelines as with pension assets, where the potential for abuse seemed greater.
What rules does an account owner have to follow when making IRA investments? The primary laws affecting IRA investments are IRC sections 219, 408 and 4975, along with the accompanying regulations. CPAs will find that IRA owners have considerable investment leeway based on what's not addressed by any government body or area of law. Accordingly, the scope of permissible IRA investments is somewhat vague and subject to interpretation.
What is helpful is that IRA investment restrictions are relatively straightforward. Collectibles generally are not allowed, with a few exceptions--see section 408(m). …