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Risk of self-directed IRAs

By November 21, 2018Uncategorized

At some point or another, an unscrupulous financial advisor may attempt to convince you to move your hard-earned retirement funds into investments held in a self-directed IRA.  Self-directed IRAs, at first glance, seem quite appealing due to the flexibility in the types of investments that they can hold as opposed to other types of retirement accounts. Please be warned, however, that self-directed IRAs can be quite risky.  If you are not willing to put your money at unnecessary risk and if you are not a veteran of the finance industry, you may want to steer clear of self-directed IRAs.  In fact, many consider self-directed IRAs as a conduit for to investment fraud.

The Potential for Fraud

Self-directed IRAs allow for widespread diversification of risk.  The ability to house such a wide range of investments  heightens risk in some cases as many of the investments allowed in a self-directed IRA are not subject to as much due diligence and review as investments held in other types of retirement accounts.  Investments in self-directed IRAs tend to carry a higher risk of fraud along with value fluctuations and exorbitant fees. 

For example, fraud is becoming a legitimate problem in digital assets such as cryptocurrencies.  Such coins and tokens open the door for ICO fraudsters to take advantage of prospective investors looking to ride the wave of popular digital currencies.  Fraudsters tend to advocate the use of self-directed IRAs as the account custodians and/or account trustees provide a very limited number of protections.  There are minimal duties for the investigation of assets or the promoter in question. 

The Basics of Self-directed IRAs

Self-directed IRAs are those held by custodians that permit investments in a wide group of assets than otherwise would be allowed by most IRA custodians.  Self-directed IRA custodians often permit investors to add retirement funds to alternative assets ranging from real estate to promissory notes, private securities, tax lien certificates, etc.  These investments carry risks that the average investor is unaware of.  There might be minimal liquidity or disclosure.  In some cases, outright fraud takes place.

How Self-directed IRA Fraud is Performed

Fraudsters have a number of ways to deceive others through the use of self-directed IRAs.  Some fraudsters exploit the tax-deferred account features of a self-directed IRA.  This type of IRA is tax-deferred with a considerable financial penalty for early withdrawal prior to a specific age.  An early withdrawal has the potential to sway an investor to passively manage the funds, reducing oversight and make it easier for the fraudster to deceive investors. 

Some fraudsters misrepresent the custodian duties to make investors believe the investment is being closely watched and is protected against potential losses.  As an example, these thieves will suggest custodians analyze and validate investments in the IRA.  In reality, this is rarely, if ever, done.    If the individual in question refuses to provide information about other investing options, it is a red flag.

How to Protect Yourself Against Self-directed IRA Risks

The first step to avoiding self-directed IRA fraud is to verify the validity of your investments and the groups offering your investments.  You should also do your best to obtain an accurate value of your investments.  Self-directed IRA custodians typically provide supposed value of investments held in the account, but other than the original purchase price, these values can be quite unreliable.  It will also help to ask questions.  If the individual offering an investment to be held in a self-directed IRA investment is not licensed or registered or if the investment itself is not registered, do not fork over your hard-earned cash. 

Beware of unsolicited investment offers.  Any such offer that uses a self-directed IRA could be fraudulent.  Some scammers will suck investors in by having them transfer traditional IRA money into a self-directed account.  Avoid such promotions, especially if returns are guaranteed.  The bottom line is every investment has risk and there are no guarantees. Any opportunity described as “can’t miss” or “guaranteed” should give you great cause for concern.  Finally, do not hesitate to ask for assistance.  Meet with a professional about self-directed IRAs, always obtain a second opinion from an impartial party, and do your research before making a commitment.

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