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Watch Out for This IRA Trap

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If you want to retire rich, then one of the best tools you have at your disposal is your IRA. The tax benefits that the tax-favored retirement accounts offer can give you a big leg up in building a nest egg for your golden years.

But with millions of middle-aged savers scrambling to catch up with their retirement savings, there's a big temptation to go for the big score by looking beyond traditional investments for IRAs. A special kind of retirement account known as a self-directed IRA can legitimately allow you to go beyond stocks and other mainstream investments, but the SEC recently warned investors that self-directed IRAs often end up tied to fraudulent investment schemes.

Why taking charge can be smart
The first thing you have to understand is that the term "self-directed" is misleading. One of the main advantages that all IRAs have over employer-sponsored retirement plans like 401(k)s is that there are very few limits on what investments you can make in an IRA. Moreover, with an IRA, you always have the ability to direct how you want your money invested -- and you typically have the ability to change your mind at will and shift your money into a different investment without penalty.

But most financial institutions prefer to draw the line well short of what can legally go into an IRA. While stocks, bonds, ETFs, and mutual funds may be among the easiest investment vehicles to put into an IRA, they're definitely not the only ones. If you follow IRS rules to the letter, you can often put a wide range of other assets into IRAs, including real estate, ownership stakes of privately held businesses, and precious metals.

During the financial crisis, self-directed IRAs gained substantially in popularity. With mainstream investments almost across the board losing immense chunks of their value, the idea of alternative investments that would hold more of their value had huge appeal. As the stock market once again starts to get choppy, interest in self-directed IRAs has remained high, with nearly $100 billion invested in the retirement vehicles according to the SEC.

Buyer beware
The problem with self-directed IRAs, however, is that you're often on your own to figure out whether an investment is on the up-and-up. Unlike regular stocks and funds, private investments often don't require SEC-regulated disclosure. Moreover, as The Wall Street Journal reported over the weekend, some unscrupulous sellers of investments for self-directed IRAs take advantage of a false sense of legitimacy that the IRA wrapper lends.

Furthermore, exchange-traded funds now give investors many more investing choices than they used to have. For instance, for precious-metals investing, ETFs ranging from the traditional SPDR Gold (NYSE: GLD  ) to the leveraged ProShares UltraShort Silver (NYSE: ZSL  ) are perfectly permissible investments for regular IRAs at traditional brokers. Similarly, mortgage REITs like Annaly Capital (NYSE: NLY  ) and American Capital Agency (Nasdaq: AGNC  ) share many attributes with the privately offered mortgage notes that became popular self-directed IRA investments during the housing boom.

The net result is that you may not truly need a self-directed IRA to accomplish what you want. And with extra hoops and sometimes higher fees associated with self-directed IRAs, if you can get by without one, your life will probably be a lot easier.

What you should do
At the same time, though, there are situations in which a self-directed IRA makes sense. For instance, with real estate investments, unique characteristics of a particular piece of property can make it impossible to use a more generalized investment like Health Care REIT (NYSE: HCN  ) or Weyerhaeuser (NYSE: WY  ) and expect anything close to the same return. The same goes for business opportunities; for instance, the return from a coffee franchise may look nothing like what shares of Green Mountain Coffee Roasters (Nasdaq: GMCR  ) will do in the coming years.

The key is to know that self-directed IRAs require more effort on your part. If you're willing to take on the extra due diligence, though, you may well be very happy with the nearly limitless flexibility that self-directed IRAs give you.

Dividend stocks are a great way to secure your future, and our latest special free report has 11 great names you should have in your IRA portfolio right now. Read it here and start investing smarter!

Fool contributor Dan Caplinger knows greed can be a big trap. You can follow him on Twitter here. He doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of Annaly Capital Management. Motley Fool newsletter services have recommended buying shares of Health Care REIT and Green Mountain Coffee Roasters as well as creating a lurking gator position in Green Mountain Coffee Roasters. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy helps you steer clear of traps of all sizes.


Read/Post Comments (5) | Recommend This Article (7)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 24, 2011, at 3:05 PM, techy46 wrote:

    If your invetsment savy, the smartest move you can make is at 59.5 years of age move most of your 401K to am IRA Rollover account to get out if having to invest in a handful of muututal funds selected by some fools in your ebterprsie that know nothing about invetsments. You can then invest the funds in any CDs, equities, ETFs and mutual funds of your choosing.

  • Report this Comment On October 24, 2011, at 9:31 PM, SUPERMANSTOCKS wrote:

    This article reminds me of my TSP account. So many funds, but no one winner!

  • Report this Comment On October 31, 2011, at 8:27 AM, Yourdeadmeat69 wrote:

    Annuity--give your $500K to someone for $30K a year for life, never to see the 500K again?

    What part of shmuck is not understood?

    DO the DUE DILIGENCE and get invested in the market, up or down, and with covered call and put options as insurance. Stick with high dividend stocks with mucho call option time premium, and you'll do better than Buffet, who is wasted away in stockholder answering mode, not margarita ville.

    That's another Buffet.

    Swim with the sharks or be eaten, the days of fixed income doing anything at all have been over since Nixon ruined the country by taking us off the silver standard 1971. In 200 years, the dollar remained backed by silver and gold, vacillating +- 50%. Out of the silver backed business 1971, the dollar has depreciated against silver oil gold cotton about NINETY PERCENT and falling.

    How's that working out for you?

    The US has substituted clever (the least efficacious of the genus of man) for productive (the most). "Clever" was supposed to turbocharge productivity, now it exists as a standalone buy for a dime, sell for eleven cents mentality of "making money". See how that works? Swim with those sharks or be eaten by them, your dollar is "designed" to drop by half its buying power every TWELVE YEARS. That's not "growth", that's a Ponzi scheme. Madoff said so, and when I want to know what criminal behaviour is all about, I ask the top criminals.

    You don't think you're Wa;ll Street? Buy a house for $400K expecting it to be $440 in ten years at 3% "appreciation" a year, and your $40K downpayment DOUBLED! Aren't you a genius?

    No, you're an idiot! The extra $40K didn't come from "appreciation" of your investment, it came from the degradation of the entire $400K in terms of real things, commodities, gold, silver soybeans, oil. You just played a numbers game and wound up with the extra $40K on your side of the ledger.

    You just played with $400K and only put up $40K--that golden goose was "designed" to fool you into thinking you made a good "investment" while the puppet masters degraded the currency to make it look like you're a financial wizard making money out of nothing. On the contrary, your money is being driven to nothing, you just reaped the same profits as someone who invests in any future, gold silver or soybeans. It's a Monopoly Game designed to make you think you're prospering, when in effect they're sawing the limb of currency valuation out from under you.

    So get invested, learn the ropes, or you'll never retire, never have enough to eat or live on in a very short period of time.

    And you'll wind up outlving your resources, and a Soylent Green patty on your grandkid's dinner plate.

  • Report this Comment On December 13, 2013, at 1:17 AM, chainblue wrote:

    The title is a bit misleading, the self directed IRA is not the trap. What you do with it is! Of course you have to be smart and investigate, but the options and chance for better returns is there. I had an hour long discussion with Kip Bowman at http://iracheckbook.com and he really can lay it out.

  • Report this Comment On April 17, 2014, at 12:28 AM, chainblue wrote:

    Some of us are just old enough to remember the apprehension of the new "self serve" firms when the internet was new. Now over 60% prefer to trade w/o a broker face to face. Same thing for the checkbook IRA. As information get out there, many more small to midsized investors will turn toward a self directed ira knowing the self directed ira rules and the process. When done correctly it can really out perform traditional IRA custodian offered investment products that are sold to you because the firms profit. Get the facts at http://iracheckbook.com they offer a great email course that you can sign up for on the website and its free and you get it automatically without a sales call which is nice when you are just investigating your options.

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Dan Caplinger
TMFGalagan

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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