Life and Death Planning for Retirement Benefits

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Life and Death Planning for Retirement Benefits

it is perfectly “legal” for an IRA to own real estate, a business, a private investment fund, or other “nontraditional” investment. Investing an IRA in unconventional choices has come to be misnamed self-directed IRA investing. The real meaning of self-directed is that the participant himself (rather than the IRA trustee) chooses the investments. Thus, almost all IRAs are “self-directed,” even those invested in publically-traded stocks, bonds, and mutual funds. An IRA that is NOT “self-directed,” i.e., whose investment choices are made by someone other than the participant (such as an IRA trustee), is unusual. Even though it is legal, investing IRA funds in assets other than bank deposits and publically-traded stocks, bonds, and mutual funds creates issues and risks that typically do not arise with more “vanilla” investments. The first problem is to find an IRA custodian or trustee willing to hold title to nontraditional investments. Some IRA providers specialize in this; most IRA providers won’t do it at all. Another problem is the necessity of valuing assets that are not publically-traded. This problem arises annually when the IRA provider must file Form 5498 (reporting the account value to the IRS) and becomes acute when the participant or beneficiary must take annual required minimum distributions RMDs) computed based on the value of the IRA ( ¶ 1.2.05 ). Even once the valuation is accomplished, fulfilling the RMD can be difficult if the IRA’s only assets are illiquid investments. Either the IRA must have cash on hand to fulfill the RMD, or the IRA must distribute interests in the illiquid investment (which creates the need for another valuation). Distributing partial interests in an illiquid asset (such as a parcel of real estate) results in shared ownership of the asset, following the distribution, between the IRA and the participant, which creates potential for a prohibited transaction ( ¶ 8.1.06 ). Roth conversion of the illiquid asset prior to attaining age 70½ would require only one valuation of the asset, and eliminate the need for RMDs and their associated problems, as long as the participant is living ( ¶ 5.2.02 (A)). Other common problems with unconventional investments include titling (see “B” below), and the increased risk of having UBTI (see ¶ 8.2). A. Partnerships. If an IRA owns a partnership interest, the IRA custodian should NOT provide the IRA owner’s Social Security number to the partnership for purposes of reporting the IRA’s share of partnership income and losses. Instead, the IRA custodian is supposed to give the partnership the custodian’s employer identification number. See instructions to IRS Form 1065 (U.S. Return of Partnership Income), 2009, p. 25, under “How to Complete Schedule K-1, Part II, Information About the Partner, Items E and F,” first paragraph. Unlike a “C corporation,” a partnership is a “pass-through entity,” meaning that the income is taxed directly to the partners. Some businesses (such as oil and gas exploration companies) are typically operated as partnerships rather than in corporate form, and may issue publically-traded shares (“units”) in the partnership. An investor (including an IRA) in such a “master limited partnership” is actually a partner in the business, and receives a “K-1” each year reporting the investor’s share of the partnership’s income. This will indicate the amount of reportable UBTI (see ¶ 8.2.03 (C)) attributable to the IRA-owned units, and also may create an obligation to file income tax returns in any state where the partnership operates.