The Dark Side of Self-Directed IRAs

By Gerald Rome, Colorado Securities Commissioner ~

It is quite common for employees who have a retirement plan through their employer, such as a 401(k) plan, to roll over their retirement assets to an individual retirement account (IRA) when they retire. The most common types of IRAs are Traditional IRAs and Roth IRAs. These kinds of IRAs are usually set up through a bank, a mutual fund company, or brokerage firm, and the retirement funds are typically restricted to traditional stocks, mutual funds, and bonds. Another option allows you to roll over your retirement funds to a self-directed IRA where you make all the investment decisions. And IRS rules permit a wider variety of investment options, like real estate investments, promissory notes, and private placements.

There are surely some benefits to holding assets in a self-directed IRA. Those who hold self-directed IRAs can diversify beyond traditional investments. Self-directed IRAs often have tax benefits and can allow the transfer of assets to beneficiaries after death with little to no tax implications.

Gerald Rome, Colorado Securities Commissioner

Gerald Rome, Securities Commissioner

However, all is not rosy with self-directed IRAs, and it’s important to be aware of the potential dark side of working with these types of accounts. Most important is the increase in the instances of fraud with self-directed IRAs. We have seen many cases where the fraudsters will convince the investor to transfer their retirement funds to a self-directed IRA so they can invest in the fraudster’s program. The people who hold these accounts usually do not take time or care to investigate the background of an investment promoter or offering. This is different than what is required of custodians with Traditional or Roth IRAs.

And when it comes to the alternative investing, investors should know that these types of securities are inherently more risky as well. Often the amount of information available is more limited, the vetting that takes place with traditional investments is far lower, and the amount of specialized knowledge required of the investor in order to make decisions is far higher. Investors can easily get into trouble when investing, say, in oil and gas interests if they don’t have a high level of knowledge about the industry.

Due to the popularity of self-directed IRAs and the higher risk of fraudulent activity, we warn consumers to be particularly mindful of our recommendations for how to decrease your chances of falling for a scam:
1) Be wary of “guaranteed returns.” In the world of investment, there’s no such thing as a guarantee.
2) Avoid unsolicited offers. If you are being cold called or have someone at church or a regular meeting who is approaching you with offers in investments, know that they may be targeting you specifically because they know (or can assume) you have retirement funds stored away. Don’t take a person’s word that an investment is right for you just because you think you know and can trust them.
3) Ask questions, do research, or call us. A promoter must tell you everything. Press for information, back up the info you receive by independently verifying when possible, and if you still have a gut feeling that something isn’t right, don’t invest!

As always, if you have questions about a specific offering or investment professional, give the Division a call and we can assist you in doing this research. We can be reached during normal work hours at (303) 894-2320.