A new report says that people who invest their retirement accounts in unconventional assets — such as real estate or virtual currency — may be placing their savings at risk.
Now, that might come as no surprise to you, gentle reader. Though that “opportunity” is frequently the carrot dangled in front of 401(k) plan participants as an enticement to escape the alleged tyranny of a restrictive plan menu for the relative freedom of an IRA. In that respect, the report from the Government Accountability Office (GAO), while hardly earthshattering in its assessment of the risks, could prove useful in dissuading an ill-thought out move.
Mistake ‘Take’
The GAO report cautions that retirement accounts allowing such unconventional investments increase owners’ responsibilities in ways they may not understand — mistakes that can trigger taxes and penalties. Moreover, account custodians may prematurely close an account or let valueless assets and fraud go undetected because they did not accurately determine the value of unconventional assets.
Of the IRA custodial agreements GAO reviewed, 20 required individuals to agree to be responsible for directing their investments and overseeing the selection, management, monitoring and retention of all investments in the account — and they bear the consequences of any mistakes made in managing their accounts.
Seventeen of the 26 custodians GAO identified that allow investment in unconventional assets reported holding an aggregate of more than 488,000 retirement accounts at the end of calendar year 2015. The custodians reported that the owners of these retirement accounts invested in a range of unconventional asset types, identifying real estate, private equity and hedge funds as the most common asset types held in those accounts. In addition, they reported that account owners invested in Limited Liability Companies (LLC) and limited partnerships, precious metals, promissory notes, church bonds and private placements.
The custodians also reported that these accounts have an aggregate value of approximately $50 billion. However, the GAO said it could not determine whether the accounts exclusively held unconventional assets or, if not, which portion was attributable to cash or publicly traded assets held in the accounts.
‘Unconventional’ Rationale
The report noted that individuals seeking to save for retirement by investing in unconventional assets must first determine which type of retirement savings vehicle and investment aligns with their savings goals. Nine of 17 custodians reported that clients want to invest in unconventional assets for a variety of reasons, including:
- avoiding the stock market;
- diversifying retirement portfolios;
- investing in a tangible or familiar asset; and
- investing in a company that is not yet publicly traded.
The report also noted that IRA owners who invest in unconventional assets take on a heightened risk of engaging in a prohibited transaction and losing tax-favored status for their retirement savings. In fact, it said that IRS officials stated that prohibited transactions are the most prominent compliance risk associated with investing IRA savings in unconventional assets. Moreover, GAO said that prohibited transactions are more likely to arise with investments in promissory notes, private equity, and real estate because — unlike publicly traded stocks, bonds and mutual funds — these investments can involve disqualified family members or other disqualified persons. Similarly, IRA investments in rental real estate, with its many transactions, for example, can leave IRA owners susceptible to a number of prohibited transactions, any one of which would result in the loss of the IRA’s tax-favored status.
How to best remedy the potential problems flagged in the report? Ironically, GAO’s recommended solution was pretty conventional: for the IRS improve guidance for account owners with unconventional retirement assets and clarify how to value those assets annually.
