Some advisors say checkbook individual retirement accounts are more trouble than they are worth, but they could be useful for clients in certain situations.
Checkbook IRAs are a type of self-directed IRA that allow accountholders to invest in alternative assets, such as real estate or cryptocurrencies. In a checkbook IRA, the accountholder establishes an LLC, owned by the IRA, and invests through the LLC. IRA custodians don't normally offer these investment options.
Accountholders have to be careful to comply with rules, such as paying taxes on unrelated business income if the self-directed IRA is invested in an operating company running another business. Also, accountholders must refrain from self-dealing, which they can be accused of if they have at least a 50% personal interest in the asset.
"I would not want to have that account under my management because anything you have your fingerprints on as an advisor, if something goes really wrong, [clients are] probably going to come back to you and say, 'But you said I could do it,'" Ed Slott, founder of Ed Slott & Co., a New York-based IRA consultancy, said in an interview. "Then you're in the position of saying, 'Well, I said you could do it, but remember I said there were these things that could happen.' And clients don't have that kind of memory when something goes wrong. I usually tell advisors to stay away from these kind of things."
Say it "in a nice way. I mean, you don't want to turn off the client, but I'm saying just tell them … 'There could be liability here,'" Slott added. "'You should go with somebody who specializes in that, but you're also on your own.'" Advisors can refer clients to self-directed IRA custodians and do this with a separate IRA.
Most mainstream institutions, such as Charles Schwab and Vanguard, won't get involved except for qualified charitable distributions, which are direct transfers from an IRA that only owners or beneficiaries at least age 70 ½ can make, Slott said.
"The reason most people have checkbook IRAs is to invest in alternative investments within their IRA, and the average bank, broker or fund company won't let them do that," Slott said. "They'll let them invest in stocks, bonds, funds and things like that, plain vanilla kind of IRA investments."
A case for checkbook IRAs
However, Adam Bergman, founder of Sioux Falls, South Dakota-based IRA Financial, which specializes in self-directed retirement accounts, said checkbook IRAs can be worth the risks. Bergman, a tax lawyer, worked for corporate law firms before starting his own company. He urges clients to set up LLCs for buying real estate both for limited liability protection and for privacy so, for example, creditors won't know they are using an IRA.
Using an IRA itself is fine, and for most people, retirement funds are where their savings are, he added.
"In 16 years, we've never had a client audited or any compliance challenges," he said. "You can make a mistake when you have an IRA invest in anything."
IRA Financial partners with registered investment advisors who have clients who want to invest in real estate.
"That's why it complements their service, because we don't compete with them," Bergman said.
Also, IRA Financial operates on a flat-fee model, he said. Since accounts are self-directed, and clients are making investment decisions, he said he shouldn't charge them asset management fees.
"Fee leakage is a major problem in retirement accounts, where people don't even realize they're giving up 1% a year to someone, and over a 20, 30 year period, it's so much money that's leaving their account," Bergman said.
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Few use cases
Some advisors who spoke with Financial Planning generally discouraged the use of checkbook IRAs but allowed that there is potential for worthwhile opportunities.
"I want to be charitable and say I'm sure that I could be presented with a use case that I can't think of right now," Chris Wilkens, CEO and partner at Baker Street Advisors, a San Francisco, California-based wealth management firm, said in an interview. However, in "25 years, I haven't seen a job that required that tool."
Another advisor gave a nuance that his point applies to most clients or potential clients.
"For most people, I would say it's not worth the trouble," said David R. Silversmith, a senior manager of private client services at New York City-based Eisner Advisory Group.
Even if advisors shy away from a strategy, it still could be worth pursuing, Bergman said.
"The three best investments I ever made, my advisor told me I shouldn't do, and they were real estate, bitcoin and a private investment, and that literally created all my wealth in my IRA," he said. "It's a good chunk of my wealth."
Different ways to invest in real estate
Others see downsides and recommend holding real estate in other ways.
Owning real estate in an IRA means missing out on the step-up in basis on real estate because IRAs don't have that, and the property would require an annual appraisal, said Ryan McKeown, senior vice president at Wealth Enhancement Group and based in Mankato, Minnesota.
If a client's full net worth is in an IRA, and that client wants to buy a rental property, there might not be other options, with no other liquidity, but McKeown would suggest taking a distribution from the IRA to buy the property, especially for clients older than 59 ½. They could get depreciation write-offs and other tax benefits.
Self-directed IRA custodians don't have to act as fiduciaries on behalf of clients, he added.
"That would be an absolute last resort for someone and a client of ours to ... ever have a self-directed IRA doing those kinds of strategies," he said.
