Prohibited IRA Investments and Transactions

There are a host of rules and regulations associated with IRAs that individuals should be aware of before getting started investing. IRA accounts are fantastic vehicles for saving for your retirement goals, but if you want to start using a retirement account for something other than retirement, it’s best to play by the rules.

The IRA accounts you are most familiar with are the ones (Traditional, Roth, Rollover, etc.) that you open and invest with at your financial institution, custodian, or wherever your financial advisor recommends. This is a great way to go about investing in your IRA account, as the financial institution will make sure you aren’t breaking any of the prohibited IRA investments and transactions rules listed below.

Where individuals usually find themselves in trouble is when they open a “self-directed IRA”. The self-directed IRA is an account that an individual will use to make investments without the help of a financial institution or other custodian. Most often, we see a self-directed IRA being utilized to purchase an investment property with retirement funds. Although the self-directed IRA offers the flexibility to make alternative type investments, with options come potential consequences. Here’s a list of prohibited IRA investments and transactions:

Prohibited Investments

  • Collectibles - artwork, rugs, antiques

  • Precious metals, coins, and gemstones (except U.S. coins and bullion)

  • S corporation stock

  • Life Insurance contracts

Prohibited Transactions

  • Borrowing money or loan - there is such a thing as a 401(k) loan, but not an “IRA Loan”

  • Using as a security for a loan

  • Buying property for personal use

  • Selling, leasing, or exchanging property to the IRA

Consequences

When a prohibited transaction occurs within an IRA, the account may cease to be treated as an IRA. This means that the assets in the account are now viewed as having been distributed from the account, which triggers income taxes and potentially a 10% penalty for an early distribution (before age 59 ½). In a situation where a portion of the IRA is used as a security (or collateral) for a loan, only the portion used is treated as a distribution from the IRA.

Example: John is 54 years old and has $650,000 in his Traditional IRA. His son, Michael, is looking to buy his first home, but does not have the money to do so. John decides to help his son out and lends Michael $250,000 from his self-directed IRA to purchase the home. Since this is a prohibited transaction, as listed above, the IRA is considered distributed. John will have to pay ordinary income taxes, plus a 10% early withdrawal penalty, on the full $650,000 account balance.

These prohibited investments and transactions in an IRA are rare, as they most often occur when using a self-directed IRA. It is in your best interest to play by the rules - which is much easier to do when investing in your IRA at a financial institution, custodian, or through your financial advisor.