In a Self-Directed IRA, investors open plenty of possibilities. Because the IRS distinguishes which retirement assets retirement investors should not use for their retirement, a Self-Directed IRA has many options for building a nest egg, including real estate, precious metals, and more. But there is one caveat: these are retirement accounts, after all, and they are not supposed to function like personal investments. And there is one specific no-no—transacting with a disqualified person—that deserves its own highlight right now.
What is a Disqualified Person for Self-Directed IRA Purposes?
First, a definition. What exactly is a “disqualified person” as it relates to an IRA?
The IRS has a thorough definition available on its website. We will review the specific definitions here:
- The fiduciary of the plan, or a person providing “services to the plan.”
- An employer or any of the employees covered by the plan.
- Employee organizations whose members are covered by the plan.
- Partners, such as owners and indirect owners of 50% or more of people entitled to vote within the company holding the plan.
- A member of the family of any of the individuals listed at the IRS website, such as the owner of the retirement account.
In other words, a disqualified person is someone who either owns the IRA or has a vested interest in working with the person who owns the IRA, such as a partnership. That might include a family member, as noted, but it may also include professional partnerships. For example, this may help prevent a business partner from using their retirement assets to benefit someone who owns a stake in the same business.
The goal of defining disqualified persons is to get people to avoid prohibited transactions, or any transaction with the retirement account and a disqualified person. In other words, it is important for an IRA owner not to use their retirement funds to purchase a property and then rent that property at a reduced rate to a family member. This would be using retirement funds for personal benefit rather than the purposes of long-term retirement investing. And because Congress created IRAs and allowed tax protections for the purpose of retirement investing, the IRS’s job is to ensure that these accounts are being used for that legitimate purpose.
How to Avoid Problems with Disqualified Persons
Given what you know about disqualified persons—and the fact that you can face stiff penalties if you transact with them in an IRA—it’s important to stick to some rules of thumb that can help you avoid dealing with them.
- Work with a reputable Self-Directed IRA administration firm. They will fit you with plenty of informative material about using a Self-Directed IRA. And while they cannot offer specific investment advice—such as what investments to choose—they can help you understand these rules and navigate the world of the Self-Directed IRA.
- When using retirement money to invest in real estate, work with strangers! Your property manager will handle the collecting of rent payments, for example, so there’s no reason you have to rely on people you know to fund your real estate unless you use a personal account.
- Stick to what you know. Retirement investing is not any trickier than other types of investing; it is simply a way for you to use your experience in a field like real estate to build retirement wealth. If you stick to what you know, there is no reason you cannot feel the full amount of freedom and flexibility that comes with a Self-Directed account.