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What's in Your IRA?

Many millions of Americans have an IRA or maybe more than one. You could have started it with a contribution from your work earnings, by a rollover from a company retirement plan such as a 401(k) or perhaps received an IRA by inheritance. Whatever the means, it is very important to know what you hold inside that IRA.

There seems to be no end to the various products being touted as investments for your IRA. From annuities and insurance to rental property to master limited partnership interests to precious metals there seems to be no end to the products you are being told to buy in your IRA. The reasoning is obvious, there is a lot of money in IRAs and a lot of product sellers who need to get some of that money. Before you jump on some of these offers, do your research and think about issues such as the following.

First, from the standpoint of tax deferral, there are nearly always pre-tax dollars – deferrals – in the IRA and you are taxed on them only when you take a distribution. There may also be after tax contributions which grow just as if they were tax-deferred but will not be taxed, to the extent of the contributions, when you eventually withdraw them. It is important to know that such withdrawals are taken in proportion so that a distribution is made up of both pre-tax and after-tax dollars.

Second, with taxes still looming, the type of assets or securities the IRA owns can be critical to the account owner. For example, any asset that generates what is called unrelated business taxable income can result in current income tax and penalties to the account owner even without ANY withdrawals being made. In the worst cases, an IRA may be entirely disqualified. Similarly, engaging in what is termed a prohibited transaction may get your IRA disqualified as well and this bar applies to activities you might be encouraged to engage in. For example, using IRA funds to purchase property for personal use (think real estate for your home or business) is prohibited.

What types of property generate the dreaded unrelated business taxable income? Owning real property that is in part debt-financed in your IRA will potentially generate UBTI as will certain activities within a master limited partnership. A serious kicker on these items is that the tax and penalties come out of the IRA and cannot be paid from the taxpayer’s separate, non-deferred assets.

Finally, just as you’ve heard in the context of 401(k) plans, be aware of the expenses and fees associated with different types of holdings in your IRA. Some mutual funds are very expensive while others are very low in cost. Management and advisory fees also vary widely and knowing what you may be asked to pay is important and can help you to choose assets for your IRA that do not crimp your ability to grow those assets.

 

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