For millions of Americans, the freedom offered by self-directed, traditional and Roth IRAs can be very appealing. These accounts are not limited to the narrow selection of investments that are typically offered inside employer-sponsored retirement plans, such as 401(k) or 403(b) plans. Almost any type of investment is permissible inside an IRA including stocks, bonds, mutual funds, annuities, unit investment trusts (UITs), exchange-traded funds (ETFs) and even real estate.
Even qualified plans are allowed to hold almost any type of security as well, although mutual funds, annuities and company stock tend to be the three primary vehicles used in these plans for various reasons. But there are a few limitations on the types of investments that can be held inside retirement accounts. This article explores the list of impermissible investment alternatives that cannot be housed inside a tax-deferred retirement account. (See: The 401(k) and Qualified Plans Tutorial.)
The list of investment vehicles that cannot be housed inside an IRA or qualified plan should not be confused with the list of prohibited transactions that cannot be done with these accounts, such as lending yourself money from an IRA. When asked about the types of investments that can be used inside IRAs and other retirement plans, most instructors and experts in retirement plans will simply list the disallowed vehicles and then add the caveat that everything else under the sun is permissible. (Learn more in Avoiding "Prohibited Transactions" in Your IRA.)
Here are five investments that cannot be used inside IRAs and other retirement plans.
As a general rule, no type of life insurance contract may be titled as an IRA or qualified plan, or be housed in such an account or plan. This includes whole life, universal, term and variable policies of any amount for IRAs, SEP and SIMPLE plans. Qualified plans contain one exception to this rule, known as the incidental benefit rule. This rule mandates that qualified plans are allowed to purchase a small amount of life insurance for a given plan participant. However, since the primary purpose of the plan is to provide retirement benefits, the amount of the death benefit must qualify as "incidental" compared to the plan balance.
The type of test that the IRS uses to determine this amount depends upon the type of insurance that is purchased in the plan. Defined contribution plans that purchase whole life insurance must meet the 50% test, which mandates that the amount of premium purchased in the plan per employee cannot exceed 50% of the employer's total contribution (plus any plan forfeitures) to each employee's account. For term and universal policies, the limit is 25% of employer contributions, plus forfeitures. (Interested in non-traditional investing? To make sure you follow the rules to avoid prohibited transactions, see IRA Assets and Alternative Investments.)
Types of Derivative Positions
Any type of derivative trade that has unlimited or undefined risk, such as naked call writing or ratio spreads, is prohibited by the IRS. However, many IRA custodians will prohibit the use of any type of derivative trading inside their accounts, except for covered call writing. This is because IRAs are designed to provide retirement security, so the use of speculative instruments such as derivatives is often disallowed. Those who wish to trade futures or options contracts inside their IRAs should look to more liberal custodians that permit the use of other types of alternative investments, such as hedge funds or oil and gas leases. But most custodians of major bank, brokerage and insurance-sponsored IRAs will not do this. (For more information on this advanced topic, check out The Basics of Covered Calls.)
An IRA owner who discovers a collectible or antique worth thousands of dollars on sale at a garage sale will not be able to shield the tax on the gain from the sale of this asset inside an IRA or other retirement plan. Stamps, furniture, porcelain, antique silverware, baseball cards, comics, works of art, gems and jewelry, fine wine, electric trains and other toys cannot be held in these accounts under any circumstances.
"Artwork was excluded from IRAs because during the early 1970s some stolen art from the Nazi era was found. Due to the protection that the IRA would provide to assets held in the account, the government didn’t want to provide a vehicle that could shelter stolen artwork from being reclaimed," says Kirk Chisholm, wealth manager at Innovative Advisory Group in Lexington, Mass.
Real Estate for Personal Use
Contrary to what many believe, it is possible to hold real estate directly inside an IRA. However, the IRA owner cannot benefit directly from the property in any sense, such as by receiving rental income or living in the property. It is therefore not possible to purchase one's house with IRA or retirement plan money.
"Real estate can be held in an IRA as long as investments are not in your personal name; real estate expenses and income must be paid and deposited into your IRA; it doesn’t purchase your primary residence or any other vacation home (providing an indirect benefit); it doesn’t buy or sell property already owned by you or any other disqualified person, for example, your spouse, children or their spouses, parents, grandparents and great-grandparents, grandchildren and great-grandchildren," says Carlos Dias Jr., wealth manager, Excel Tax & Wealth Group, Lake Mary, Fla.
Many IRA custodians cannot facilitate the direct ownership of real estate or oil and gas interests, and those that do often charge annual administration fees that are much higher than normal. (For more see House Your Retirement with Self-Directed Real Estate IRAs.)
Most (but Not All) Coins
As with all other types of collectibles, most coins made of gold or any other precious metal are disallowed, with several exceptions. Some allowed coins:
- American Eagle coins (proof and non-proof)
- American Gold Buffalo coins (non-proof)
- American Silver Eagle (proof and non-proof)
- Austrian Gold Philharmonics coins
- Canadian Maple Leaf coins
In order to be allowed to be held inside an IRA, coins must be very pure in their mineral content and not seen as a collector's coin. Krugerrands and the old Double Eagle gold coins are disallowed because they do not meet this standard. But gold coins that the IRS determines to have more actual currency value than collection value may be permissible.
The Bottom Line
The list of investments that cannot be held inside IRAs and other retirement plans is miniscule compared to the vast assortment of vehicles that can be used. However, it is useful to know what cannot be held inside these accounts in some cases.
For more information on impermissible investments inside IRAs or other retirement plans, consult your retirement or financial advisor. (To learn how to work with the tax man to avoid getting gouged when you convert your plans, see How IRA Contributions Affect Your Taxes.)