Individual retirement arrangements (IRAs) are supposed to be simple and flexible investment vehicles, but their investment rules are more complicated and restrictive than many investors realize.
When you invest only in publicly traded stocks, bonds and mutual funds, there are no special issues. However, the tax law prohibits or penalizes some other investments by IRAs. Though part of the law for a long time, these pitfalls are becoming more important as the investment options available to mainstream investors increase and as investors are attracted more to “hard assets” and other non-traditional investments.
The restrictions on IRA investments are not well-known and, as a result, investors often stumble into penalties or other problems. The most common mistake is using a retirement account to hold an investment that falls under one of three categories: prohibited investments, taxable investments and transactions, and prohibited transactions.
The prohibited investment rules apply to IRAs and also to other self-directed accounts, such as 401(k)s. The main category of prohibited investments is “collectibles” as defined in Section 408(m) of the Internal Revenue Code.
When an IRA acquires a collectible, the amount used for the acquisition is treated as a distribution to the IRA owner. It does not matter whether the collectible is held or eventually sold.