The arena of self-directed retirement investing has recently been experiencing a paradigm shift. Investors have been moving in large numbers towards Checkbook Control plans which give them greater investment freedom at a more economical cost. This is not the first time the financial industry has experienced such a shift. In the 90’s, the industry experienced a similar phenomenon with the emergence of online trading platforms. Previous to that time, if an investor wanted to purchase stocks, he/she had to go through a stockbroker who would charge significant fees for an elongated stock buying process. With the emergence of online platforms, investors were able to purchase stocks at a much lower fee rate and do so in real time without the hassle of a middleman. Today the idea of using a broker to process a trade sounds justifiably antiquated.
An almost identical process has been taking place with self-directed retirement investing. Just a few years ago, the field was dominated by custodian-based models where an investor had to go through his/her custodian in order to place an investment or execute a related transaction. This led to a paperwork heavy process as the custodian filled the order, while simultaneously raising the fee rate significantly to cover the custodian’s cost. The Checkbook Control model does away with those issues by putting the investing and transaction power back in the hands of the investor. That way investments can be placed quickly in real time, and there are no unnecessary custodian fees.
However, as with all productive model shifts, there is always a transition period where the older model puts up a fuss in the hopes of maintaining the status quo. That is currently happening right now in the self-directed arena, and it has led to a number of claims and publications which seek to distort the reality of the modern investing world.
Let’s take a look at one particularly egregious report which goes by the name “10 Myths About Checkbook IRAs Exposed”. We’ll examine the claims, see if they have any validity, and explore the current legal guidelines as they apply to the issues under discussion.
1. Checkbook IRAs and IRS Approval
The Claim: The IRS does not approve the Checkbook Control model and in fact lists it in its annual “Dirty Dozen” list of tax scams.
The Truth: The Checkbook Control platform was given explicit approval by the U.S. Tax Court in Swanson v. Commissioner, 106 T.C. 76 (1996), and then ratified by the IRS in Field Service Advisory (FSA) 200128011 (April 6, 2001). The ability to add funds to such an account was approved by the Department of Labor in Advisory Opinion 97-23a. Currently, over a hundred thousand investors enjoy the legality of the Checkbook Control platform.
The aforementioned based its claim of non-approval on the IRS’s inclusion of “abusive retirement plans” on its Dirty Dozen list. The reason for its inclusion was explained by the IRS itself as due to the ability “to engage in activity that is considered prohibited”. In other words, the platform itself was legal; there was just a concern that it could possibly lead to tax abuse in the form of prohibited transactions. However, the past few years have shown this fear to be unfounded as the vast majority of self-directed accounts were used responsibly and within the guidelines of tax law. As a result of this positive outcome, the IRS no longer lists “abusive retirement plans” on its Dirty Dozen list.
2. Checkbook IRAs and Retirement Risk
The Claim: Retirement funds can be put at risk if they are found to be engaging in Prohibited Transactions with a Checkbook Control model.
The Truth: Any kind of self-directed IRA is subject to the danger of Prohibited Transactions. This is true not only in the Checkbook model, but within the Custodian model as well. In fact, the Custodian model contract states explicitly that the Custodian will not be held responsible for any Prohibited Transactions performed with the retirement funds. Their so called “review” of investor transactions is usually superficial at best, and misleading at worst as they assume no responsibility for the legality of the transaction. The custodians have actually been sued for this misrepresentation.
In all cases, the onus of performing legal transactions lies solely on the shoulders of the investor. However, bear in mind that this is not nearly as scary as it sounds. The few rules governing Prohibited Transactions are fairly simple to learn, and it’s incredibly rare that an investor will ever run into any trouble. That probability approaches zero if your self-directed IRA facilitator offers decent customer service, and you pose your questions as they arise.
Prohibited Transactions are part of the US Tax Code, and apply to all retirement plans: brokerage based, self-directed, and Checkbook Control. In the standard brokerage account, Prohibited Transactions are almost never an issue as the investment choices are severely limited (stocks and a few funds), and do not allow for investor involvement. Self-directed accounts, on the other hand, do allow for greater investment freedom, and thus potentially raise the problem of committing a prohibited Transaction.
In truth, however, even in the self-directed platforms, it is very rare to find occurrences of Prohibited Transactions. The reason for this is simple: investors wish to maintain their retirement accounts in good legal standing and thus they choose to invest in a way which does not involve anything illegal. The rules of Prohibited Transactions are fairly simple to learn, and once an investor spends a few minutes learning them, there’s virtually no chance of stumbling. If it happens that a questionable situation does come up, it can always be referred back to the self-directed facilitator for a quick and easy answer.
There are some unscrupulous vendors out there who tout the advantage of the Custodian model as providing an extra level of security to help investors avoid Prohibited Transactions. However, when one looks at the fine print of the Custodian contract, you will find a constant emphasis on the fact that the Custodian takes no responsibility for the legality of your investments. In other words, there is no guarantee whatsoever against Prohibited Transactions. Your best protection is to spend the short time necessary learning the few rules that you need to know.
3. Checkbook Promoters Falsely Guarantee the Safety of the Checkbook IRA
The Claim: Checkbook IRA facilitators do not believe in their own platforms, and say so in their documentation.
The Truth: I have personally looked through the Checkbook documentation and I have never found such a claim. It’s hard to write this, but this claim appears to be an overt and willing misrepresentation. Broad’s self-directed IRA platform has been crafted under the guidance of the country’s top ERISA law firms (documentation available upon request), and their self-directed Solo 401(k) is an IRS approved Qualified Retirement Plan. Perhaps the most telling statistic is the fact that Broad’s management uses the Checkbook Control platform for their own retirement funds. With this knowledge, it’s hard to understand how a claim of dubious security can even be made in the first place.
4. Continuing Legal Support After Account/Plan Setup
The Claim: Checkbook IRA facilitators falsely promise ongoing legal support.
The Truth: Here at Broad we do not promise ongoing legal support, just ongoing client support. That means that whenever you have a question, you can give us a call and we’ll try our best to help you out. Although we do refer unusual questions to our ERISA attorneys, 95% of the questions asked usually have fairly easy answers that are well known to people in the arena. You expect your doctor to know how to address most health issues, and to refer appropriately when he/she doesn’t know the diagnosis. The same holds true with your self-directed facilitator; you can expect them to know how to address common situations and you can expect them to ask their lawyers if they don’t know the answer. Since you’re not the first customer at Broad Financial, chances are that your question has already been answered. This setup insures the quickest and most accurate information for you as a client, and in the most economical manner possible.
The statement of this claim is inherently misleading. Legal support can only be provided by legal professionals, and is indeed imperative if one is found in a situation where legal action and advice is called for. That being said, being an investor via a Checkbook IRA should never require any legal services. The self-directed account itself has already been set up according to all relevant tax regulations, and the investor’s role should be limited to… investing!
Of course, questions do occasionally arise, but the vast majority of these questions are “garden variety”. Thousands of investors have already seen great success with these platforms, and any experienced facilitator will know the answers to just about any question you may pose. In the unusual case where an investor finds him/herself in a novel situation, Broad will refer the question to our own legal counsel and come back to the client with an appropriate response.
In short, qualified facilitators can certainly offer unlimited client support, and that can include the occasional legal question as well.
5. Checkbook IRA Facilitators and Regulatory Oversight
The Claim: Checkbook IRA facilitators have no regulatory oversight which means that investors are not protected.
The Truth: No IRA model, self-directed or otherwise, insures the safety of your retirement funds. Just ask the millions of investors whose IRAs were decimated when the market crashed. An IRA by its very definition is an investment platform which allows for both profit and loss. If you make good investments, it will profit. If you make bad investments, it won’t. What’s causing the confusion here is the fact that Custodians do have mandatory regulation. However, this regulation does not extend to the retirement funds while they are placed in investments. It only refers to the handling of the funds while they’re being held by the custodian. In this sense it’s similar to FDIC insurance at your local bank. Funds held by the bank are covered by FDIC, while funds that are currently sitting in outside investments are not covered by FDIC. Once again, this claim is seemingly based upon an intentional misrepresentation of the kind of regulation that is imposed.
One further point bears mentioning, and that comes in the form of a simple question. Where would you feel more comfortable storing your retirement funds: in a checking account to which only you have access or in a third-party account to which you do not have direct access? Checkbook Control puts your funds under your control. You won’t have to spend nights worrying if somebody is mishandling your money behind a third-party screen.
6. Checkbook IRAs and Business Taxes
The Claim: A Checkbook IRA will expose your self-directed account to unnecessary business taxes (UBIT).
The Truth: UBIT (Unrelated Business Income Tax) is a tax that is charged for running an active business as part of your retirement account. The logic behind this tax is so that retirement funds don’t undercut traditional businesses by utilizing their tax deferred status. This tax is imposed based upon a determination of whether the investment is active or passive. Passive investments, like rental properties or stocks, do not incur UBIT. Active businesses, like groceries and dry cleaners, do incur UBIT. The tax has absolutely nothing to do with the platform that you are using. If you invest in an active business, then you will be charged UBIT whether you invest with the Custodian model or with the Checkbook model. Similarly, if you invest in a passive investment, you will not be charged UBIT in either platform.
7. Checkbook IRA v. Custodian for Time Savings
The Claim: Checkbook IRA facilitators say that the Checkbook Control platform will save you time. Yet, they fail to mention the non-time related advantages of using a Custodian model.
The Truth: This is a specious argument as it doesn’t address the topic under contention, i.e. the saving of time. Just for the sake of completeness, however, let’s quickly address time. It’s simple. Checkbook IRAs save you a lot of time. You write a check and the investment is done. There is no paperwork, no bureaucratic hassle, and no waiting for approval. With Checkbook Control, the investment happens instantaneously. It’s hard to get faster than that.
Now let’s discuss the claim that a Custodian will make administering your self-directed IRA much easier. They claim this is so because they will keep track of your IRA’s paperwork. That’s true – they will keep track of the paperwork. However, let us ask a simple question? How will they get that paperwork to begin with? The answer is that the investor has to be on top of it and send it into the custodian. In other words, the investor must deal with the LLC’s paperwork, as well as the Custodian’s accompanying paperwork. It’s hard to believe that this is more efficient than just keeping your LLC’s paperwork in the dedicated binder that you receive from Broad.
8. Checkbook IRA v. Custodian for Saving Money
The Claim: Checkbook IRAs actually come out to be more expensive than Custodian IRAs.
The Truth: This is one of those arguments which shouldn’t even have to be made. As an investor, all you have to do is ask for a fee schedule, and compare the different platforms. Their claim is absolutely correct in the fact that you shouldn’t fall for promises of saving money. Run the numbers yourself and you’ll find in the vast majority of cases, the Checkbook Control model comes out significantly cheaper than the Custodian model.
When an investor wants to determine the difference in prices between two different platforms, he/she shouldn’t rely on the company’s own marketing pitch to make that decision. Every company will find a way to proclaim an economic advantage. Rather, the investor should ask for a rate sheet that includes start-up costs, as well as all possible fees. If the company won’t give you such a document, or if the document is so convoluted that you’re still not sure what you’ll be paying, then it’s time to move on. It’s your money, and you should always be clear as to how it’s being handled.
When we get down to the detailed comparison between the Checkbook IRA pricing and the Custodian pricing, here’s what comes out. The Checkbook IRA has slightly higher start-up costs as it requires the formation of an LLC and all applicable paperwork. That LLC is necessary as it is the tool which gives the IRA its Checkbook versatility. The Custodian model has a lower set-up fee (no LLC involved) and that fee is purely a function of the paperwork involved.
That being the case, why would it make more economic sense to pursue the Checkbook IRA route? The answer lies in understanding where the real fees occur in the investment process. Custodian IRAs charge their clients for every single transaction. That means for every purchase, sale, maintenance activity, or anything else which would involve paperwork, the client has to pay a fee. Chances are if you are interested in using a self-directed IRA, it’s because you have a specific alternative investment in mind. That kind of investment often involves ongoing maintenance or other oversight activity. The fees will come hard and strong, and can often erase the price differential within the first month of investing. The Checkbook IRA, due to its unique LLC structure, is able to offer zero fee investing. That means that no matter how many transactions you perform, or how much maintenance you put in, you will never pay any fees to do so. The initial price discrepancy will pay for itself many times over, and almost always within the first few months of the plan.
9. Checkbook IRAs and Auctions
The Claim: Checkbook facilitators falsely state that you can’t use a Custodian model to purchase assets at an auction.
The Truth: Broad has never made such a claim. However, we’d certainly be interested in finding out how the process could be simpler than signing a check. As for post-auction paperwork, please see above. A Custodian never saves you on paperwork, and certainly not for free. Find out what your role in the paperwork process will be, and what transaction fees will be imposed by the custodian for their role.
A quick word about retirement plans investing in auction assets: The standard auctions as the consumer knows them usually involve collectibles of some sort, e.g. works of art, celebrity memorabilia, etc. As such, these auctions are off limits for retirement funds. One of the few restrictions placed on asset choice in an IRA or 401(k) is an absolute prohibition on investing in collectibles. Hence, when we discuss auctions from a retirement plan perspective, more than likely we’re dealing with auctions such as foreclosed homes or tax liens.
That being said, these kinds of auctions often possess their own unique set of rules for making bids and purchases. One of the standard requirements is the need to make good on the winning bid with a bank certified check. This check must be presented within a relatively short time span, which in many cases is an hour. Custodians typically do not work with that kind of time frame. The standard Custodian procedure involves the filling out and submission of paperwork, an approval process, and only then execution of the desired transaction. Taken together the normal wait from inception is a few days to a week. The Checkbook model, however, performs all of its transactions in real time, i.e. immediately. There is no delay for Custodian paperwork or administration. As such, it is particularly suited for the auction process.
Recognizing this discrepancy, Custodians have worked out procedures which enable investors to purchase assets at auction. Still, as with everything else the Custodians do, this investment ability comes saddled with additional paperwork and fees. In short, you certainly can invest in auctions with a Custodian model, but it will never be with the ease or economy found with the Checkbook platform.
10. Changing Platforms
The Claim: People are under the misconception that it’s hard for them to change models from a Checkbook IRA to a Custodian IRA.
The Truth: No company can hold your money hostage. Transferring to a different retirement account is a fairly standard procedure across all platforms, traditional or self-directed. If a company offers you resistance, it’s not due to something intrinsic to the process. Rather, it’s a problem with the company itself. You can find out more about customer satisfaction with various companies by checking their performance ratings on the Better Business Bureau. Here’s a link to Broad’s rating page with the BBB.
If you work for a company and utilize its 401(k) plan, then you might have a problem accessing those funds to make a transfer. Most companies offer 401(k) plans via a third party provider, and one of the standard clauses in the provider agreement is that the funds will be held by for the duration of the employment period. In other words, as long as you are working for that specific employer, your funds are stuck in that 401(k) plan.
However, if you already have a self-directed plan, (or work for a company which allows you to transfer retirement funds,) then effecting the transfer is just a matter of paperwork. This will be roughly the same whether you’re moving from a Custodian to Checkbook, or in the opposite direction.
The one factor that can make a difference is the specific company that is currently holding your retirement account. There are a number of companies that are somewhat unscrupulous in their client dealings, and may offer the client a drawn-out hassle when trying to transfer funds. The best way to identify these companies is to do a little research beforehand. The Better Business Bureau is a good first stop for information. Unfortunately, many consumers are not aware of their company’s attitude towards making a transfer until they’re already in the midst of the process.
Here at Broad we believe that every investor should invest in what they know and understand, and do it in a way that makes sense to them. We encourage you to extensively review the various models out there, and come to your own conclusion. If you have any further questions, please don’t hesitate to call us at 800.395.5200.