Can You Invest in Alternatives Within an IRA?

October 19, 2021

The sooner you save for retirement, the more financially secure your future will be. An individual retirement account (IRA) is a great way to save for retirement, but leveraging the right kinds of assets means that you can invest your contributions for even higher gains — all while enjoying some serious tax savings.

And yes, those investments can often include alternative assets ranging from real estate funds, to commodities and more.

What is an IRA?

There are many ways to save for retirement, but one vehicle that is extremely popular in the U.S. is the individual retirement account, aka the IRA. Established by the U.S. government as a way to encourage individual retirement savings, the IRA has over the years become the primary way that many Americans finance their golden years, in part because of the benefits they enjoy from these accounts both today and in the future.

IRAs allow investors to save money for retirement while also reducing their tax liabilities, thus increasing their ability to save. For 2021, most investors can contribute up to $6,000 in an IRA. For investors aged 50 or older, the maximum contribution is $7,000. The one benefit of IRAs is that they allow a wide range of investments.

Before learning about IRA investment options, understand that there are many different types of IRAs, including:

  • Traditional
  • Roth
  • SEP
  • Self-directed

Each of these IRAs has its unique properties. For example, a SIMPLE IRA can only be funded by your employer, while a Roth IRA taxes earnings up front, which means disbursements are tax-free.

Investment options within an IRA

Think of an IRA as a special kind of investment account. Like any other account, you can choose from a wide range of assets to invest in, but when those investments are made within your IRA you can also enjoy unique tax benefits. And the list of options is long.

Individual stocks: You can invest in publicly traded companies through your IRA. There are thousands of stocks that you can buy, sell, and trade. You can buy shares of a small tech startup or international stocks in an emerging market.

Mutual funds: With so many stocks to choose from, it’s not always easy to know which ones to buy. If you’re uncertain but still want to benefit from stock investing, purchase shares of mutual funds. A mutual fund is a pool of money from investors that is used to build a portfolio of:

  • Stocks
  • Bonds
  • Other investments

Mutual funds are based on a specific strategy. There are ones that track specific indexes, mirror the broader stock market, and funds that provide exposure to certain asset classes, sectors, or market capitalization.

Depending on your broker, you may be able to make automatic investments into specific mutual funds.

Exchange-Traded Funds (EFTs): Exchange-traded funds is an asset that tracks an index, sector, or commodity. They are very similar to mutual funds but can be traded like stocks. ETFs are priced like stocks and are traded throughout the day.

ETFs because they have low expenses. In some instances, you can buy a small number of shares, or even fractional shares.

Real estate investment trust (REIT): A real estate investment trust is a stock that gives you shares of real estate. There are REITs for all sorts of property types, including hotels, industrial complexes, office buildings, multi-family apartments, and others.

Investors are fond of REITs because they have a track record of paying out high dividends. This is because by law, they’re required to distribute most of their net income to shareholders.

Bonds: As you near retirement age, bonds are a popular option for diversifying your portfolio. Bonds allow you to lend money to a company (or a government) in exchange for interest payments.

U.S. Treasury bonds are an almost guaranteed source of income and stability, which is important as you get closer to retirement. To avoid taxation on gains or income, it’s best to put taxable bonds into your IRA. Municipal bonds, and other tax-free bonds, aren’t ideal to invest within an IRA. Because they’re already tax-advantaged, there’s no real benefit.

Cash: Not all of your IRA contributions have to be tied up in investments. Many investors choose to keep cash on hand for a number of reasons. Having access to cash within your IRA allows you to purchase investments quickly. Cash is flexible, whereas if you have no cash, you have to sell assets to get funds to buy other assets.

Investments prohibited in an IRA

IRAs are extremely flexible and convenient. While these accounts support a wide range of investment options, not everything is allowed. Here are some of the prohibited investments to be aware of.

Life insurance

A life insurance contract cannot be titled as an IRA or housed in one. This includes all types of life insurance and all types of IRAs. However, there is one exception known as the incidental rule.

In some instances, qualified plans can be used to buy a small amount of life insurance. However, the death benefit amount must qualify as incidental in comparison to the plan balance.

Real estate for personal use

You are allowed to hold real estate within your IRA. However, the big caveat is that the IRA owner cannot benefit from the property in any sense. This means that the IRA owner can’t live in the property or receive rental income.

It’s also important to note that any real estate in your IRA also cannot benefit any disqualified person. This includes your spouse, your children, your children’s spouses, your parents, grandparents, great-grandparents, or so on.

Antiques and collectibles

Some alternative assets are OK for IRAs, while others are not. If you have an antique or collectible item that’s worth a lot of money, you can’t use your IRA to shield the tax on the gain from the sale of the asset. Antiques and collectibles cover a wide variety of items, including:

  • Porcelain
  • Stamps
  • Baseball cards
  • Fine wine
  • Jewelry and gems
  • Art

Most coins are also prohibited within an IRA. However, your IRA can invest in certain coins minted by the U.S. Treasury

Certain derivative positions

Any type of derivative trade that has undefined or unlimited risk cannot be invested within an IRA. This includes ratio spreads and naked call writing. The one derivative trading allowed is covered call writing.

If you want to trade options contracts or futures inside of your IRA, find a custodian that permits alternative investments.

When used properly, IRAs are an extremely powerful way to fund your retirement. There are many different investments that can be held inside of an IRA, but there are also a few prohibited assets. By knowing what is and isn’t allowed within your IRA, you can make the best use of your own account.

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