MASTERCLASS: Self Directed IRA – September 2017

Self-directed IRAs empower retirees with the freedom to call the shots by investing in a wide range of alternative investments that are unavailable in traditional IRA accounts. Why are retirees drawn to alternative investments, how can custodians improve client outcomes and how does the DOL fiduciary rule impact the industry? In this edition of MASTERCLASS, five experts join Asset TV to share their knowledge about the changing self-directed IRA landscape. The result is an all-encompassing lesson about the advantages, regulations and creative pitfalls with self-directed IRAs.

  • Timothy Kuhman – VP Compliance & General Counsel at the Kingdom Trust Company
  • Bev Edwards – Senior VP and Counsel at Mainstar Trust
  • Jack Kiley – Principal at MidAtlantic IRA
  • Bill Humphrey – Co-Founder and CEO at New Direction IRA
  • Kaaren Hall – Founder & President at uDirect IRA Services

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  • 57 mins 05 secs

Gillian: Welcome to Asset TV, I’m Gillian Kemmerer. Self-directed IRAs place retirees in the driver’s seat when it comes to managing their outcomes and offer a range of opportunities unavailable to traditional IRA accounts. Today we have assembled a panel of five experts to dive deeper into the advantages of self-directing and to parse through some of the forces shaping the industry such as the DOL fiduciary rule. From the role of the custodian to the disqualified person’s rule, we will cover it all in this edition of Masterclass. Thank you all so much for joining us here today. We have some familiar faces and some new ones, so we’re thrilled to have you. So let’s get started with a look back, Kaaren, and it will be really helpful just to give us a sense, over the course of your career, how have you seen, will the self-directed landscape change and the adoption on behalf of RIAs? Kaaren Hall: Right. Well, the self-directed landscape, I think has changed so much since 1975 when self-directed IRAs were first announced. I mean when IRAs came out you could self-direct from the beginning. But I really think that self-directed IRAs saw a resurgent in 2009, when the banks weren’t lending anymore. And when banks stopped lending, people were looking for capital and they found self-directed IRAs as a source of that capital. And since then the industry has become more popular, more well known. And I think that’s what I’m seeing is, is just every day fewer and fewer people saying, “I never heard about that.” And more people being familiar with self-directed IRAs, what they do and how they work. Gillian: Interesting. And, Tim, do you find that since the banks have stepped back you’ve also seen a pick up in interest in self-direction? Timothy Kuhman: Absolutely. Not only from the seller financing and from the perspectives that Kaaren was talking about, but simply from a perspective of diversifying portfolios so that they’re not just invested in stocks, bonds, mutual funds and those sorts of things. People are more and more interested in true alternatives like real estate and things of that nature, precious metals, private equity. Gillian: And certainly in a low yield environment in traditional asset classes it becomes all the more pertinent. Timothy Kuhman:. Yeah, absolutely. Gillian: Bev, from the custodian perspective, how have you seen the business change? Bev Edwards: They’re, with the aging of the baby boomers and the fact that they have a lot of money built up in their IRAs; we are seeing a lot more interest. We’re also partnering with RIAs to offer their suggested investments to our accountholders. Gillian: Excellent, and, Jack. Jack Kiley: We see similar things. I would say that a lot of RIAs are looking for other alternatives besides just stocks and bonds. And as their clients become more sophisticated in other alternatives they in turn get those questions and they turn to us to hold those in retirement plans. Gillian: Excellent. And, Bill, we’ve seen the increase in education of the retirees, obviously they can watch the financial headlines. They see the way traditional markets are moving. Have you seen an uptake in this interest in self-direction? Bill Humphrey: You know, I think the biggest thing we’ve seen is the internet and access to info and education about it. So we really focus on education so we can get out there and say, “Here is what you can do.” And I think RIAs are finding that their clients are sort of leading them into it. So we’re happy to help RIAs learn just like the clients themselves. Gillian: Excellent. So why don’t we get started with some of that learning, because we have a lot of RIAs that are watching this program. And it would be wonderful to talk through some of the advantages of a self-directed IRA. So, Jack do you want to kick us off there? Jack Kiley: Well, I think the biggest advantage is just diversification. So what most people learn through financial planners is that they need to diversify their portfolio and they tend to do this individually but not in their retirement plan. And I think logically if you can do that or diversify individually, they want to do that through their retirement plans. And this is a great avenue to accomplish this. Gillian: And then when we talk about this diversification, maybe, Bev, you can take us through. What are some of the asset classes you can invest in, in a self-directed IRA versus a traditional IRA? Bev Edwards: Almost anything is open and available. And I might just mention that there are accountholders who want to hold a particular asset, let’s say it’s a precious metal, a real estate, an LLC, any sort of offering. But they want to diversify in another way; they want to hold part of it in their self-directed IRA. And they want to also purchase some in a taxable account. And there are administrators and custodians in the business who offer both accounts. So for RIAs looking to have one custodian that would service not only diversification through the type of asset but also the type of account, they can find that avenue now more and more. Gillian: Excellent. And, Bill, when you think about just the overall landscape and you’re really selling this to an RIA, what are some of the major advantages that you would point out to them? Bill Humphrey: Well, I think keeping the customer happy is probably the first one and somebody walks in, they have experience with real estate or precious metals and they want to do that. And like Jack said, it’s a big pile of money in their retirement; sometimes it’s the biggest pile. And they want to diversify it into as many things, and particularly things that they understand and they’ve been successful with personally. So that ability to own any asset, either inside or outside your retirement plan is really a nice tool for an RIA to offer to their clients. Jack Kiley: Yes, for most people statistically, their retirement plan is their second biggest asset after their home. So it just makes sense to allow that diversification. Timothy Kuhman: And one of the other things that I think the RIAs need to understand is that while we specialize in holding alternative assets, I think all of us here will also hold the traditional assets. So if they’re looking for a custodian that can hold everything, that would be us. Gillian: So they’re not just limited to those investments that they can’t seem to get in a traditional? Timothy Kuhman: Yes. Gillian: So it’s really a full circle opportunity for them. And, Kaaren, are also direct advantages to you. But it sounds like there’s a certain type of client that this might be right for. Maybe you can comment a little bit on the degree of investment knowledge or information that you have on your own before you actually pursue a self-directed IRA. Kaaren Hall: Well, first it’s going to be somebody who is interested in investing outside of the stock market, interested in investing in non-correlated assets like real estate or precious metals, like everyone has said. So there’s that. But I think that we see people from all ranges of the spectrum of investment knowledge using self-directed IRAs, some are experts. Some are novice. So usually I think the ideal person is somebody who is like Bill has said, saved money all their lives and now they’ve got a large chunk of it and they’re looking to diversify. Gillian: Excellent. Bev, what can’t you hold in a self-directed IRA? Bev Edwards: Help me out here, guys. There are three things, life insurance, collectibles, yeah, or an S corp cannot have a self-directed IRA as a shareholder, so that’s a little different. Gillian: And then, Jack, can you explain a little bit more about what a collectible would classify as? Jack Kiley: Well, when I’m talking to people I glibly say anything you see on Antiques Roadshow would be classified as a collectible. It’s something that has an numismatic or collectible value. Such as works of art, fine wines, rugs, those sorts of things. Kaaren Hall: Yeah, too many bottle collections or wine collections became bottle collections. Timothy Kuhman: Or a 65 Mustang. Gillian: That’s interesting. Have you had someone try to put that in a self-direct? Timothy Kuhman: Yeah, my son. Kaaren Hall: And you could buy an inventory of cars if you’re going to sell them, as long as you have no personal use. And that’s an asset in a commodity but nothing you’re going to use personally. Timothy Kuhman: Yeah, not a collectible… Gillian: It’s particularly bad when it comes to the wine collection. Timothy Kuhman: And no cigars. Bev Edwards: But almost any financial asset can be held in a self-directed IRA if you find a custodian or an administrator who is willing to hold it. Gillian: And what about a case like gold coins where it might fall under a precious metal, does that fall into collectible or… Jack Kiley: Yes some. Kaaren Hall: It has to do with the degree of purity of the metal whether it can be held or not. Gillian: Interesting. So there are some kind of nuances that you need to understand when you’re going into this. Timothy Kuhman: There are some grey areas. Gillian: And actually, Tim, I’ll start with you, what are some of the common pitfalls that you see with those who are interested in self-directed IRAs that may not necessarily be aware of all of this nuance? Timothy Kuhman: I think some of the pitfalls, especially in the self-directed area are the accountholders and sometimes the RIAs themselves don’t understand that the custodian is not doing any of the due diligence. And it’s really up to you, the accountholder or the registered investment advisor to do that due diligence, or at least help your accountholder do that due diligence. So a firm knowledge of what it is you’re thinking of investing in is very helpful. I mean you wouldn’t do anything in your self-directed IRA that you wouldn’t invest in with your personal money. That’s my way of looking at it. And I know a lot of people go to their investment advisor and say, “Okay, tell me what I should invest in and don’t do any research.” My way of thinking is those investors should be doing their own research, whether they’re relying on the investment advisor or not. And I think all of us would agree that investing in your self-directed IRA is a team sport, just like investing outside of your IRA would be, you know, you should have your custodian and your investment advisor and your attorney and your tax guy, you know, all of those people should be involved. Gillian: It’s called self-directed for a reason, so you need to be a part of that team. Kaaren Hall: Well said, yeah. Gillian: And then what are some of the other pitfalls that we should really keep in mind when we’re thinking about this particular form of investment? Bev Edwards: I would say that self-directed IRA investors are a creative bunch. And they may strive to be so creative as to be outside the rules. We’ve had cases where man and a woman are loaning and investing together and then end up getting married and that was the plan all along. And all of a sudden you have, you know, prohibited transaction possibilities. So it’s a good enough deal staying inside the rules. So the creativity can be a downfall. Gillian: Okay. Let’s talk about some of those interesting rules because one of them has to do with disallowed persons. And, Kaaren, maybe you could lead us off with a discussion of what exactly that entails. Kaaren Hall: Sure, disallowed people, you can think of it as your lineal ascendants and descendants, primarily your parents and grandparents, and their spouses, you and your spouse, and then your children and grandchildren and their spouses. Also disallowed people could be like a 50% business partner or anybody offering services to the plan are disallowed. Now, I don’t know of any other area in finance or anywhere else where they have these disallowed people or you can’t do business with them. But for self-directed IRAs you can’t. And if your IRA does business with these disallowed people, it creates what’s called a prohibited transaction, which it doesn’t sound so bad, it’s prohibited. It doesn’t sound like someone’s going to come after you. But the truth of it is that if your IRA commits a prohibited transaction, it isn’t an IRA anymore, now it’s your personal cash, it’s taxable, there could be penalties. Gillian: Interesting. And, Bill, maybe you can give us a bit more understanding of what some of those penalties are so we can be aware, so no one will try to lend or try to put something in from one of their parents and just sneak it under the… Bill Humphrey: Right, right. So I think, again, going back to education is understanding that the pile of money comes with some strings attached to it, like for example, you can’t use it personally. So it’s in this bucket of retirement for the future and you’re not supposed to get any benefit from it. So we always talk about the condo in Mali, when it’s snowing in Colorado, people are thinking of someplace else to go and they discover that they can invest this pile of money and they think, I can have that investment in the condo in Mali and then go stay there. But the investment is okay, it’s just the personal use and taking advantage of it. And if you do that then the IRA is no longer an IRA. And it starts back whenever it originally happened. So it’s really important to think of that money as for the future, not for any benefit today or tomorrow, until you actually take the money out and put it in your pocket and deal with the tax consequences then. Jack Kiley: And part of the challenge is what’s referred to as current benefit, so the minute that you get that current benefit, this is what triggers a taxable event. Current benefit runs in both directions, so whether you’re giving a benefit to the IRA or the IRA is giving a benefit to you that triggers the issue. Kaaren Hall: And like Bill said, it goes back to the date of the infraction. So maybe you committed the prohibited transaction in 2000, and it’s discovered in 2017, well, they’re going to go back and you’re going to owe back taxes and penalties. Gillian: Interesting. And, Bev, do you find that these situations are caught out frequently? I’m imagining this house in Mali for example, and you wonder, you know, to what extent could you get caught? What are some of the paper trails that get followed? Bev Edwards: Well, I think it’s important to point out that it’s all on the accountholder at that point. If the accountholder derives a current benefit and the IRS becomes aware of that, they can’t turn and point a finger at the custodian or the administrator. It’s really on the accountholder to do … to stay within the rules. The custodian is not necessarily going to know if you take a trip to Mali and stay in that condo. If your records or your personal finances are being investigated for some other reason, that is when the IRS is going to delve in and look at the prohibited transactions in your IRAs. Bill Humphrey: And that’s one of the places where RIAs can really benefit their clients because one of the first questions you ask is, “Why are you making this investment? And is it going to grow your IRA for the future? Are you going to get a trip to Mali every so often out of it?” So the IRA understanding or looking at that investment saying, “It’s a good idea, a bad idea.” As an investment itself it’s really a nice benefit to the client. Gillian: To what extent is the advisor responsible if you abuse it? Bill Humphrey: Well, they’re not. But because it is the client’s IRA and it is them in charge of it. And what we’ve seen over the years is clients coming to their RIAs and saying, “I want to do this.” And the IRA says, “You can’t.” So they go and find out whether they actually can. And they do it themselves without the guidance from that guy or advisor. And it’s an opportunity for those advisors to get back in the picture and say, “Okay, I understand you’re outside of the normal bounds, but let’s make sure it’s still an investment.” Gillian: Okay. And you had a point as well. Timothy Kuhman: You said, you know, how would anybody find out? Well, I’ll give you a true life story about how people find out. There was an accountholder who had a piece of rental property in his IRA. So a happily married man had a piece of rental property in his IRA, was doing everything he should be doing. Then the marriage fell apart and he went and moved into the house and his soon to be former spouse called the IRS. There’s all sorts of ways that it can happen, but that’s just one. Gillian: Yeah. That’s a particularly gruesome one. So let’s talk about IRAs getting loans. This is, I think, an interesting point that is special to self-directed IRAs. Why would someone have their IRA get a loan, Bev? Bev Edwards: To leverage it. You can get a loan and then buy, for example, a piece of real estate that maybe you wouldn’t have had the funds to purchase otherwise, and get some good assets in your IRAs and then further leverage it. It’s something that’s becoming more and more popular as people learn about it. Timothy Kuhman: And remember, these are income producing properties. So a loan is being paid for, by the income that’s coming in from the property, so it makes sense in some circumstances to go ahead and leverage it, get the bigger property. Kaaren Hall: And of course the next step to having an IRA take a leverage is the tax that the IRA would pay for, the proceeds that are derived from leverage are taxable and it’s called UDFI – Unrelated Debt Financed Income Tax. So you need to balance that out, you know, pencil everything out ahead of time to see, okay, I’m investing, these are the expenses, and factor in the UDFI tax. Gillian: Excellent. Bev Edwards: If you’re going to have real estate, whether through a loan or not in your IRA, it’s important to understand that the expenses related to the upkeep or whatever it may be, that cash also needs to be readily available on your IRA, because you can’t pay for those things outside the IRA. Gillian: Got it. So any kind of servicing that you’re doing to the house in Mali or whatever other property that you have, has to be taken care of through the actual [inaudible]? Jack Kiley: Right. So typically what we say is any income derived from those assets needs to travel back into the IRA. And any expenses attendant to the asset needs to be paid out of the IRA, so, including the tax that Kaaren’s referring to as well, all of that needs to come out of those funds. Gillian: Perfect. Now, we’ve talked a lot about sort of the pitfalls, the advantages, some of the rules and regulations. But let’s maybe focus our conversation on the RIAs that are watching and are really interested in maybe helping and guiding their clients into investing this way. So let’s start with clearing out some of the common misconceptions. And maybe, Bill, I’ll start with you. What are some of the common misconceptions you find that RIAs have about self-directed IRAs? Bill Humphrey: Well, I think probably the first and foremost is that we might be competitors for that advisor that’s offering a different asset. But we’re not. We’re just offering access to different assets. And we’re actually here to help the advisor and the client figure out how it works so that we can make the transaction smoothly and communicate as best we can with everybody. The other thing is that it’s expensive and it’s complicated. And it is not expensive because it’s just a transaction that … the transaction itself can be more complicated, but so can buying any kind of real estate that has a loan attached to it. It’s the same transaction; it’s just that the IRA’s buying it rather than the person. Gillian: Jack. Jack Kiley: But I would say actually the first hurdle that we hear from RIAs is that you can’t do this. And that’s the first hurdle. Obviously you can, otherwise we wouldn’t be doing this, right. So it’s a little bit of education on that; and it’s really finding, again, a custodian, finding somebody that’s going to allow a broader spectrum of investments than just stocks and bonds. And when you look at most IRA documents, basically what the document says is that the holder can only buy whatever it is that the company that provides that document sells. So that’s typically the first barrier that they run into. Good RIAs who are diversifying their clients and really want to move them into other asset classes will look at this as a great tool and in partnership, then I use that term very loosely, with us to expand the financial wealth of that account. Timothy Kuhman: Yeah. To Bill’s point, everybody sitting at this table here; we are what’s called passive non-discretionary custodians, directed custodians. None of us give tax advice, legal advice or investment advice. So we’re not competing with the RIAs at all. We’re not giving advice. We simply give them a vehicle to diversify their clients’ accounts into assets that they wouldn’t normally have available to them. Gillian: It’s interesting that the perception even still exists about competition. You’d think the DOL fiduciary ruling would have clarified for everyone who gives investment advice and who doesn’t. But we’re going to get to that in a minute. Kaaren, what are some of the common headwinds that you find you face when communicating with RIAs? Kaaren Hall: I think Bill said it very, very nicely and succinctly about that we’re competition. And we’ve covered that. But I think too that they’ve got questions about the rules and that’s what we’re here for. I mean everyone here on the panel, that’s what we do all day is talk to people about the rules, what can and can’t be done, and the process. How long is it going to take? You know, and the technical aspects of the transaction. Gillian: And, Bev, when we spoke previously to this panel you told me a little bit about some of the things custodians can do in conjunctions with RIAs to come out with better client outcomes. Maybe you could tell us a bit more about that. Bev Edwards: I was going to mention that RIAs sometimes fail to look at us as a full service option. If they have an accountholder, you know, or a minority group of their accountholders who want to do something crazy like hold real estate. We’ve even had RIAs thinking that they have to have that in a separate IRA, causing their accountholder to have to have two IRAs open, pay two annual sets of fees and so on and so forth. It would really behoove the RIAs to understand that all of us are full service options. I think you said it earlier, Tim, that we can hold both the alternative investments as well as the traditional stocks and bonds. We can do taxable, non-taxable; can be a full service option for the RIAs. Gillian: And do you find that RIAs are kind of coming to you and working to waive fees or doing anything to help their clients? Bev Edwards: That is another thing, custodians and administrators can work with RIAs to streamline the whole process for the accountholders. For example, if their RIA says, “I’m thinking about recommending this or that investment to my broader base, let’s preclear it, let’s have you see if it’s administratively feasible to hold before I go out and do that. And then when our accountholders come to us to open accounts, that process has already occurred.” Another thing is a lot of RIAs like to offer something to their accountholders in the way of a lesser fee or the RIA will pay the fee. All of those things can be accomplished through a custodian as well, where the custodian would kind of omnibus the fee to the RIA or maybe the RIA wants to kick in on the fees so the accountholders are billed directly but at a lesser rate. There’s all kinds of creative things you can do when you partner, and again, I use that term very loosely, with a custodian who can hold all the assets you’re wanting to recommend. Gillian: All benefiting the end accountholder. Timothy Kuhman: Indeed, and let me the bad guy in the panel here. One of the things that we’ve run into with investment advisors is that once they bring somebody to us who wants to open an Individual Retirement Account and put some alternative asset in, they don’t want us to talk to their client at all. And I don’t know about anybody else’s regulator, but I know that, you know, our regulator requires us to talk to those clients. They’re accountholders with us; we have to communicate with them. You know, and I understand their mindset, but they have to understand that we have to do some communication with those folks, we have to. Gillian: Of course. Bev Edwards: The contractual relationship is between the accountholder and the custodian. There is no contractual relationship unless there’s some agreement on fees or something minor like that, between the IRA and the custodian. Gillian: So clearing up that competition mindset is something that needs to be eliminated right away. Timothy Kuhman: Yes. Gillian: And then there’s one thing that I wanted to ask you before I move on, Bev used the phrase, administratively feasible, can you just quickly explain what that means to everyone who’s watching. Timothy Kuhman: Well, all of us have a comfort level with what we’ll do and what we won’t do. And when we look at an asset, most of us look at it purely from a risk management standpoint on our part, what risk we’re willing to take as far as assets we’ll allow people to hold. And so we will look at an asset and determine whether or not it’s something that fits on our platform, something that we would like to hold. Kaaren Hall: Some custodians will hold racehorses, you know, some won’t, you know. Some custodians will hold mango trees in the Philippines, some won’t. So that’s up to the custodian. Gillian: Mango trees, houses, wine, racehorses, even self-direction. So, Jack, I want to take a moment to talk through for all RIAs watching, what an investor and an RIA should look for when choosing a self-directed plan provider. Jack Kiley: Well, I think it’s communication more than anything else. It’s an organization that they can work with, they feel comfortable with; can explain the rules well; because as you get a taste here, sometimes it’s like walking through a minefield. A lot of times it is as Bev said, it is getting out in front of the investment, we have a term, we call it vetting the investment beforehand, you know, to see first of all if it’s feasible on our end. Second of all, what would be the process for actually custodying that asset. And everybody has to understand their role and there has to be a very good communication. Gillian: And to be clear, determining feasibility is not investment advice, it’s purely a decision-making here? Jack Kiley: Well, and I think the distinction there is we … we are determining whether that’s something that our organization feels comfortable holding as opposed to advising a client what to hold. You know, we’re not in a position to, to give the client advice. We know nothing about their risk aversion, their other assets, what other things they do. Once we get an application we do have a sense of what they do for a living but we don’t have all the inputs necessary to even begin to give advice. Timothy Kuhman: Nor are we really required to, because we are that directed custodian. Jack Kiley: That’s true. Gillian: When you talk to RIAs and they’re vetting out different self-directed providers, how do you help them think through that process? Bill Humphrey: I think probably the biggest thing is for us is education. Do they want education? What form, do they want it for themselves? Do they want it for their clients? And then technology, I think in our 13 years, we’ve seen technology go from everything being on paper to a lot of it almost being entirely paperless, and that’s our goal. So does that technology tie into their system? And how does the transaction go? So can it be electronic signature and the form’s already prefilled out so that the advisor knows how to complete it? We had an email this morning from a national stock firm saying they had these assets that were private placements and they were going to throw them out, because they didn’t know how to hold them anymore. So rather than just getting rid of that client, can the self-directed provider give you a way to maintain contact with those assets? Can they be aggregated into some master system or can the transaction still flow through that provider or that asset advisor and show up, so that the client only has to go one place to see it? And that’s really been our focus is technology, making it more like people are used to with online banking and a transaction with ability to buy and sell shares shouldn’t be that hard. And it has been in the past, so getting that education, how to do it and the actual doing it easy. Gillian: Okay. So if we’ve eliminated some of the misconceptions, and an RIA has figured out that this is an option they want to provide. Kaaren, how do you help the IRA explain why this is such a good idea to offer as an additional tool? We obviously have some clients like you said, that come knowing that they want this but why should an RIA be offering it to someone who may not already know? Kaaren Hall: I think because of diversity, you want to diversify your portfolio. And like we’ve touched on here today, some asset classes may or may not be very fruitful these days or maybe we’ve peaked out in some areas and maybe we’re looking at a downturn in some areas. And you’re looking, you know, where else can the money go? And a self-directed IRA offers so many choices; it really opens the floodgates to so many different choices. Gillian: Tim, do you find that RIAs are increasingly turning to their clients and offering this to those who didn’t know about it before? Timothy Kuhman: Absolutely, there’s no doubt about it. We deal with RIAs on a daily basis, you know, looking for those things. There are also, at this point there’s a number of IRAs out there … RIAs out there who… Gillian: Financial advisors. Timothy Kuhman: Yeah, financial advisors who specialize in the alternatives. Gillian: That’s right. And we’ve seen it increasingly here among our audience members as well. Jack, when you talk to an RIA and really encourage them to offer this as a tool, what are some of the things that you encourage them to communicate back to their clients? Jack Kiley: Well, again it widens the spectrum of investments. It dovetails generally into what the financial advisors is trying to accomplish which is the goals of the individual, the client, which is to grow their wealth, to diversify into different things, different asset classes. A lot of people obviously after the big meltdown have focused more keenly on what is the growth in stocks? What is the dividend payout? All those things. And the reality is, is most of those clients are getting older, you know, the average dividend payout is only about 4% total. And to live on 4% as you reach retirement is really hard. So they’re looking for other alternatives to get a higher, what we refer to as a cash on cash return. And alternatives – certain alternatives may fit into that portfolio or into the types of things that they want to do. Gillian: Absolutely. Bev. Bev Edwards: For RIAs who have quite a number of high net worth individuals, they became high net worth because they’re experts in something. And they’re often experts in something related to the financial industry. So to allow them the option to invest in what they know best is very attractive. Gillian: Now let’s stay on you for a second, Bev, and talk a little bit about the role of the custodian. When an RIA is being investigated for example, what are you required to disclose? Bev Edwards: It depends on who the requestor is. We have taken a … we were adamant that we will not provide any PII information, Personal Private Information about our accountholders to anyone other than our regulator without client permission. And that would be our accountholder. So if we have the SCC for example, call and say they want information of all of our accountholders who have invested in a particular asset, we say no, unless they are willing to domesticate a subpoena in Kansas, which is our home jurisdiction. We don’t have any information about the RIA, so it’s easy to answer truthfully that we have nothing to provide in that regard. That goes back to what I said earlier, the custodian client relationship is with the individual, with the accountholder, not with the RIA. We don’t have any information in our files or our account files about the RIA or about the asset except what would be available generally to the public. Gillian: Got it. And, Tim, coming to you, what can the custodian do and what can’t they do? Timothy Kuhman: It depends upon what you mean by the question, it’s kind of a broad question. But from a custodial perspective, the things that we can do is we can hold the assets for you. We can’t find the market for them. If you want to sell it you have to do that yourself. We can’t go find the asset for you. If you say, “Well, I want to invest in real estate but I don’t know where to find one”, we don’t do that. So we don’t give tax advice. We don’t give legal advice. We don’t give investment advice. Those are the things we can’t do. The things we can do is help you through the process like Kaaren has said. You know, here’s what the rules are. We’re not going to interpret them for you, but here’s the rules. And that’s why I said earlier, this is a team sport, you know, you need your own attorney who’s familiar with ERISA law. If you’re using a 401(k) and specifically 26 U.S. C 408/408(a) if you’re dealing with your IRA and you need one of those people, because they have to understand the prohibited transaction rules, what you can do and what you can’t do. Some of us I know, I know I do, we’ll give people references you know, I’ll say, “Here’s a list of people that I’ve worked with in the past, attorneys who know these rules.” But we can’t do anything that appears to be advice, you know, but processing those things, those are absolutely things that we can do, absolutely. Gillian: And let’s talk about the role that the self-directed client accountholder plays, and as well as the RIA. So, Kaaren, coming to you, what kind of due diligence is required for assets that are purchased by self-directed plans, and how much interaction is required with the RIA? Kaaren Hall: Right. Well, the due diligence, I mean it’s not required. But if you’re intelligent you’re going to do due diligence on your investments. We had a client who was about to invest half a million dollars in a 15% note on real estate unsecured. And so if she’d done her due diligence on this particular asset class and on this particular asset she would have discovered that the asset sponsor had actually been incarcerated for two years by the SCC. So you know if you have a cellphone you have the oracle of all human knowledge in the palm of your hand, right. So just type that person’s name with the word ‘fraud’ after it. On our website we have a list of some of the different entities that you can contact like NASD and FINRA and even AARP can help you do your due diligence. But as far as what’s required it isn’t, when the RIA is looking to do due diligence it’s the same thing, it’s talking to people, looking on the internet, a LexisNexus search, something like that. Gillian: Kind of similar question to you, when you look at the level of due diligence that needs to be done by an RIA or a self-directed client accountholder, do you find that there are particular areas where they tend to be too lax? Are there any particular investments that you really want to see people doing more due diligence on? Bill Humphrey: You know, it really varies depending on what the investment is itself and the experience of that person investing in that thing. So a lot of our clients are doing what they already know, and they’ve done it with their personal funds so now they’re doing it with their retirement funds. But there are also people that are led into investments, like the 15% return that should raise flags, that don’t realize that it should raise a flag. And I think that’s where the advisor is really important, because they’ve been looking in investments for years and they understand what those flags are and stepping in to say, “Hey, again, is that a good investment? What’s the details of it? Is it secure and unsecured? And what’s your personal experience?” Because it all does come back to the accountholder, because it is their investment, their decision-making, but the advisor can really play a valuable piece. Gillian: And again, they’re the ones who are liable if something goes wrong, the accountholder. Timothy Kuhman: And to back up Bill’s point here, your question was what assets would you recommend them doing the most due diligence on. In my mind, if you look at all the Ponzi schemes that have ever been affected, the vast majority of them are going to be private equity based. And a registered investment advisor knows how to vet those because that’s what they do on a regular basis. Gillian: Absolutely, yeah, good point from history. Jack, I asked a question to Tim earlier about what the role of the custodian is, but can you help us understand the role of the administrator as well? Jack Kiley: Well, the, you know, the role of the administrator is that he’s the dotter of I’s and crosser of T’s, so it’s making sure that the paperwork is correct, that everything is in order, that when the custodian looks at it that they’ll be happy with the result. You know, so that’s our main role. Gillian: Got it. Let’s move over to some special topics that are really impacting the self-directed industry right now. And the one that I know that we’ve all been itching to talk about has to do with the DOL fiduciary rule. We’re still waiting on the end fate of that rule. But it’s interesting how it might begin to impact self-directed IRAs, given the fact that the clients themselves are directing it. So, Kaaren, starting with you, can you give us just the general blueprint of where the issues lie for self-directed IRAs here? Kaaren Hall: Well, as we were discussing off camera, with self-directed IRAs we really aren’t impacted by this fiduciary rule. And the reason is because we are not advisors. Now, initially self-directed IRAs were going to be included in that fold, but RITA, the Retirement Industry Trust Association, you know, met with the DOL and made our case that we don’t offer any advice as Tim’s been pointing out. And so they agreed and we are not included as being considered fiduciaries, so we’ll start with that. Gillian: Okay. Now, Tim, coming over to you, would you need to hire an independent fiduciary to self-direct under this rule? Timothy Kuhman: Kaaren may actually be better suited to do that because I just saw the article that she gave me earlier today. But I guess there are some instances where there may be a need for that. I’m guessing most of the self-directed custodians are not going to go and do that. So that would be, that would definitely be an asset then that would be administratively unfeasible for us, because we’re not going to take that extra step. Kaaren Hall: think if that were the case it would be an unintended consequence of the DOL rule. And of course right now as of this moment there is no head of the DOL. These rules haven’t been implemented and we’re still, you know, working on the DOL to help them understand some of the unintended consequences. And I’m sure with, as you know in your role there are lots of unintended consequences with the fiduciary rule. Bev Edwards: Yeah. The DOL is not a regulator for self-directed IRAs. And those of us here at the table we’re not fiduciaries. So more to come on the DOL rule, but I think the impact is going to be more for the people in the audience who are fiduciaries and do hold themselves out as fiduciaries as opposed to custodians for self-directed IRAs. Gillian: Jack, how do you think about the future of the DOL ruling, have you started to make any changes in your business to prepare for its implementation? Jack Kiley: Well, I think like everybody else, we’ve sort of been whipsawed. I think we started to make changes and then didn’t. I think we do a very good job at what we do and we’re waiting to see what comes out of it. Gillian: Bill, similar question to you. Bill Humphrey: Well, I think what we have seen is that if there are advisors out there that want to enable something for somebody they need to have a provider that’s willing to educate the client about it so that the advisor can just expose the client to it rather than selling it to them. So like with crowd funding, there are companies out there that have assets available. They’re not really pushing them, but you want to have an ability to go buy that asset through the advisor or independently. So we’re tweaking our systems so that we have more education available and more automation available for the advisors and the crowd funders out there that want to open the door to self-directed accounts. Gillian: And, Kaaren, this idea that you’d have to hire an independent fiduciary to self-direct, would this be on the responsibility side of the client or on the administrator, who will it fall under? Kaaren Hall: Well, again it’s not real yet, but yeah, it would be on the client. Gillian: Okay. Let’s talk a little bit about precious metals investments now which I find a very interesting topic with regards to self-directed IRAs. And Bev, I’m going to kick you off with this one. Help us understand maybe some of the complications around this and what we’re still trying to get clarity on from the IRS. Bev Edwards: The IRS promised several years ago, although it has not yet come to fruition to make clear who would be a qualified depository for precious metals. There is some disagreement in the industry about whether a depository needs to be a trust company or an otherwise qualified custodian. But the fact of the matter is that’s not where the industry is. Accountholders, potential accountholders might go to a precious metals show and they purchase precious metals and it’s already at a depository, it’s not going to change hands. So unless the industry were to change dramatically, we’ve got quite a number of depositories out there. So it’s important for the custodian to reconcile what is being held at that depository to make sure it’s a reputable depository. And reconcile what the depository says they have against what the accountholder statements purport to have, you know, to make sure that the money goes to where it’s supposed to be and the metal changes hands, although it’s still sitting in the depository without really moving. Gillian: Tim, at Kingdom Trust, how do you think about this? Timothy Kuhman: We try not to. You know, we hold a good deal of precious metals and for the most part that those precious metals are in places like the Delaware depository or an IDS facility, Brinks, you know, they’re in qualified, what would otherwise be qualified depositories for those funds. We do have a few who hold it in bank deposit … safety deposit boxes and those sorts of things. So we’ll hold them and we’ll stick to what the IRS has already said. And we’ll see what happens down the road. Kaaren Hall: I think one point of contention we’ve found with precious metals is the idea that you can, that your IRA can invest in precious metals and then you can store them in your house and then put your hands through them while you’re watching TV and hold all the coins. Gillian: Does that count as use? Kaaren Hall: Yeah, that would be personal possession and that would be a prohibited transaction. I don’t think that the IRS would find it any different. Timothy Kuhman: No, there’s a part of actually 408 which tells you specifically what needs to be in the hands of a custodian and what kind of a custodian. Gillian: And precious metals fall under this but [inaudible]? Timothy Kuhman: It’s specifically precious metals. Kaaren Hall: There’s some wrong messages being put out there in the media that you can have personal possession and I think that should be clarified. Gillian: Simply not the case. Now, Bill, when you are talking with clients and let’s say precious metals are involved in their plan for their self-directed IRA, who’s really responsible for helping them navigate the nuances of that? Bill Humphrey: Well, again, it is the client. And unfortunately or fortunately sometimes the people selling the metals have a lot of interest in selling more metals. So they might not share all the rules and like Kaaren was saying, the industry, the checkbook LLC holding precious metals in your basement or under your bed is pushed by companies that want to sell more metals. Timothy Kuhman: Or more LLCs. Bill Humphrey: Or more LLCs or both and it’s an interesting thing that again advisors could step in and say, “Wait a minute, is this a good idea.” So we do a lot of precious metals and we have depositories across the US and a couple in Canada and Singapore even that are storing metals for IRAs. But the key thing is if the client wants those metals they have to come through us to get them. They can’t go and get their safe deposit box key or go and pull them out from their basement either. Gillian: Okay, perfect. Now, Jack, I want to take a quick look ahead to what’s coming down the pipeline for self-directed IRAs. If we’re looking five/ten years into the future, how do you see this business evolving and even the role of the IRA in helping to self-direct? Jack Kiley: Well, gosh, if I had a crystal ball I wouldn’t need to sit here!! Personally I think the … and it’s just my opinion, I think this space grows, I think it’s poised for great growth for a number of reasons, some of which we’ve discussed, others include things like pension plans already hold a fair amount of non-traditional assets or alternative investments. And as money moves to the IRA side of things, those clients or those participants are going to want access to those same types of investments. I think as Bill has mentioned, I think the technologies around the accounts and the speed in which things can move now will make this even easier. I remember when I started this back in the early 80s, it was really hard to buy a piece of property in an IRA, that was faxed signatures, in fact fax machines weren’t even around, Fred Smith hadn’t invented FedEx yet. So there were a whole host of issues that now we look at and we’re going to say, “Oh, that’s not a problem.” It’ll become much easier; the flow of information becomes easier, education. I think IRAs as a group, you know, are going to be looking for other avenues to offer to their clients. And this is a virtual untapped area at the moment. You know, I don’t know the exact percentage but it’s certainly south of 10% of total retirement assets that are held in these alternatives. And that’s just poised to grow exponentially I think. Kaaren Hall: I think that we’d be remiss if we didn’t talk about the retirement crisis that’s looming. I mean how can we stick our head in the sand and not say that Americans are prepared to retire, because we’re just not. And then when you talk about pensions, how many fully funded pensions are there in America? How many teachers and firemen and policemen have worked all their lives and put money away in a pension only to find out, oops, guess what, it’s underfunded. And maybe the state has to pick it up. So I think self-directed IRAs will grow and grow as we realize more and more how we have to take personal responsibility for our retirement and not rely on other things. You know, I think the more independent we are and the more we self-direct, the more secure our future will be. Gillian: I think the funded size of the average corporate pension plans in the low 80s or so, so it’s definitely a crisis. Timothy Kuhman: Yeah, the other part of that is that, and I could be wrong about this, and please correct me if I am. But there’s a lot of traditional assets out there that aren’t cash flow. And as long as all of us are going to live into our 90s and maybe early 100s, and our children even longer than that, if you’re retiring at 65, you’re going to need cash flow. And alternative assets are, you know, some of them are very good at generating cash flow and generating a good amount of cash flow. Jack Kiley: Statistically I think, again, I think the payout on a stock and bond on average is like 4%. Timothy Kuhman: That’s about right. Bev Edwards: I think the financial media focus on some of the fiascos, Bernie Madoff of course is the one that always comes to mind. I think it’s actually helped the industry, yes, it’s scared some people but that’s a good thing. The knowledge, the ability to research and investigate and make a solid decision, I think is way higher now than it used to be. And that’s on the accountholder, but also on the advisors and fiduciaries. The knowledge is more readily available. There’s places you can go to learn about whether an asset promoter has been in trouble before, is reputable. And I think that helps a lot. Gillian: And I feel like every time we have this discussion there’s sort of a new topic that we touch on that I had no idea that you could actually work with in self-directed IRAs. And actually, Bill, I was going to touch on this with you, health savings accounts can be self-directed, is that right? Bill Humphrey: That’s right, believe it or not, and still it’s been 12 years now that HSAs have been around and people think they’re health spending accounts, so savings accounts. And you can save the money and they’re an investor just like all of the IRAs that we’ve talked about and have opportunities to grow. In fact my own HSA is self-directed and has assets in Hawaii, assets in Texas, assets in Kansas as well. So it’s opportunities that people don’t even realize, that you don’t have to write the check out of your HSA today, you can write it 20 years from now, leave the money in the HSA, let it grow, invest it, and have the triple tax advantage of deductible going in, tax free earnings and not taxable coming out. Gillian: Hawaii am I a disallowed person or am I allowed to? Bill Humphrey: We can talk about that. It’s not a condo, but. Gillian: When we have high net worth individuals who let’s say have cash sitting on the sidelines waiting to determine what to do with it. Tell us a little bit about whether or not that’s insured? Bev Edwards: Well, one of the byproducts of having a large self-directed IRA is that you might be selling and buying real estate, there might be a period of time when there’s half a million dollars in cash waiting to make that, you know, that next investment. So it is important to know that even though your custodian or your administrator may be a non-depository, that they do have a cash management program. And that they’re working with a number of banks to spread the omnibus amount of all of the undirected cash out so that there isn’t too much cash sitting in any one FDIC insured account or product. Gillian: Let’s talk a little bit about each one of your businesses. Obviously you come at this from slightly different perspectives which has really added to the depth of this conversation. So I just want to give you each the opportunity as we close, to give us a little sense of what you do and how you do it and what makes you different in the marketplace. So, Tim, I’ll start with you. Timothy Kuhman: Kingdom Trust started out as your traditional … I shouldn’t say that in this group, but your traditional self-directed IRA custodian. And with the changes to the custody rule via Dodd Frank, we have become a qualified custodian under that particular rule so that we can hold assets for investment advisors and funds and funds of funds, family offices etc., and do. That’s a good part of our business. We also have been doing some Escrow work under the Jobs Act Crowd Funding rules. I think that makes us a little unique under this … with this group anyway. Gillian: And tell us about uDirect, Kaaren. Kaaren Hall: Sure. uDirect IRA Services, we utilize the services of a trust company custodian. We’re a third party administrator, so we’re the point of contact for our accountholders for anything that they need. When they call, we talk to them about, tell us about the asset that you’re going to invest in. Tell us about what is this? Who’s buying it? Who are the principals? And what are you doing? And then once they get into the deal they’re looking, if they’ve got questions they come to us. So I think our strength is the point of contact and our accessibility and our incredibly reasonable fees. Gillian: Excellent. Bill, New Direction. Bill Humphrey: So, New Direction started to teach people how they can self-direct because we discovered, Catherine, one of the other co-founder and I discovered that people didn’t know, so we had to teach ourselves. So our mission was to teach other people. Then we discovered that it was complicated and paper intensive. So our focus has, over the last 13 years has been making it easier for clients, providing education to both advisors and individual clients so that the transaction goes much more like they expect that transaction will be and to be successful with their investment hopefully. Gillian: Excellent. Jack, what about Mid Atlantic? Jack Kiley: MidAtlantic is a third party administrator, we’re owned by CPAs. So we have that tax aspect. Customer service is really a big focus as, you know, education is king. We do a lot of conference calls and small groups with, typically it’s the advisor and the lawyer and we are explaining the rules so that everybody is on the same page so the team is all together so to speak. And, you know, quite frankly it’s a lot of fun. Gillian: Excellent. And, Bev, last but not least, Mainstar Trust. Bev Edwards: I’m council to the Midwest Trust Company Enterprises that has really … called the four-legged stool. There’s Midwest Trust which does personal trusts for high net worth individuals. Benefit Trust, which is the retirement plans and the collective investment trust. Trust Sourcing Solutions, which provides accounting and recordkeeping for small bank trust departments. And Mainstar Trust, which until recently was known as First Trust Company of Onaga. And Mainstar Trust serves as a custodian for self-directed IRAs and also the … kind of the related taxable accounts. Gillian: Excellent. Well, thank you all so much for taking the time to chat through this incredibly complicated, but obviously rewarding space, helping us to understand how retirees can put themselves in the driver’s seat in a time when we’re seeing low yields in the traditional asset classes. So, thank you for joining us here today. And thank you for tuning in. From our studios in New York, I'm Gillian Kemmerer, and this was the Self-Directed IRA Masterclass.