Jonathan Forsgren: When it comes to retirement plans, you've probably heard of and likely have a 401k, traditional IRA or a Roth IRA, but you might not be as familiar with the option for a self-directed IRA, which can offer greater flexibility in the types of investments held within and tax breaks on earnings. Hello and welcome to this masterclass on self-directed IRAs. We've brought in two experts in the field to share their insights on self-directed IRAs. Joining me in studio today are Jean Meyer, president at Mainstar Trust and Kaaren Hall, CEO at uDirect IRA service. Jean, Kaaren, thank you for joining us today. So the first question's going to go to Kaaren. What is the difference between a typical IRA and a self-directed IRA?

Kaaren Hall: Yeah, great question. In 1975 when IRAs were created, it was just an IRA and it still is, but it sort of been divided into the self-directed bucket and the typical. So a typical IRA would hold market correlated assets. IRAs are like buckets that hold assets. So when IRAs were created through the ERISA Act, they said that an IRA can hold any asset except life insurance contracts and collectibles. So the savvy investor took advantage of that straight up and started investing in alternative assets. The average person who worked a job had a 401k, they were rolling over their 401k, putting it in an IRA, they might not have been aware that they could invest in alternative assets because they were probably working with a financial advisor. So a self-directed IRA lets you invest outside of Wall Street, lets you invest in alternative assets, where a typical IRA is really stocks, bonds, mutual funds and that sort of thing.

Jonathan Forsgren: So Jean, I'm going to come to you next. What are some of the lesser known or uncommon features of a self-directed IRA that it would be helpful for financial professionals to share with their clients?

Jean Meyer: Well, the basic IRA is the same, no matter what you invest in. The custodian or administrator is going to have to know who the customer is, they have to follow AML, anti-money laundering laws, they have to follow bank security laws, FinCEN 314. They have to follow all the same things no matter which type of investments they have. But by virtue of investing in these alternative investments, some of the questions or interaction you might have with the IRA service provider are going to be different. For example, some of the investments, if you were going to invest in a mutual fund, two, three clicks and you're the owner of the mutual fund. But if you're going to buy some alternative investments, there might be subscription documents, there might be other forms that need to be completed, and the IRA owner can't sign these forms. It has to be the IRA itself and that's represented by the institution that you're working with, with your IRA.

                                                            Another example might be that these investments are often more illiquid and so there's not always cash to pay fees or do other things in the IRA. So there's just going to be more interaction with the financial institution, that maybe the listeners of this class are always trying to serve their customers and want to be the point of focus and not have to deal with anybody else. But just by the nature of the investments, sometimes Kaaren and I have to get involved a little bit more.

Jonathan Forsgren: Okay. Kaaren, I'm coming to you with the next one. What type of accounts can be self-directed?

Kaaren Hall: Any kind of retirement account pretty much you can self-direct with IRAs. It's a traditional Roth, SEP, SIMPLE, spousal, inherited IRA. So all the IRAs can be self-directed. With the, I guess the ERISA world, if it's an employer plan, typically not like in the ERISA world. So that is to say that you can self-direct a solo 401k, not typically a full blown 401k. You may handle that differently. But it's because, the reason you don't a full blown 401K for a lot of employees is because of the fiduciary responsibility the plan sponsor has. But all those other plans are self-directable. Also, self-directable is the Coverdell which is also called the ESA or education savings account. You can self-direct that, that helps you to save money for children's education. And you can also self-direct an HSA or health savings account, which has got fabulous tax benefits. And that's something to really look at.

Jonathan Forsgren: I'm going to take a moment to kind of step back from the actual IRAs and ask Jean here, what are some of the characteristics of someone who should consider having a self-directed IRA?

Jean Meyer: Well, to have any IRA, if you're going to make contributions, you have to have earned income and be a US citizen. But for the characteristics of somebody that might put this type of asset in there, they're often less risk averse. So they're willing to, I just don't want my money in a money market earning very little interest. I want to take a chance on something. So they know that they're going to maybe lose but hopefully make money in their IRA. Another example might be somebody who wants to use their personal expertise. For example, let's say I'm a real estate developer and I understand when it's a good deal for some real estate or some buildings, or something like that. So I might buy that in my IRA. Or maybe I'm a banker and I understand what a good loan is and so I might loan money out of my IRA. So you can use some of your professional expertise as well as using the advice of advisors.

Jonathan Forsgren: So I'm going to come to Kaaren with this. Jean mentioned real estate and loans as potential assets. What other assets fit into a self-directed account?

Kaaren Hall: Well, real estate really is the number one, so we'll start there because almost all alternative assets seem to be correlated to real estate in some form. But the other kinds of assets that you can invest in not correlated to real estate would be, for example, precious metals. And precious metals, they have to have a certain, very high degree of purity, 9.999. For example, a Krugerrand is not acceptable in a self-directed IRA because the level of purity isn't high enough. Isn't that surprising?

Jonathan Forsgren: Yeah.

Kaaren Hall: So an IRA doesn't hold collectibles, so it doesn't hold collectible coins, numismatics. What it does hold is liberties and things like that in metal bars and things. So metals is a really popular asset class, especially when people are trying to use it as a hedge against inflation. And so that's one. And everything else seems to relate to real estate, where it would become like mobile home parks or buying performing and non-performing debt. Maybe even like receivables, factoring where you're investing in some receivables. Maybe a dentist's office has some receivables and you can invest in that. It would be factoring. So those are some of the other alternatives.

Jonathan Forsgren: I'm going to take it back to real estate and give it back to Jean here. You both mentioned real estate and real estate seems to be one of the more popular, as Kaaren mentioned, asset types to include in a self-directed IRA. But what are some of the pitfalls that a potential investor should look out for when investing in that asset class?

Jean Meyer: So as Kaaren said, you can invest in real estate in various different ways. Loan money to buy real estate, give it to a person that raises capital, buy a [inaudible 00:08:03] or something like that. But most of the pitfalls are really when you're buying what I call raw real estate, where you're investing in something. Maybe it is rental property in the Bahamas and is like, okay, I'm going to rent it out 51 weeks of the year and then that one week I'm going to go live there. No, you can't use your own IRA. You can't stay at your own rental property if your IRA owns it. That's kind of like double dipping. You can't get a tax benefit from the IRA and then get to use it and have fun with it. Other examples are, it's often hard if you're a fix and flipper to put that in your IRA because all money or all payments have to come from the IRA.

                                    So if you're like your own fix and flipper, I'm going to go to Lowe's and pick up some paint and just my IRA will reimburse me. It's like, no, can't do that. Everything has to flow in and out of the IRA. So that includes rent, all of that kind of fun stuff. Some other things that are not always known is that any leases really should be signed by the IRA. IRA should pay the taxes, it should pay the insurance. And that's kind of hard sometimes. Many people have a management company to handle that and then all those payments go in and out of the management company, but the IRA has an agreement with the management company. So that's the link that's needed. So that's really the biggest pitfalls with real estate is that you're just tempted to do it yourself because it's all about saving money, but it could get you into trouble.

Jonathan Forsgren: So Jean, staying with you, how does one fund their IRA?

Jean Meyer: So there's only certain ways you can get money into an IRA. There's contributions, which right now if you are under 50 is $6,000 a year. If you're 50 or over, it's $7,000. That's called catch-up contribution. You can add a little bit more money because maybe you didn't save as much as you should have when you were younger. So using that thought in our alternative world, there's maybe not a lot of investments you can buy five, $6,000. So younger people, they need to accumulate some wealth to really find some of the more common alternative investments that might be out there right now. As you get a little bit older and maybe you've worked at some employers, you have a 401K plan, so you've accumulated wealth but you don't work at that company anymore. You can do what's called a rollover. So you rollover your money from your old 401K to an IRA and that's not taxable because it's a rollover.

                                                            There's different rules. If you were to take possession of the check, you'd have, get it back into that retirement account within 60 days. But that's a good way to get a big chunk of money in your IRA if you want to buy some private stock or buy some real estate, that type of thing. In fact, a lot of people, when we were talking about the types of accounts, they go, I want to rollover IRA and there really isn't a rollover IRA. But so many people think that way that we've added it to our website just so it's there for people to reference. But they still have to either invest in the, or open up a traditional or a Roth account, but they're getting their money from a rollover. So that's kind of how they think about it.

Jonathan Forsgren: How does today's inflation play into contributions? Because if things are capped and you see inflation increasing at the rates that they are, what should somebody who's saving think about and will those regulations change?

Jean Meyer: They are subject to change. Within the next month or so, if there's going to be a difference, we're going to hear about it now. So I don't know. It's been a while since they've changed it, I think.

Kaaren Hall: Yeah, it has been. But they're indexed for inflation typically and so with a lot of inflation we're probably going to see a pretty nice sized contribution limit increase because we've got such runaway inflation right now.

Jonathan Forsgren: Kaaren, I'm going to stay with you. What are some of the pros and cons of private placement investing with a retirement account?

Kaaren Hall: Private placement investing is probably the number one asset class for self-directed IRAs as an industry. I sit on the board for the Retirement Industry Trust Association and that's our finding. And so if you're going to invest in a private placement, it's like a Reg A, B, C, D offering that's approved by the SCC, you have to be typically accredited, which means you have a certain net worth or a certain income. And there are provisions for other people that aren't accredited but maybe like 35 can invest in a private placement. When your IRA gets involved in a private placement, first off, you really want to make sure that you know the operator. You want to make sure that you do your due diligence.

                                                            And there are some great websites to do your due diligence on. NASAA, N-A-S-A-A, the National Securities Administrators, FINRA, which is the securities police, and even the AARP and others, or just Google the name of the asset sponsor maybe with the word fraud after it and see. Because we had a situation one time where we had an account holder who was going to invest in a private placement, a very large one. I mean, her contribution was very large and it was surprisingly large. And so had she done her homework, she would've seen that the asset sponsor was actually, had been incarcerated for stealing money.

                                                            So due diligence is first do your homework, that's first. Private placements are great because it's private equity that really builds America. It's the self-directed IRA money coming from grassroots level into companies, builds the buildings in the city that we're in, that sort of thing. So at least creates some of the financing. But with private placements, one of the things that you need to be careful of is, is the asset sponsor taking on leverage? And we'll talk about it I'm sure more at length, but there are some time, there are ways in which an IRA can be taxed. One is UBIT, Unrelated Business Income Tax and another way is UDFI, Unrelated Debt Financed Income Tax.

                                                            So if your IRA invests as an equity partner in a deal and the asset sponsor and the whole deal is taking on leverage, some of the earnings IRA receives are due to leverage and that will bring the UDFI issue into play. That's something for your tax advisor to handle for you. Your IRA would file a 990T. As Jean pointed out, all expenses including this tax are paid for by the IRA. So your IRA would pay this tax if it's due. So understand it's not income tax, it's this special kind of UBIT or UDFI tax. And again, it's reported on a 990T. And if you want to read more about it, you can look at IRS' website, IRS.gov Publication 598 covers that. And so that's one of the things to look out for in private placements. A lot of times the asset sponsor doesn't tell you if there's leverage in the deal or not.

                                                            So you really need to ask as an IRA investor because you want to know if you are going to need to file a 990T. The UBIT and UDFI taxes are pretty high. They're the same as a trust rate. I think it's almost 40% right now. It's pretty high. But that doesn't mean it will kill your deal. Maybe the proceeds you're receiving make the tax nothing compared to the proceeds you're receiving. So it's definitely part of your due diligence to ask the asset sponsor if they're taking on leverage.

Jean Meyer: Could I add a little something to that as well?

Jonathan Forsgren: Please.

Jean Meyer: Another thing to understand with the investment, especially if you're close towards RMD age, so required minimum distribution. So if you have a traditional IRA, at some point when age 72, you have to start taking money out of the IRA. So keep in mind on a traditional IRA, you weren't taxed on the money going in, but you're going to get taxed on the money going out and the government wants it sooner or later. So that's kind of why there's that rule. So back to the private placements, if you are getting close to RMD age, you have to think in mind, I have to have liquid assets in some IRA somewhere to cover that RMD. If you have multiple IRAs, you don't have to take the distribution out of this IRA. You can sum up the required distribution of all of them and take it out of IRA A that's your liquid one.

                                                            But if you don't, what you can do, and a lot of people don't realize it, is you can do a distribution in kind. So you might want to ask the sponsors like, hey, can I re-register the asset if I need to from my IRA just into me as my name separately? It would still be a taxable event, but your financial institution would cover that for you. So I think it's important to make sure that these investments kind of know that they're going to have retirement investors and can do some things to make some of the stuff the IRS says have to be done, helps it get done.

Kaaren Hall: Yeah. There definitely are private placements that are IRA friendly and you can ask for that, look for that.

Jonathan Forsgren: Great.

Jean Meyer: And then one other thing. So your custodian or your administrator isn't going to be able to give you advice on which investments these are. That's why it's called self-directed. So that means it's you or maybe your rep, or your RRA, or something like that. So we can't make investment decisions, we can't make recommendations and I know that we try very hard to adhere to that. As much as people would like us to, it's just not what we do.

Jonathan Forsgren: Jean, I'm going to come to you with this one. How and why should asset valuation play into an investment decision making in a self-directed IRA?

Jean Meyer: So this is another thing maybe to ask the sponsor as well, but the IRS says that every asset in an IRA has to be valued at least annually. So if you hold a mutual fund or IBM stock, that's priced daily. That's an easy valuation to get. But some of these like an LLC or an LP, or maybe some private stock, they just aren't valued that often because it's expensive to do that. But you have to be able to do that for an IRA, especially, again, if somebody's in RMD age. So back to the government, back to the IRS, they're going to want to know how much money they're supposed to be getting. They want to know how much is invested in these IRAs.

                                                            And while there's no tax, unless there's a taxable event like a distribution, it still is monitored and is starting to be kept track of by the IRS a little bit more now. So being able to get evaluation is very important because it is one of the main duties of the custodian administrator is to ensure that everything's valued. They're not going to come up with the value, but they're either going to ask the sponsor or the account holder to help facilitate and find what that value is. And if they're not, then you're subject to the custodian resigning from that asset or from your account because it's that critical that it's done at least annually.

Kaaren Hall: And that's a great part of your due diligence, isn't it? Like before you even open a self-directed IRA, you really need to know what they are and you need to know that there are these things like valuations. Because it becomes as a total surprise to a lot of people and they don't know they're supposed to get evaluation and then they talk to evaluators and they find out what they cost, and some are less and some are more. But then they think, well, I don't want to pay for that. I shouldn't have to pay for it. Where does it say in the tax code? Because it doesn't say in the tax code that you have to obtain evaluation. What it says is that the custodian administrator has to provide a value to the IRS, an accurate value. And if do, if we were to provide a value and just come up with one ourselves, that would put us into this shady category of being a fiduciary, which we are not. So we stay out of that.

Jonathan Forsgren: So Jean, I'm going to come to you with this and then Kaaren of course you can jump in afterward if you'd like to add anything. Jean, in general, what is the role of an IRA service provider, whether that be a custodian or administrator?

Jean Meyer: So again, we go back to the regulation and there has to be a custodian involved with an IRA. It's just part of the rule. So it has to be some sort of financial institution and they have certain responsibilities, that can be, well, they have to do tax filing. So if there's a distribution, we have to file a 1099-R. Every year, we have to file what's called a 5498.

Kaaren Hall: 5498.

Jean Meyer: 5498. Escape me. But it is, and it just is kind of an accounting of the IRA. It says what the value is. A few years ago we now have to say how much of the value is in alternative investments. That was something the IRS wanted to know. Just got to kind of give them an idea of, is this an IRA in RMD status or not? So it's really just an accounting that goes to the IRS. We have to give the account holders annual statements more frequently. And so we're just providing customer service as well. So there's things that we have to do and be involved, and we work very closely. Sometimes there's an administrator like Kaaren's company involved and they do the same things. There just has to be, they have to work with a custodian as well. And to the degree that they do that, the combination, the partnership, it kind of varies from organization to organization.

Kaaren Hall: It does. When I founded my company in 2009, I worked for another administrator and so I thought, "Well, all I need is someone to hold the money and be regulated, and so forth." And so I did find a trust company custodian, we partnered with them and so we've used them. So it's been a great relationship. But just as you say that they do the 5498s, all the tax reporting and the record keeping, and also the cash management. And what we do is the customer service, the one on one, talking to people, giving them consultations and things.

Jean Meyer: Right. So the IRA and all of its assets are in the name of, Mainstar Trust is custodian for John's IRA. And so we have to keep track of the assets. That's the other part of the custodian is safe keeping of the assets, whether they be physical and more and more, most things are book entry these days and not physical, but we still have to keep track of them, do the valuations as we've talked about before, and then handle distributions and customer questions. Ideally, especially to the audience, they don't want to hear from the custodian or the administrator. They want to be the ones that are working with their account holders. But again, in the alternative investment world, sometimes it just can't happen. Other ways that the parties can work together just to help maintain the expectations of the account holder, I think is important as well.

Jonathan Forsgren: Kaaren, I'll come to you with the next question. How can financial professionals enhance their relationships with their clients?

Kaaren Hall: I think from an administrative point of view, I'll give you my opinion. I'm sure that Jean has more to say as a trust company. But one of the things that we do is we make sure that everyone gets together and people can see one another, and we have events. So we have a lot of networking events. Of course, we can't recommend any asset, but we can have people, asset sponsors and IRA investors come together for a networking party for example. And that is a great way that we work with RIAs is to bring them together, bring everybody together. And that's just the, and everyone has fun now that we're past COVID and we're able to get together. It's especially nice. So that's one way. But I think the most important thing is just to keep people aware, keep your clients aware of what's happening and just make sure that you're keeping in touch with them. Clients like to feel loved.

Jean Meyer: To add to that a little bit, maybe this answers another question too. Often, I think it varies from organization to organization, but in our situation, the advisor can have some authority over the account, some trading authority. They can't request distributions, that has to come straight from the account holder. But there are ways that the advisor can, and play a bigger role in the IRA if they need to or if they want to, if that's how it's set up. So that's another way to kind of everybody works together, they get copies of statements, we can take instructions for them. Always trying to keep in mind what is the best for the account holder, but there are ways that we can work together as a group.

Jonathan Forsgren: So we touched on regulation a little bit earlier, and I'm going to come back to that now. What regulatory changes have impacted self-directed IRAs in the past couple of years? We'll start with Kaaren and then Jean you can add.

Kaaren Hall: I know that we're going to be talking about the SECURE Act and I think that the SECURE Act is really the most impactful recently. I mean, we had the Build Back Better Act and that nearly decimated us, but fortunately that didn't pass, so yay. Okay, that was good. But the SECURE Act that passed in 2019 went into effect. And as Jean was talking about, RMDs, required minimum distributions, the age for a long time has been 70 and a half. And so what that means is once you reach the age, the RMD age of 70 and a half, the year after, you had to begin taking these RMDs. And so what you would do is take the valuation of your account on the 31st of December of the prior year. That's why valuations are so important so that we know what the account was really valued at on that date.

                                                            So you go back to December 31st, take that value, and you can go on the IRS website, there is an RMD chart and you can find the factor. So your age when you match it, will come up with a factor. And then you multiply the retirement dollars that you have by that factor and that will tell you how much of an RMD distribution you have to take. So it used to be that you had to do that at 70 and a half. With SECURE Act 1.0, that was changed to 72. And that's great. Some people are grandfathered literally and other people are ... It's now 72. But we're coming upon the SECURE Act 2.0. It's already been approved by the house and it's going to be before the Senate. I'm sure in the next month or so we'll have some final outcome. But the nice thing about the SECURE Act 2.0 is it has bipartisan support.

                                                            And unlike the Build Back Better Act, it's really for the saver. It really helps the saver so much more in a lot of different ways. Setting every community up for retirement enhancement is the SECURE Act. And there are three things that it touches on. Like I mentioned RMDs, one of the things that it would do is change RMDs gradually starting in 2022 to going up to the age of 73 in this year. And then in 2029 up to the age of 74 and then 2032 up to the age of 75. So this is again proposed. It's not in stone yet, but it will be soon. So that's what the SECURE Act 2.0 is looking to do. It's also looking to increase catch-up contributions. Like you were mentioning with an IRA, if you're under 50 it's 6,000, if you're 50 or older it's 7,000 because you have $1000 catch-up contribution.

                                                            And right now say with a 401k, your catch-up contribution is $6,500. So if you're over a certain age, your catch-up contribution will increase under the SECURE Act. But in this case, it's for people age 62 to 64. So there's a lot of minutiae. So we have to see how it really comes out in the wash. But they are looking to raise the catch-up contributions, which would be great because really no one has enough money in retirement. If you're not making any money, it can go pretty fast. So the more we can do to help people save for retirement, the better. And that's why I think everyone's so in favor of this.

                                                            And also one of the things too with RMDs that the SECURE Act 2.0 addresses is fines and penalties. So today, if you don't take your RMD and you're required to and you don't do it, the penalty is enormous. Excise taxes can equal up to 50% of the value of what your RMD would've been. It's tremendous. And so I think legislators took a look at that and said, hey, we can make this a little easier on people in their retirement years. And a lot of people have more things to do in their life than remember their RMD, right?

Jonathan Forsgren: Right.

Kaaren Hall: So you can get busy and forget. So SECUR Act 2.0 is looking to lessen the penalty, maybe down to 10% or 25% of what the RMD would've been. But just remember that you do need to take your RMD annually by December 31st and that is incredibly important. That's another thing to do, if you're opening a self-directed IRA account, another part of your due diligence is understanding what are the road posts ahead that you need to plan for. And this is one of them. And the SECURE Act I think will benefit retirement savers greatly.

Jean Meyer: So one of the things also in SECURE Act 1.0 that went into effect, other than getting rid of that gosh-awful 70 and a half requirement, it's a even number year, but it also eliminated what people called the stretch IRA a little bit. So prior, and I probably won't get this exactly right, either you were a spouse beneficiary or a non-spouse beneficiary. And the spouse had different options. They could take the IRA, if their spouse died, they could take it as their own, they could take it all out in five years or they could do the lifetime payments. And then the non-spouse had five years I think to use it. Or let's say they passed away, they could then give it to somebody who did the same thing. In other words, you would just keep extending it. Or possibly they would name, if I had some money, I might name my grandchildren so my assets would go to my grandchildren.

                                                            Well, they're not going to pass away for a while because they could have taken their lifetime payment. So that would've gone on and on, and on, and on. And then my grandchild would give it to his grandchild and the payments of my IRA could just last forever because if they didn't choose the five year, they could choose lifetime payments and just have it keep going. So what SECURE Act 1.0 said was, no, we want the IRAs used up within 10 years. And so if you're, but they kind of grouped it differently, it's called eligible designated beneficiary or non-eligible designated beneficiary.

                                                            So spouse falls into the designated eligible group. Minor children until they become of majority age, they're included in that group. Disabled people, there are some different requirements, and you can also give it to somebody as long as they're not more than 10 years younger than you. So the goal is that this IRA is going to be used up in 10 years. So that's one of the things the SECURE Act did that some people aren't real happy about because it really changed some of the financial planning that people had been doing. So that's still is going to come up now because it's been a couple of years, we've had a pandemic, we've forgotten about that. But that is going to be an impact as the IRA owners pass away and how long the beneficiaries have to take that money out of the IRA.

Kaaren Hall: It's true. And so just from what you've said, it really brings to light how complex the beneficiary IRA, these rules are. Like if there's a full moon on a Tuesday, then you do this. So you really get into the weeds with these rules. So that's when you really need to talk to your financial advisor. Don't you agree?

Jean Meyer: Right.

Kaaren Hall: That's what I mean. Yeah. And say, I just received an inherited IRA, someone passed away and gave it to me. What do I do? And get professional advice because it is quite complex.

Jonathan Forsgren: So speaking about regulations and legislation, you were talking about SECURE Act 2.0 that's still pending. Are there any other pending regulations or legislation that are related to IRAs and retirement savings?

Jean Meyer: Well, she mentioned the Build Back Better Act. So it was going to do some things that would change quite a bit what we do. It would put like a maximum size of an IRA. It didn't want to have people required to have some kind of, I'm not using the right word, education or accreditations. They didn't want to have those kind of rules on an investment in an IRA. The IRA could own up to 50% of a company that the IRA owner was connected with and the Build Back Better rules were going to lower that to only be 10%. So that was going to impact our industry. And as Kaaren said, it didn't pass, but it's still out there. That could be always pulled up out of the drawer at any time. So those are things to pay attention to.

Kaaren Hall: Right. And it would've eliminated, because of that very rule you were talking about, would've eliminated something called the checkbook IRA commonly or the IRA owned LLC. It's when your IRA has third party create a special purpose LLC, your IRA funds a checking account of that LLC and now the account holder can use the checking account from this special purpose LLC to invest. So in other words, it puts the custodial responsibilities, frankly, some of them, in the hands of the IRA owner. It gives them check writing authority to go out and acquire assets and pay the expenses of the assets. And as Jean also mentioned, she talked about the 5498 and how we use it to report what assets are held in an IRA today.

                                    So it was maybe five years ago that we started adding what kind of asset was in the account. And now that we have $80 billion allocated to the IRS for auditing, I think that the IRA owned LLC might be low hanging fruit because it could be simple to create unintentionally a prohibited transaction in there. We haven't really touched on prohibited transactions, so maybe we can do that in a moment. But the Build Back Better Act would've decimated the checkbook authority in an IRA. And I don't know how long it's going to last. I mean, it's always threatened, but we'll see.

Jonathan Forsgren: Well, you just brought it up, you just mentioned it and so let's stay on the topic of prohibited transactions. So what are some of the most, I guess popular, unintentionally I'm sure, but what are the-

Kaaren Hall: The top ten.

Jonathan Forsgren: Biggest infractions? Right.

Kaaren Hall: Yeah. Okay, here we go. Well, a prohibited transaction's first off rule book, if you want to look it up, it's Internal Revenue Code, IRC 4975. It's where you can look up everything and know it all, because we can't begin to cover it all in this interview. But prohibited transactions are, think of it like a game of keep away. So your self-directed IRA, when you set out to do a self-directed investment and create a self-directed IRA account, you're playing this game of keep away and you're keeping away from prohibited transactions. Because if your IRA were to commit a prohibited transaction, there's the possibility that the IRS would alert you that you'd done this and then you could face, first off, the bubble of the IRA, the tax protected bubble would burst basically. And all that money would become your personal money taxable to you likely with excise taxes.

                                                            So it wouldn't be very pretty. Now it would become your money. No longer tax protected IRA retirement money. That's one thing that would happen if you committed a prohibited transaction in your IRA. And it's just not pretty. [inaudible 00:37:21] So it's a game of keep away from that. So one of our main focuses, your direct IRA services, is to make sure that we talk to our account holders. The first thing we want to do is have a consultation and say, tell us about your investment? Who are you investing with? So that we understand the parties because in a self-directed IRA, certain people are allowed and some are disallowed to the IRA. So the allowed people are your lineal ascendants and descendants. Your parents and grandparents, you and your spouse, and your children and grandchildren, I'm sorry, they're the disallowed parties. Up and down the family tree are the disallowed parties.

                                                            But the parties who are allowed are out to the side on the family tree. So it doesn't mean that your IRA can't buy an asset from a family member. It just matters where they sit on the family tree. Because your IRA could, for example, make a note to your brother to buy a house, but your IRA could not make a note to your son to go buy a house. Because your son is a disallowed person, that would be a prohibited transaction. You see? So it all falls back, so who is the party involved? It's extremely important when you're self-directing that you avoid a prohibited transaction. And one example is, when I first started the company, it was during their session and we had somebody who had been an appraiser. There wasn't a lot of appraising going on, so he had a 401K to rollover and he wanted to create a self-directed IRA.

                                                            And I said, "Oh, that's wonderful." I said, "What are you going to invest in?" He says, "Oh, well, I'm going to make a loan to my sister." And I thought, "Well, okay. A sister is allowed. The sister's out to the side on the family tree. That's okay." So I thought, "Well, I really better ask another question here." I said, "When your sister gets that money, what is she going to do with it?" And he says, "Oh, well, she's going to invest in my company." So that at least it's another rule called the indirect rule. If you can't do something directly, you can't do it indirectly. That would also be prohibited.

                                                            So instead he made other arrangements because that would be a prohibited transaction. So we highly encourage any self-directed IRA investor to talk to their administrator, talk to their custodian before they go out and make an investment, and just ask, hey, does this look like a prohibited transaction to you? Because the onus is on the account holder not to commit the prohibited transaction, again, with self-directed. It is self-directed so you are responsible for what you do in your IRA. But of course we want to help you if we can. So prohibited transactions, again, are a game of keep away and we're happy to help and discuss that with our account holders.

Jean Meyer: So kind of just taking that to the next level. I mentioned you can't go take vacation in this rental property if your IRA owns it. And you can't go live permanently on anything your IRA owns either. And Kaaren mentioned that you can't loan money to your grandson, but you could loan money to your nephew. And so it gets kind of convoluted. And you can't loan money or do any kind of financial transaction with your financial advisor either. Say, hey, you want to buy some land from me? Even though they're not in your family tree, they're advising you on that-

Kaaren Hall: No fiduciaries, right?

Jean Meyer: Right. And you couldn't do it with the custodian either. So I think that's always good to remember. But if you think you've done something and there's been, like it was by accident or there were special circumstances involved, there is something called a private letter ruling that you can submit to the IRS and plead your case. And the IRS will say, even though you're going to send a private letter ruling, pay any taxes to me and pay any penalties to me, and maybe I'll give it back to you. But it is a chance to kind of plead your case, defend yourself. And the IRS can say, okay, fine. And they are made public these private letter rulings. But if there was one that I had requested, Kaaren can't rely on it. Now, that's not to say she doesn't get an idea of what the IRS, which way they would lean, but technically she can't rely on a private letter ruling that I would've got.

Kaaren Hall: Right. And these private letter rulings aren't free, are they?

Jean Meyer: No.

Kaaren Hall: They're not. It's $10,000 to file one, plus you need to have an attorney. So you're probably looking at a pretty big tax hit before you file a private letter ruling.

Jonathan Forsgren: Right. Keeping in the realm of regulations. What are some of the biggest challenges facing self-directed IRA processing right now?

Kaaren Hall: I would say that the regulators are very concerned about valuations. I would say that that is, it's always been a touch point. For example, you touched upon valuating startup companies. Well, how do you valuate a startup company? So a valuation for a company could be $40,000. Well, how many startup companies have an extra 40K? They really don't. So it's almost like pulling the tree up by the roots to see if it's growing and you're just going to kill the tree by doing something like that.

                                    So where the regulators want valuation, it also has to not kill business. So there has to be some intermediary or some sort of happy middle ground. And what we do right now is rely on the account holder to provide the valuation. As Jean pointed out, a stock or something like this, you can just look on your iPhone and see the value at any moment. But when it's an alternative asset, you have to have that valuated. But some are hard to value assets. And so the magic cure to how to value hard to value assets really hasn't come up. But it is something that legislators are looking at right now.

Jean Meyer: And typically the financial institution, the custodian, the administrator, we're not going to overanalyze what's provided as that value.

Kaaren Hall: Yeah. It's not their place.

Jean Meyer: Right. It's not a function that we do. So that's something to remember as well. Something else that I think is impacting the IRAs is fraud. Just fraud in general. It's out there, it's everywhere. And people really have to be diligent to try to limit it as much as possible. So people's personal information gets stolen, their emails are hacked. Hackers will just sit and lurk and watch emails for a while and determine, oh, Kaaren always sends an email. I'm going to take over her email and change the wire instructions on this delivery and have John's account come to me or the balances come to me. So-

Kaaren Hall: That's why we have great security measures in place, right?

Jean Meyer: Exactly.

Kaaren Hall: We've spent a lot of money on IT security.

Jean Meyer: Exactly. You have to do it for IT security. But typically it's not the custodian or the administrator's email that was hacked, it was the account holder's email that was hacked. So we'll get callbacks from your processor to say, hey, I got this instruction from you, is it right? Whatever the security procedures are in place, if they log onto your account, you're going to have two factor authentication. You're just going to have to, there's more and more steps that are going through in order to have us make sure I know it's you. And so that's just something that everybody has to be more diligent in this day and age because the fraudsters are getting smarter too.

Kaaren Hall: I'm sure you take a lot of classes on that kind of due diligence. I know we do. Just to make sure that we're up to speed and providing the best security that we can that's available.

Jonathan Forsgren: And should somebody be a victim of fraud or have their email breached, are they responsible? Is that something, are they getting penalized by the IRS?

Jean Meyer: The IRS really isn't involved. It's just a loss of funds.

Jonathan Forsgren: Okay. Understood.

Jean Meyer: I mean, if the processor made an error, then it's kind of all depends where it happened. It's never pretty. Somebody loses usually in this case. Certainly as soon as we know if something's gone out, we try to work with the other bank on the other party, hey, we think this account that we sent to is fraudulent, can we get the money back? It's hard to get the money back.

Jonathan Forsgren: So in this discussion we've talked about not taking out the required distribution, but when can someone start to take out distributions without being penalized? Jean, why don't you answer that one?

Jean Meyer: Well, I was going to say, you can take it out any time you want to, you just might be penalized. And of course you'll have to pay a tax on it. So it kind of depends on what type of IRA you have. So always keep in mind the IRS is going to get its money. So on a traditional IRA, it gets put into the IRA pretax, usually it's tax deferred of some sort, and then it can grow. And then you are taxed as the money comes out.

                                    On a Roth IRA, you've already paid taxes on the money, you contribute it to the IRA and then you can, so as it grows, you take the money out tax free. So that's the general gist of both of those. So the general rule is, for an IRA, traditional, you have to be 59 and a half. After that, you can take the money out. So if it's traditional, you'll be taxed but not penalized. For a Roth IRA, it's the same age, but you also have to have had the IRA for five years, the Roth IRA. So again, you can take it out after that, you won't be taxed and you won't be penalized.

Jonathan Forsgren: And is there a cap on how much you can take out each year?

Jean Meyer: No, you could drain the whole IRA if you want to.

Jonathan Forsgren: Okay.

Kaaren Hall: It's your money.

Jonathan Forsgren: Okay. Kaaren, we're going to come to you with the next question. We discussed being taxed on your investment or IRA investment when it goes through a private placement. But what if you, yourself in a self-directed IRA used leverage to make your own investments?

Kaaren Hall: Well, a lot of people do that. And my background was actually in the mortgage world. And so when I found out that an institution would lend money to an IRA account, I was surprised, but it's sort of a commercial loan and it's called a non-recourse loan. And so what happens is, say for example the IRA is looking to purchase a house, then what they would do is contact a non-recourse lender, work out the terms and see if that makes sense for them. And the lender will lend money to the IRA account to make that property acquisition. They're going to be underwriting that loan based upon certain factors like any underwriter for any mortgage. And they'll be underwriting for things like location and condition, but mostly cash flow. So a lot of these non-recourse lenders want to see that you have a, for example, a lease agreement in place already so that they feel good about getting paid back.

                                    But it is called a non-recourse loan. So what that really means is that if the IRA were not able, didn't have the liquidity to make the payments back to the lender, the recourse would only be to come against the subject property and to take that and to foreclose on that. But they could not come against you personally and they could also not seize any other assets in the IRA. So a non-recourse loan is something that a lot of people do use. So when your IRA acquires a property using leverage, say for example, it's $100,000 house, 70,000 comes from your IRA, 30,000 is leveraged. So it's 30% leveraged. Here comes your $1000 rent check into your IRA, your proceeds.

                                                            Well, 30% of those proceeds were received because of leverage. And so it's that 30%, not the whole $1000 rent check, but the 30% that was received because of leverage that is subject to UDFI taxes, again, Unrelated Debt Financed Income Tax. So again, when you're self-directing, you definitely want to understand how the whole process works before you just jump in with both feet. And you can also again read about UDFI at the IRS' website, IRS.gov Publication 598.

Jonathan Forsgren:And then I'm going to continue on the idea of buying property, but slightly outside of an IRA. So with 401ks, you can take a loan and buy your own property and as Jean pointed out, in a self-directed IRA, you can't stay at your own property. So in this case, if someone wanted to purchase a home that they would live in, could they use a self-directed IRA as collateral?

Kaaren Hall: They could not. Using an IRA as collateral is actually a prohibited transaction. So it's something that the IRS specifically says you can't do. It's not to be used as collateral for a loan. With a 401k, there's a special provision where you can borrow the lesser of 50% or $50,000, the lesser of, and you can take that money and use it for personal uses, but you must repay it back to your 401k within five years. So you could take the money out of your 401k perfectly fine as a 401K loan, use it in your home acquisition cost and live there that way. But in a self-directed IRA, any asset that's purchased, there could be no personal benefit, no personal use, no present benefit, that sort of thing. Those are prohibited transactions.

Jonathan Forsgren: So you couldn't take a loan as you could with a 401k?

Kaaren Hall: You don't borrow money from your IRA. The only sort of time you could do that is a 60 day sort of distribution. You could take money out of your account and as long as you paid it back to a retirement account within 60 days, you're not penalized or taxed for that.

Jean Meyer: In full.

Kaaren Hall: In full.

Jonathan Forsgren: In full.

Kaaren Hall: In full. Yes, very good point. Pay it back in full. And you can do that, but you can only do that once every 12 months. So it used to be that it's like every IRA account that you had could do that once a year and now it's the congregation of all your retirement accounts together, you can do that one time every 12 months. So that's the only way an IRA could borrow money. But the 401k money is again the 401k loan, $50,000 or 50% the lesser of. And then the IRA can actually borrow money itself. The IRA borrows the money when it's acquiring typically real estate assets because that is the sort of asset that a non-recourse lender is looking to hold.

Jonathan Forsgren: Well, Kaaren, Jean, thank you so much for sharing your expertise today.

Kaaren Hall: Thank you.

Jean Meyer: Thank you Jonathan.

Jonathan Forsgren: And to our viewers, thank you for watching. For Asset TV, I'm Jonathan Forsgren. We'll see you next time.