Nontraditional Options Let IRA Investors Crank Up the Risk

Most retirement savers are determined to keep their investments simple. They stash most of their savings in low-cost index funds or in target-date funds, which are portfolios of diversified funds that become more conservative as you approach retirement. This strategy has served savers well in recent years: The S&P 500 index was up 36% for the past year and 18% annualized for the past five years (through September 10).

But if you’ve been following the news, you may be wondering if that’s all there is. Bitcoin has generated enormous returns for people who invested in the cryptocurrency years ago (or even months ago). The white-hot housing market has priced out many home buyers, leading to increased demand for rental properties. Some investors have profited by buying and selling so-called meme stocks, such as GameStop and AMC. And there’s always the temptation to make a long-term bet on an obscure company that could turn out to be the next Amazon.

If you own a traditional or Roth IRA, you can invest in just about anything, with the exception of life insurance and collectibles, such as antiques. Employer-provided 401(k) and other retirement plans are more restrictive, but some allow you to trade individual stocks and specialty funds (see More Choices in Your 401(k)).

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For nontraditional investments, you’ll need to open a self-directed IRA, a type of account specifically designed to invest in alternative investments, such as cryptocurrencies, real estate and precious metals. (Major IRA providers, such as Fidelity, Vanguard and Schwab, place restrictions on their customers’ investments.) Fees may be higher than you’d pay for a traditional IRA, and self-directed IRAs have occasionally been hijacked by financial outlaws to steer investors into fraudulent investments. Before investing in a self-directed IRA, check with your state securities regulator and the Securities and Exchange Commission to see whether the provider or custodian has been the subject of any enforcement actions. Avoid unsolicited offers to invest in a self-directed IRA, particularly if the promoter urges you to transfer money from a traditional IRA or 401(k) plan.

Although you can make a lot of money investing in alternative investments, you could lose it, too, jeopardizing your retirement security. And if you run afoul of IRS rules regarding transactions in IRAs and other tax-advantaged accounts—which is particularly easy to do if you invest in rental properties—you could find yourself with an unwelcome tax bill that could decimate your savings.

The Apple of your IRA?

Earlier this year, ProPublica, an investigative news organization, revealed that Peter Thiel’s $2,000 investment in a Roth IRA in 1999 is now worth more than $5 billion. As PayPal’s cofounder, Thiel was able to buy 1.7 million shares of the company for a tenth of a penny per share three years before PayPal went public. Because the money is in a Roth, his profits will never be taxed. (However, unless he decamps to New Zealand and gives up his American citizenship, his billions will still be subject to federal estate taxes when he dies.) The story triggered an uproar, with some lawmakers questioning whether tax rules should be changed to prevent wealthy people from using a Roth as a tax shelter. But Thiel’s tax-free windfall was entirely legal, says Ed Slott, founder of IRAhelp.com.

Unless you’re on the verge of founding the next PayPal, you’re unlikely to replicate Thiel’s success. But there’s nothing to stop you from using money in your traditional or Roth IRA to bet on a company you’re convinced will be the next Apple or Amazon.

Some major IRA providers restrict investments in over-the-counter stocks (also known as penny stocks), which are companies that don’t meet the requirements to be listed on a major stock exchange. To invest in these stocks, along with shares of privately held companies, you may need to open a self-directed IRA.

But most major IRA providers will allow you to invest in any publicly traded company that’s listed on the Nasdaq or New York Stock Exchange, which means you don’t need to set up a Robinhood account to dabble in the next GameStop. And if you’re determined to try your hand at buying and selling individual stocks, doing it in an IRA offers some significant tax advantages. You don’t have to report your gains and losses to the IRS every year, as you do with a taxable account.

With a traditional IRA, taxes on dividends (if there are any) and gains are deferred until you withdraw your money. You’ll pay taxes on withdrawals at ordinary income tax rates, which currently range from 10% to 37%. That’s higher than current long-term capital gains rates, which range from 0% to 20%, depending on your income. However, because you’re not taxed until you take money out of your IRA, you have more control over taxes, Slott says. You could, for example, take withdrawals in a year when your income is low to minimize your tax bill (with the caveat that you’re required to take required minimum distributions once you turn 72).

With a Roth, you’ll never pay taxes on your gains, as long as you’re 59½ or older and have had the account for at least five years when you take the money out. Losses are another story. If you make a bad bet in a taxable account and decide to bail on a stock, you can deduct losses against your taxable gains; if your losses exceed that amount, you can deduct $3,000 against ordinary income. But if you lose money in a traditional or Roth IRA, “the government is not going to share your pain,” Slott says.

That wasn’t always the case. Prior to 2018, some losses in a Roth IRA were deductible if, after closing all of your Roth accounts, the amount remaining was less than the amount you contributed, plus anything you converted. (Deductible losses in traditional IRAs were limited to nondeductible contributions.) Even then, such a loss was treated as a miscellaneous deduction, which meant that you could only deduct it, along with other miscellaneous deductions, to the extent it exceeded 2% of your adjusted gross income. But the Tax Cuts and Jobs Act, which took effect in 2018, eliminated miscellaneous deductions.

For that reason—along with the fact that this is your retirement savings—you should exercise care when investing IRA money in individual stocks. Neal Nolan, a certified financial planner in Asheville, N.C., tells clients who are interested in stock picking to limit their investments to money they can afford to lose. “You should never lose sight of the big-picture, long-term approach,” he says. “It’s like a form of gambling—when done in moderation, it’s probably okay.”

A roof over your retirement savings

Housing inventory is expected to remain tight for the foreseeable future, which means demand for rental properties will continue to rise. But buying a house requires you to invest a lot more money than you may have in your taxable accounts.

Companies such as Entrust and Equity Trust offer self-directed IRAs for investors who want to use money in their IRAs to purchase rental property. But to preserve your account’s tax-advantaged status, you must follow a complex set of rules that reduce your flexibility—and possibly your profits, too.

To start with, any funds used to maintain the property and cover other costs, such as property taxes and insurance, must come out of your IRA. If you hire someone to repair the roof, for example, you must pay that individual with money from your IRA, not other sources. Sweat equity is also prohibited—even if you’re capable of painting the house, the IRS requires you to pay a third party to do it. In addition, you can’t take any of the tax breaks typically available to property owners, such as write-offs for depre­ciation, property taxes and other expenses.

If you’re retired and own rental property in a traditional IRA, you’ll encounter major hassles when the time comes to take required minimum distributions. Once you turn 72, you must take annual withdrawals from all of your tax-deferred accounts, based on the year-end balance of your IRAs. To determine the year-end value of a piece of real estate, you must obtain an appraisal, which can cost thousands of dollars, says Greg Giardino, a CFP in Hawthorne, N.J. (This doesn’t apply if your property is in a Roth IRA because you don’t have to take RMDs from a Roth.)

Finally, IRS rules against self-dealing limit how you can use your rental property. You can’t live in it, and your family members can’t live there, either. If you buy a rental property with an IRA and let your sister live there, for example, the IRS could disqualify the entire transaction, which means the IRA would be treated as if you withdrew all of the money. You would owe income taxes on the entire amount, plus a 10% early-withdrawal penalty if you’re younger than 59½, says Slott, of IRAhelp.com.

There are other ways to add real estate to your retirement portfolio that won’t jeopardize its tax-advantaged status. One option is a real estate investment trust. REITs own offices, malls, warehouses, hotels and other properties. REITs that invest in apartment buildings are well positioned to profit from the tight housing market. Nuveen Short-Term REIT ETF (symbol NURE), for example, invests about 50% of its assets in apartment leases. Its shares were up almost 36% for the year to date (through September 10).

REITs are required to return at least 90% of taxable income to shareholders, so dividends are typically generous. Because dividends are taxed as ordinary income, IRAs provide a tax-efficient way to harvest these dividends. In a traditional IRA, taxes on the dividends will be deferred until you take withdrawals, and if your REITs are in a Roth, dividends—along with all other earnings—are tax-free.

A little bit of bitcoin?

Bitcoin has been around for 11 years, and the cryptocurrency is rapidly going mainstream, attracting interest from both Wall Street institutions and Main Street investors. Bitcoin gets its name from the technology behind it. Every transaction is encrypted by computer code, known as blockchain technology, which eliminates the need for a middleman or a central bank. Only 21 million tokens will ever be made, and nearly 19 million are already in circulation, so fewer than 3 million are left to be created. That aspect of the digital currency appeals to investors who want a hedge against inflation, says Chris Kline, COO and co-founder of Bitcoin IRA, which allows investors to invest in bitcoin and other cryptocurrencies in traditional and Roth IRAs.

Although bitcoin has been popular with young investors (see Should You Invest in Crypto?), there’s plenty of interest among older investors, too, Kline says. Many of Bitcoin IRA’s customers are in their forties and fifties and are looking for ways to diversify their retirement portfolios, he says.

As is the case with any investment, past performance is no guarantee of future returns—and that’s particularly true for bitcoin. “When one looks at the value of bitcoin, you have to wonder if you’re a little late to the party,” says Nolan, the Asheville, N.C., CFP. Advocates for bitcoin counter that it still accounts for a sliver of the global investing market and has plenty of room to grow. Because of its extreme volatility, though, it probably shouldn’t account for more than 1% to 3% of your retirement savings.