An Individual Retirement Account (IRA) is a tax-advantaged retirement plan designed to help account owners build long-term financial security. Whether you have a traditional IRA, Roth IRA, or self-directed IRA, these accounts provide access to a wide range of investment options, including mutual funds, exchange-traded funds (ETFs), real estate, and certain alternative investments. However, the IRS has strict guidelines on the types of investments that are allowed within an IRA. Understanding what is not permitted can help IRA owners avoid prohibited transactions, taxable income, and potential penalties.
IRS Rules on IRA Investments
The Internal Revenue Code (IRC) sets clear restrictions on IRA investments to prevent misuse of retirement savings. While IRAs offer flexibility in investment choices, certain asset types and transactions are explicitly prohibited. These rules help ensure that IRAs maintain their tax-advantaged status and are used for long-term retirement savings rather than for personal or immediate financial gain.
Additionally, the IRS prohibits self-dealing and transactions that involve a disqualified person. A disqualified person includes the IRA owner, their family members, or any fiduciary with decision-making authority over the account. Engaging in a prohibited transaction with a disqualified person, such as selling personal assets to an IRA or using IRA funds for personal use, can result in early withdrawal penalties and taxable income.
Investments Not Allowed in an IRA
The IRS prohibits specific types of investments in IRAs, including:
- Collectibles
Collectibles are considered personal-use items rather than legitimate retirement investments. The IRS prohibits the following types of collectibles in an IRA:
- Artwork
- Rugs
- Antiques
- Gems
- Stamps
- Coins (with some exceptions for certain precious metals)
- Alcoholic beverages
- Any other tangible personal property deemed a collectible
- Life Insurance
Life insurance policies are not allowed as IRA investments. An IRA is intended to be a retirement savings vehicle, not a financial instrument for estate planning or insurance protection. Instead, annuities can be included as part of an IRA account if they meet IRS requirements.
- Real Estate for Personal Use
While real estate investments are permitted in a self-directed IRA, the IRS prohibits personal use of any IRA-owned rental property. For example, an IRA owner cannot:
- Live in an IRA-owned property
- Rent the property to a family member or other disqualified person
- Use the property as a vacation home
- Perform repairs or renovations themselves (which is considered self-dealing)
To maintain compliance, any real estate investment in an IRA must be exclusively for investment purposes, with all expenses and income handled through the IRA custodian.
- Shares in an S-Corporation
The IRS prohibits IRAs from holding shares in an S-Corporation. This is because S-Corporations are restricted to having only certain types of shareholders, and IRAs do not qualify under the IRS definition. However, an IRA can invest in partnerships, private placements, or hedge funds under specific conditions.
- Prohibited Transactions
In addition to restricted asset types, the IRS prohibits transactions that could lead to immediate taxable income or penalties. These include:
- Borrowing money from an IRA (e.g., using an IRA as collateral for a loan)
- Selling personal assets to an IRA
- Receiving an immediate financial benefit from an IRA investment
- Using IRA funds for a small business owned by the account holder or a disqualified person
These restrictions are in place to ensure that IRA investments remain tax-deferred and are used exclusively for retirement purposes.
Why These Restrictions Matter
The IRS enforces these investment restrictions to prevent taxpayers from misusing their IRAs. If an IRA owner engages in a prohibited transaction or invests in restricted assets, the entire IRA could lose its tax-advantaged status. This could result in the entire account becoming taxable, along with additional penalties, such as early withdrawal fees and required minimum distributions (RMDs) for traditional IRAs.
For investors looking to maximize their IRA investments while staying compliant, it’s important to work with an IRA custodian that ensures transactions align with IRS regulations. While Mainstar Trust does not provide investment advice, they serve as a trusted provider of self-directed IRA accounts, ensuring proper administration and recordkeeping of retirement funds.
Choosing the Right IRA Investment Strategy
While there are restrictions on what an IRA can hold, there are still many investment opportunities available. Depending on an investor’s risk tolerance and financial planning goals, an IRA can include traditional investments like mutual funds and ETFs, as well as alternative investments such as real estate (when structured correctly), private placements, and tax-advantaged annuities.
Before making any investment decisions, IRA owners should carefully evaluate their options, consider their contribution limits, and understand the tax implications associated with different types of investments. Avoiding prohibited investments and transactions ensures that an IRA remains compliant and continues to provide long-term retirement savings benefits.
Get Started with Mainstar Trust
If you’re ready to set up an IRA account for retirement investing, Mainstar Trust can provide the custodial services you need. Whether you’re looking to diversify with alternative investments or stay within the bounds of traditional investment choices, Mainstar Trust ensures your account is administered according to the absolute latest IRS regulations. Contact our team today to explore your options and start building a strong retirement plan tailored to you.