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IRAs are US retirement savings plans with tax advantages, but prohibited transactions aim to ensure account stability and security. IRA regulations are monitored by the IRS, and prohibited transactions include certain investments and parties involved in transactions. IRA custodians have the authority to establish more restrictive transaction policies. Disqualified persons, including IRA custodians and their employees, as well as the IRA owner and other beneficiaries, are prohibited from certain transactions.
Individual Retirement Accounts (IRAs) are retirement savings plans in the United States that provide owners with certain tax advantages. By law, to improve account stability and security, IRAs are prohibited from certain transactions, adding a safeguard to ensure funds will be available for the owner’s retirement. These IRA prohibited transactions target not only the types of investments that can be made, but also the individuals or organizations that are party to the transactions with an IRA. Compliance with IRA regulations is monitored by the Internal Revenue Service (IRS).
First established by the Employee Retirement Income Security Act of 1974 (ERISA), IRAs allow workers to open accounts and fund them with a limited amount of their earnings. Amounts contributed to the IRA, as well as any earnings, are exempt from federal income tax, and generally state income tax as well, until actually withdrawn from the IRA. Changes have been made to the IRA program since its inception, including the introduction of the Roth IRA, but prohibited IRA transactions apply to all IRAs.
Limits on the type of assets the account can hold are reflected in one of the largest IRA-prohibited transactions. Deposits to an IRA must be in cash, and an IRA cannot invest in collectibles such as fine art, stamp and coin collections, and antiques. Some precious metals can be purchased by an IRA as long as they meet certain requirements. IRAs are strictly prohibited from purchasing life insurance.
One of the most misunderstood IRA-prohibited transactions concerns the use of IRA assets to purchase real estate. This is prohibited only if that property provides an immediate benefit to the taxpayer. For example, an IRA owner cannot use IRA assets to buy his own residence, even if he later makes rent or mortgage payments to the IRA. Real property can be owned by an IRA if the owner does not benefit from it, such as an apartment complex whose residents pay their rent directly to the IRA. However, the IRA owner cannot act as a paid property manager.
Another misunderstanding arises over the power of the IRA custodian to prohibit transactions. However, the Internal Revenue Code is very clear and specifically gives custodians the authority to establish more restrictive transaction policies. For example, many IRA custodians will only allow the purchase of securitized real property, such as real estate investment trusts (REITs), even though the Code generally allows direct ownership of real property. Use of IRA assets to make non-traditional investments that comply with the Code must be done through a custodian that allows the particular investment contemplated.
There is also a group of IRA-prohibited transactions classified by the IRS as transactions with disqualified persons. Among others, any person with a fiduciary responsibility for the IRA, or any person who benefits from it, is considered a disqualified person. This includes the IRA custodian and their employees, as well as the IRA owner and other listed beneficiaries. Family members by blood or marriage of disqualified persons are also disqualified. Therefore, an IRA cannot lend money to its owner or any member of their family, nor can it be used as collateral for such a loan.
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