20 of the Most Frequently Asked Questions About International Investment Through an IRA: Part 1
by Joel M. Nagel
IRAs are a great way to grow a portion of your investment assets on a tax-deferred basis. Most Americans have their IRA assets locked up in U.S. stocks, bonds and mutual funds.
The tax code, however, which regulates IRAs and other defined retirement accounts, does not place many of the restrictions and limitations on such accounts, which classic Wall Street brokerage houses impose. In other words, most Americans do not get full access to a world of international investment and true global diversification, simply because it is not expedient or profitable for their brokerage house to offer such investments.
The following frequently asked questions (FAQs) are designed to educate and inform our clients about what they really can and can’t do with their hard-earned retirement dollars.
- Is it legal to invest outside of the United States with my IRA?
Yes. The tax code does not prohibit investment outside of the U.S. with individual retirement account funds. - What can I purchase outside of the U.S.?
Real estate, stocks, bonds, mutual funds, virtually anything you can buy inside of the U.S. - How do I do this practically?
There are several steps: - First, you need to find a U.S. domestic custodian that will allow you to make foreign investment. Many traditional custodians will not facilitate foreign transactions, because the money in your account is no longer trading on their platform. The custodians who do facilitate foreign transactions generally advertise that they permit “self-directed” investment. They charge you annual fees based on the custodian and compliance work that they do for you, not based on transaction revenue.
- Next, depending on what you want to purchase, a structure would be created inside your IRA, generally an LLC or an IBC. The entity is deemed “disregarded” for tax purposes as long as various formalities (which we will discuss later) are observed.
- Finally, the entity establishes a bank/brokerage/metals account with various international financial institutions that cater to this type of clientele. Funds are moved from the IRA to the LLC/IBC (which, remember, is owned by the IRA) and finally into the end investment. The corporate entity then reports back to the IRA custodian on the increase or decrease in the value of the investment, and the custodian is responsible for reporting on those values to the IRS on a regular basis, to keep the account in proper compliance.
- What types of retirement accounts can be self-directed?
We speak generically in terms of IRA accounts, but specifically we are referring to: - SIMPLE IRA
- Traditional IRA
- SEP IRA
- Roth IRA
- Individual 401(k) (including Roth 401(k)
- Coverdell Education Savings Account (ESA)
- Health Saving Account (HAS)
- Do I have to use a structure?
No, a structure is not necessary, although it gives the investor maximum flexibility and control, both as to the investment as well as to the distribution of the assets. The investor can either liquidate assets to fund a distribution, or simply distribute out shares in the corporate entity as the distribution. - So, how does it work if there is not a structure involved?
In that case, a foreign bank or brokerage account is opened directly in the name of the IRA. The U.S. custodian is the “owner” of record, and the foreign financial institution reports directly back to the U.S. custodian with regular statements. The custodian reports on the account value to both the end client as well as the IRS, making sure that compliance is maintained. - What are some of the advantages to using a structure, such as a company or limited partnership, for making investments inside an IRA?
Here are just six advantages that come to my mind. You might certainly come up with more if you try. - Speed. Some of the best deals are available because funding is needed immediately. If you have an entity set up and funded, it is ready for you to invest immediately.
- Convenience. Explaining how self-directed IRAs work, especially in a foreign jurisdiction, is slow and cumbersome. Real estate closings, in particular, are easier to facilitate with an entity in place.
- Privacy. An entity can provide a curtain around the real beneficial owner. From an asset protection standpoint, privacy of an investment lessens the chance of litigation and public exposure.
- Control. You have complete and unfettered control of the assets. You have an obligation to act as a fiduciary back to the IRA, and make investments you believe are best for your account, but you and you alone make that decision.
- Asset protection. In many cases, someone going after the assets inside an entity owned by an IRA will need to pursue his/her claims in the jurisdiction where the structure is located. Many jurisdictions such as Nevis, Belize or the Cook Islands are very asset-protection friendly, and hostile to frivolous lawsuits.
- Lower costs. Oftentimes the costs of the structure are less than traditional and on-going asset manager fees charged by many banks and brokerage houses.
- Are there any types of interest that cannot be held in an IRA?
There are two major types of assets that cannot be held in an IRA. The first type are items specifically excluded by name. These are investments in life insurance contracts and “collectibles.” That limitation applies to assets held both within the U.S. and outside of the US.
Secondly, a U.S. operating company (as opposed to a passive investment) cannot be held in an IRA without attracting what is called Unrelated Business Income Tax or UBIT. UBIT generally makes the notion of holding this type of investment (as a minority investor) in an IRA unattractive, unless there is a significant amount of depreciation involved in the assets to wipe out the UBIT. If the interest is not a minority interest, but rather controlling interest in an operating business, then the investment could be a prohibited transaction, rather than an exclusion of the investment (more on that below). So you could not, for example, have controlling ownership interest in a beach bar in a foreign country which you operate inside your IRA, and if your interest were a minority, passive interest you would end up with UBIT. - What are prohibited transactions, as opposed to impermissible investments?
The IRA rules are designed to benefit the plan itself, not a particular individual, even though the individual ultimately benefits. These rules are designed to make sure that investment is at “arm's-length” and not done in a “self-dealing” manner. Persons who would be “disqualified” persons to your IRA include both you and your spouse, children, parents, etc., as well as any corporation or partnership owned or controlled by any combination of those persons. So you could not, for example, use IRA funds to buy a piece of property in France and let your children live there, or buy property in Central America where you planned to live. These would be prohibited transactions. Other prohibited transactions include lending money to a disqualified person, or furnishing of goods or services to a disqualified person. - Can my IRA invest in foreign private placements?
Yes, generally you must meet the requirements of an “accredited investor” or “qualified purchaser.” Those rules are a bit technical to go into in this article, but essentially your net worth (including the value of your IRA) must be high enough to permit you to make private placement investments. Also, depending on the investment you are trying to make, you may need to have the ownership inside a structure (LLC or IBC) as opposed to a direct investment by your IRA.
To receive the full list of "20 Frequently Asked Questions About International Questions Through an IRA," or to ask your own questions, contact Joel Nagel.
Joel M. Nagel is an international business attorney, entrepreneur and investor. He practices in Pittsburgh, Pennsylvania, and creates legal structures around the world to protect the assets of his global clientele. He is a contributing editor to Hemispheres, and speaks at conferences worldwide on international business law and asset protection. To contact him, click here.