Prohibited IRA Transactions Can Mean Big Trouble

One of the benefits of investing in an IRA is that you have many different investment choices available to you. Compared to other types of retirement accounts, you will have a plethora of choices to put your money in. However, there are certain transactions that you will not be able to partake in. If you do get involved with a prohibited transaction, it could cost you dearly.

Prohibited Transactions

In most cases, your IRA custodian will help you avoid getting involved with any prohibited transactions. However, with some IRAs, you will have complete control over where you put your money. In this case, you will need to look out for prohibited transactions that could negatively impact your IRA. Here are a few things that the government has forbidden you to invest in with funds from an IRA.

Life Insurance

In the investment world, sometimes people want to invest in life insurance policies. For example, you could pay an elderly person a certain sum of money in order to be named the beneficiary of his or her life insurance policy. Then when that person dies, you could potentially collect a large sum of money. While this can be a legitimate way to invest, you will not be able to do so with funds from an IRA.

Collectibles

Another forbidden investment area is that of collectibles. This could include any number of things including rare stamps, coins, baseball cards, figurines or antiques.

Personal Business Dealings

You cannot invest in anything that would be considered a personal business deal. If the business deal has the potential to help you in any way besides providing you with a return for your IRA, this transaction would be forbidden. For example, let's say that you took money from the funds in your IRA and used them to purchase a vacation property. You rent out the property most of the time, but you also stay in it during certain times of the year. This type of transaction would not be allowed under the current rules. Since you are benefiting by getting a free place to stay on those vacations, this would not be allowed.

Losing Tax Benefits

If a transaction in your IRA has been determined to be a type that is prohibited, you will face some serious financial consequences. The government might decide to disallow your IRA the tax benefits that traditionally come with it. For example, they could decide to charge you a 10 percent early distribution penalty on the amount that you used for the prohibited transaction. This could potentially make you lose a substantial amount of money because of a poor choice of investment.

In addition to charging a penalty, they could also eliminate the tax benefit in the account. Since you have been funding the account with pretax dollars, they might charge you taxes on all of the money in the account. This could devastate your retirement savings overall. Therefore, you need to be very careful when choosing investments for your IRA.

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