Pros and Cons of a Checkbook IRA

The term "checkbook IRA" is unofficial, but it refers to an IRA that affords the account holder full control of investments through a checking account. The account holder establishes a legal entity, such as a trust or LLC, which is managed solely by the account holder or an administrator. The IRA opens a bank account, and the account holder receives a checkbook for this account. The account holder can then make investments with IRA funds simply by writing a check. 

Pros of a Checkbook IRA

The main advantage of a checkbook IRA is the level of control it affords the account holder. Even with a self-directed IRA, without a checkbook linked to the account, the account holder must always contact an account manager in order to make investments. With a checkbook, though, immediate action is available to the account holder. For example, the account holder can eliminate the 2- to 3-day review period standard on any investment through a custodian.

Further, a checkbook IRA can present savings on custodial fees. Typically, a custodian will charge a fee on every single investment and transaction made through an IRA. By making these investments directly, the account holder does not owe a fee. A custodian may still be required to oversee the account, but only a minimal annual fee will be charged.

Cons of a Checkbook IRA

While removing custodial fees may sound appealing, you are losing the advantage of having a custodian review your investments prior to confirming them. This can expose you to a host of problems, but the most common problem is making an investment that is not authorized to be carried out with IRA funds. For example, certain real estate transactions and business investments cannot be made with tax-deferred funds. If you make an unauthorized investment, you may be penalized by the IRS. 

Aside from this risk, there is also a risk of misreporting your investments come tax time. A custodian is paid not only to execute your investments but also to make sure that you are paying the taxes you owe on any earnings you secure through those investments. Your custodian is in charge or distributing your W-4 each year. Without oversight into each transaction you make, a custodian is more likely to misreport income on your investments.

When to Use a Checkbook IRA

The checkbook IRA option is best used by someone who is very familiar with investments and tax accounting. For example, this is a great option for a Certified Public Accountant (CPA). Many CPAs run independent practices. They may not be eligible for 401(k) plans from an employer, but they can still set up retirement accounts. Since these individuals are very well-versed in allowable tax-deferred investments and further understand tax implications of their transactions, they may not benefit from use of a custodian. Here, saving on the cost is wise. It is not wise to self-direct your IRA if you are very unfamiliar with the IRS regulation of the account and have little or no investment experience.

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