Why Tempt Fate?

As a businessman and investor I can relate to clients, prospects and students who contact me with personal financial problems that they hope to solve using IRA money, without taking a taxable distribution.  Many times, they are looking for solutions to current problems in their personal or family finances, using assets currently in a Self Directed IRA account. Frequently the solutions they seek to implement are based on "self dealing" with "disqualified" parties and so constitute "prohibited transactions" (sometimes called PT's) in an IRA.  In a recent response to a client concerning some potential investments, I made the following comments, which I have paraphrased here for the benefit of others:

From our perspective as people working self directed retirement plans(who do not provide legal, accounting or investment advice), the loan you propose to make to a spouse or lineal family member and the investment in a siblings existing business venture are transactions that would probably be viewed by the IRS as prohibited (self-dealing) and if you proceed with these transactions, the entire assets of your IRA may be deemed distributed to you as of January 1st of the tax year in which the transactions were made, if discovered and reported.  The financial penalties for a forced distribution like this are in my view, severe and not worth the risk. 

Some CPA’s or other advisers take the view that a specific, individual transaction is unlikely to ever be discovered by the IRS.  If you accept this idea and do a transaction of this nature, you are playing a form of tax roulette. 

I keep thinking of the actor Wesley Snipes possibly serving time in prison because his advisers told him paying income tax is unconstitutional and therefore unnecessary. Do you think he is happy today with that decision, even though he had the use of the money that should have gone to taxes? http://www.cnn.com/2008/CRIME/04/24/snipes.sentencing/

You may be better served if you are in need of money and have no other source, to take a taxable distribution now from your IRA.  If you make risky transactions and  are audited, you may end up on an ongoing, never ending merry-go-round with the IRS.  You have to ask yourself whether this is something you really want, or must have. You also need to understand that it is very difficult or may be impossible to replace this money in the IRA through contributions in the future.

In my experience with clients who cannot get a loan from any other source because their income or assets are insufficient to support the loan or their current debt service is too high to be sustainable, even if they could legally borrow from their IRA (which you cannot legally do per Section 408 of the IRS code available at:www.irs.gov/pub/irs-tege/irc408.pdf), they are not truly capable of making the payments to service the additional debt.  This may not be the case for you, but I wanted to share my experience.

Recently, I have seen a parade of clients in deep financial distress and great economic and emotional pain and strain.  19 of 20 are looking for a solution to their pain that does not involve any risk or additional pain or any reduction to their current lifestyle or any additional cost.  For those 19 who find a short term, “painless” solution (painless = very expensive in current/future costs or interest rates) to a current economic problem, typically an unsustainable debt load and diminishing income (or no income) to service it, they are back in deep distress in a year or less, with the additional burdens created by the “painless solution” they took in the first place.

The 1 in 20 who take the time and honest effort to review every aspect of their finances and credit and who adjust life style and budget to a sustainable level have less stress, more peace of mind and a simpler life style they can maintain in the future.  The other 19 are merely living for the moment and putting off the inevitable…

If you make an investment with IRA money from your Self Directed IRA, all returns on the investment must go back into the IRA as they come in, for the exclusive benefit of the IRA.  You cannot have the personal use of the plan assets for a while and then put them back into the IRA at your convenience.

I certainly understand the temptation, but the facts are not in your favor when you tempt fate by forcing a prohibited transaction using IRA assets. My advice to friends, family and clients is the same. 

Do not tempt fate or you will most likely regret it.