Do you have a hankering to diversify beyond the typical stock, bond and exchange traded-fund holdings that generally comprise the bulk of one's retirement investments? For the more entrepreneurial minded and adventuresome investor, the self-directed individual retirement account is an option that anyone can use to invest in alternative assets such as rental real estate or gold.
Confidence in the stock market as a place to invest may be on the decline, as fewer Americans put their money into stocks during the last decade. The number of Americans who invested in stocks hit a high at 65 percent in 2007 before the global financial crisis hit, according to a Gallup poll. That number has trended lower to 52 percent in 2016.
The typical company-provided 401(k) retirement plan or traditional IRAs allow investors to choose from a variety of mutual funds, ETFs, bond funds or cash. These are all paper assets. A self-directed IRA allows investors to purchase and hold tangible assets in an account.
"Tangible investments, such as real estate and precious metals, are assets that you can drive by, touch and feel. These types of assets can often provide a safety net for investors who feel that having all their retirement savings invested in the stock market might be too risky," says Nate Hare, executive vice president at Quest IRA in Houston.
There are no legal differences between an IRA with traditional investments such as stocks and mutual funds and an IRA holding nontraditional investments such as real estate, Hare says.
"The only differences are with the company administering the IRA in question," he says.
Most mainstream brokerage companies offer traditional IRA options. Investors interested in other strategies will need to find an IRA custodian that specializes in alternative assets.
Rising inflation concern in the current climate could be one reason to consider alternative assets like real estate or physical metals for your retirement account. The price of these assets tends to rise as inflation increases.
"I have clients and I personally participate in real estate IRAs," says Angela M. Thomson, certified financial planner at Coastal Financial Planning in Lincoln, Rhode Island. "They are a very easy transaction, provided that all the titling has been done properly in the initial phases of the purchase."
Investors can purchase and own any type of real estate in a self-directed IRA from a rental house to an apartment complex to commercial real estate. All rental income would be funneled back into the IRA and all maintenance and taxes would be paid out of it.
"The rental income is treated as dividend income and not taxable because it is held under the IRA umbrella until normal retirement distributions occur," Thomson says. "It is a great way to defer taxes and rental income for a sustained period of time. Substantial taxes are saved annually, as all income is being deferred in the IRA."
There are more hoops to jump through when using a self-directed IRA and account holders need to make sure they follow the rules. For example, an investor can't live in a property held in an IRA, nor can any of the investor's family members.
As an example, an investor has a small rental in his IRA, says Chris D. Hardy, certified financial planner and CEO of Paramount Investment Advisors in Suwanee, Georgia.
"His tenant calls and says that the dishwasher quit working," Hardy says. "The investor, being fairly handy and frugal, decides that he can do the replacement himself. He goes to the local home retailer, purchases the dishwasher and delivers it to the house and installs it himself."
[See: 7 Reasons to Invest in an IRA.]
In this situation, multiple prohibited transactions have occurred, Hardy says.
"First, one of the prohibited transactions is to provide services to the plan by a disqualified person," he says. "This investor cannot go and pick up any supplies and deliver them to the house personally. He would need to hire and pay someone, from his IRA, to do this. Also, if he were to purchase the dishwasher with his own funds and not the IRA funds, this would be a prohibited transaction."
On the plus side, rental returns can be a fairly predictable and stable asset. Thomson points to an example of a $200,000 property that will generate $1,400 a month in rental income or $16,800 annually.
"Assuming real estate taxes, municipality taxes, insurance and property maintenance represent $5,500 annually, you have netted a gain of $11,300 or 5.7 percent gain on your investment," Thomson says. "Given the level of volatility in the market, most clients would be happy with a stable and reliable annual return at that level."
There are risks and managing a rental property takes time and work. There are the "same risks as any other property, you can lose money, you can be sued, and tenants can tear up your property," says David L. Blain, chief executive officer at BlueSky Wealth Advisors in New Bern, North Carolina.
"Investing in real estate isn't as easy as the late-night infomercials make it out to be. I've invested in real estate for many years, and it's not a sure thing or necessarily higher returns, especially when factoring in your time and effort," he says. "For the IRA investor, an additional risk is that you don't follow all the rules correctly and the IRS assesses massive taxes, penalties and interest. It happens all the time."
Another option investors have with a self-directed IRA is to invest and hold physical metals.
Gold is wealth insurance, says Philip Diehl, president of U.S. Money Reserve, headquartered in Austin, Texas, and former director of the U.S. Mint.
[See: 8 Gold ETFs to Buy Anytime.]
"Gold outperforms other asset classes when hard times come and often rises when other assets are crashing," Diehl says. "Including gold in your portfolio protects your wealth by offsetting losses in your other assets."
There are rules surrounding what types of physical metal can be put into an IRA. Diehl points to various weight American Gold Eagle and 1-ounce American Silver Eagle and Platinum Eagle coins minted by the Treasury Department as approved coins.
Beware, you can't store these coins at home if buying them in an IRA.
"Coins approved for use in an IRA must be held by an IRA trustee," Diehl says.
Investors should expect to pay an annual or quarterly fee based on the size of the IRA.
Kira Brecht is a regular contributor to US News & World Report. She has two decades of experience as a financial journalist and market analyst, writing about the stock and commodity markets, investing and active trader strategies, the economy and the Fed. She empowers individual traders and investors with the skills and knowledge needed to achieve their financial goals. She has passed Level 1 and 2 of the Market Technician's Association (MTA) Chartered Market Technician (CMT) exam. She was managing editor at SFO (Stock, Futures & Options) Magazine for 10 years, creating digital magazine, newsletter and online content aimed at educating the individual investor. She contributes to a variety of publications including TD Ameritrade's Ticker Tape, Dow Jones/Wall Street Journal newswires and Kitco, a precious metals news service. Follow her on Twitter @KiraBrecht. Connect with her on LinkedIn.