If, like so many people, you made your IRA contribution for 2017 only recently in 2018, just before the 2017 tax return filing deadline, you missed earning up to 15 months of pre-tax investment returns on your contribution.
Don’t repeat that mistake. Make your IRA contribution for 2018 now. This will provide an additional year's worth of pre-tax investment returns compared to making the contribution at the last moment in April 2019. You will also get pre-tax compounding on these extra returns for potentially decades to come, until they are finally distributed. And you'll get these extra returns for every year that you make your contribution early, rather than late.
Don’t worry about making a mistake. If it later turns out that you are ineligible to make the contribution, you can fix the error without penalty up to October 15th of the year after the year for which the contribution was made. Excess contributions can be withdrawn, and eligible IRA or Roth IRA contributions can be recharacterized as being made to a traditional IRA, and vice versa.
2. Illegal Investments
The law allows a very wide range of investments to be made through an IRA, but not all kinds. IRAs cannot invest in:
- Life insurance: The purpose of an IRA is to provide funds to be used in retirement, not after death.
- Collectibles: These include antiques, artworks, coins, gems, rugs, stamps, alcoholic beverages, and other tangible personal property that obtains its market price from value to collectors.
Exceptions: An IRA can invest in certain specified U.S. gold and silver coins. See Publication 590-A, Contributions to Individual Retirement Arrangements (IRAs), for details. It can also invest in gold, silver and platinum bullion of specified purity [see Tax Code Section 408(m)].
The amount of any illegal investment is deemed distributed to you. If you are under age 59½, a 10% early distribution penalty may apply as well.
3. Prohibited Transactions
These are many improper uses of your IRA by you, your beneficiary, or any other “disqualified person” including members of your family (spouse, ancestor, lineal descendant, and any spouse of a lineal descendant). Examples of such improper use of an IRA include:
- Borrowing money from it
- Selling property to it
- Using IRA assets as security for a loan
- Using IRA funds to buy property for you
Basically, if you benefit from your IRA in any way other than receiving a distribution from it, or support your IRA financially in any way other than making a contribution to it, you should be concerned about the possibility of committing a prohibited transaction.
The trap is that many investments that are legal to own in an IRA can readily lead to making prohibited transactions.
Example: It is legal for an IRA to own real estate. Thus, you can have your IRA buy a vacation condominium. But a prohibited transaction occurs if...
- You or members of your family use the condo
- Should the condo need cash to pay for repairs, taxes or other expenses, you advance money to it
- You or a family member personally guarantees the condo's mortgage or financial obligations
- An equity loan is taken against the condo for the benefit of a family member
Similarly, an IRA can own an operating business. But a prohibited transaction may result if the IRA-owned business employs a family member, receives funds from a family member to cover a cash need, has its debt guaranteed by a family member, or makes payments to a family member.
Safety: Don't let your IRA make any kind of investment that might ever need a cash infusion, exceeding the cash available in the IRA. A stock investing risk is buying stocks "on margin" (using borrowed funds). If the stock market falls, the IRA may be subject to a margin call that it doesn't have the funds to cover.
Danger: A prohibited transaction will be fatal to your IRA. The penalty is having the IRA disqualified and deemed distributed on the first day of the year in which the transaction takes place.