Custodians, also called trustees, vary by type of IRA. Marketable securities, such as mutual funds or stocks, require no effort to choose a custodian; however, IRAs that have alternative investments, such as private notes, precious metals or real estate, need a self-directed IRA custodian. An Individual Retirement Account (IRA) offers investors certain tax benefits for retirement savings. Some common examples of IRAs are the traditional IRA, the Roth IRA, the simplified employee IRA (SEP) and the employee savings incentive compensation plan IRA (SIMPLE).
All IRAs are run by custodians for investors. Custodians may include banks, trust companies, or any other entity approved by the Internal Revenue Service (IRS) to act as custodians of an IRA. Most IRA custodians limit IRA account holders to stocks, bonds, mutual funds, and certificates of deposit approved by the company. An IRA is a custodial account and requires a custodian to maintain their tax-advantaged status.
The custodian ensures that all investments are approved by the Internal Revenue Service and also completes all required reports and documentation for the tax authority. The custodian acts as the basic account supervisor and is also responsible for functions such as sending investment performance statements and buying and selling investments for the IRA. With a self-directed IRA, there is also an external custodian, but this company simply acts as an intermediary between you and the investment. The custodian maintains and manages assets and is responsible for keeping records, but generally does not assess the value or legitimacy of the investment.
A custodian is needed for any IRA. The custodian of a self-directed IRA is going to be different from that of its normal guardian. You can't go to one of the big box stores, like Edward Jones or Charles Schwab, and have a truly self-directed IRA. They have accounts that they call self-directed, but in reality, you can buy from a fixed menu of investments that they have created for you.
An IRA doesn't have to be strictly a custodial account. It can also be a trust account. The differences between a custodial account and a trust account are minor, but significant. Both types of accounts hold funds for the benefit of the account owner, but the trustee has discretionary authority over the funds in the account, while the custodian does not.
The custodian maintains control of the child's Roth IRA, including decisions about contributions, investments, and distributions. In addition, the statements are sent to the custodian. However, the child is still the effective account holder and the funds in the account must be used for the child's benefit. When the minor reaches a certain required age, normally 18 or 21 years old in most states, the assets must be transferred to a new account in their name.
Once you find a custodian, you'll open an account and contribute money to it, just like you would with any other IRA. A custodial IRA is an individual retirement account that a custodian (usually a parent) has for a child with earned income. Once the custodial IRA is opened, the custodian manages all the assets until the child turns 18 (or 21 in some states). All of the funds in the account belong to the child, allowing him to start saving money right from the start.
In addition to taking advantage of the benefits of combined growth, your child may be able to use the funds for future expenses, such as college tuition, or even to buy a first home. You can open a Roth IRA with custody or a traditional IRA with custody, and the appropriate account rules and benefits will apply. If you choose the option of a non-self-directed IRA, there are several financial institutions available to act as custodians, once you have established your account with them. This means looking for a custodian who knows the rules regarding consolidation and understands what types of IRAs cannot be combined.
The following graph illustrates how the amounts of annual contributions to the Roth IRA can turn into impressive sums over many years. David Moore, of IRA Advantage, and Tom Moore, of Equity Advantage, explore misconceptions about self-directed IRAs and discuss whether a custodian is required. In addition, at the time of retirement, the account owner must have had a Roth IRA open for at least 5 years, counting from the start of the first calendar year that a Roth IRA was opened. Self-directed IRAs allow you to invest in a wide variety of investments, but those assets are often illiquid, meaning that if you're faced with an unexpected emergency, you may have difficulty getting money out of your IRA.
Brokerage firms act as custodians for many types of IRAs, but most reputable brokers don't offer self-directed IRAs. The custodians of self-managed IRAs are usually companies that specialize in them, including some banks and trust companies. For additional information on IRAs, see the Internal Revenue Service's Online IRA Resource Guide. The responsibilities of an IRA custodian or trustee are determined by the provisions of the trust agreement or custodial account.
Establishing a Roth IRA for children allows the children in your life to start taking advantage of the opportunity to grow up tax-free at an early age. Most institutional IRA providers will act as trustees for the accounts they provide. A brokerage agency could be the IRA entity of your choice if you like the idea of investing in individual stocks or bonds, as well as in mutual funds or ETFs. Fraudsters are more likely to exploit self-managed IRAs, as the custodians or trustees of these accounts may offer only limited protections.