By Brian Hepp

To help you save money for retirement, there are a number of options available. One of the most common is the Individual Retirement Account (IRA). While hundreds of investment alternatives are accessible through an IRA, there are some types of investments and transactions that the IRS doesn’t allow in IRAs. Therefore, it’s important that you, as an investor, understand exactly what you can and can’t do with these types of accounts.

Special IRS rules governing IRAs fall into two general categories —those restricting the types of investments that can be held within an IRA, and those limiting the types of transactions that can be executed. To help make you aware of these rules, we’ll take a look at each in more detail.

Technically, the IRS doesn’t actually “approve” assets in IRAs, but it does indicate which assets are not allowed. Some of the investments that are prohibited include: life insurance, artwork, rugs, antiques metals, gems, stamps, coins (with limited exceptions), alcoholic beverages and certain other tangible personal property.

As mentioned earlier, the IRS not only prohibits certain types of investments, but also certain types of transactions. Some examples of prohibited transactions are: borrowing money from your IRA, selling property to your IRA, receiving unreasonable compensation for managing IRA assets, using the IRA as security for a loan, and buying property for personal use (present or future) with IRA funds, among others.

Specifically, the rules regarding IRA transactions don’t allow for self-dealing. In other words, the rules are designed to keep a reasonable distance between you — the investor — and your investments.

The relationship between you and the assets in your IRA is probably more complex than you thought. One thing you need to understand is that you and your IRA are two separate entities in the eyes of the IRS. That may seem logical, but it is an important distinction. As the owner, you actually own the account, but there is also a custodian or trustee through which your assets are managed and held. You can direct them to purchase or sell an asset for your account, but you cannot become directly involved in the transaction itself.

Also, you cannot be a manager, director, officer or other individual compensated directly or indirectly by any company you are investing in within the IRA either. In addition, you cannot personally transact business with your IRA, such as buying assets from the account or selling to the account any assets you own outside of the IRA. Once again, these rules keep you separated from the investments in your account.

It is essential that you are aware of the types of transactions that are prohibited, because the penalties for breaking the rules can be stiff. If at any time during the year you engage in a prohibited transaction within your IRA, the account stops being an IRA as of the first day of the year (the same holds true if your beneficiary engages in such a transaction). Your account is then treated as having distributed all of its assets at their fair market value as of the first of the year. You will have to pay income taxes on this amount. The IRS’ 10-percent early-withdrawal penalty may apply as well.

While many of us spend our time worrying about what we can do with our investment accounts, pay close attention to the things you can’t do as well. Regular review of your IRA holdings will also help keep you in line with your goals and objectives.

Brian Hepp is a financial consultant for Santa Monica-based A.G. Edwards & Sons, Inc. Member SIPC. He can be reached at (310) 453-0077 or brian.hepp@agedwards.com.