My email to Senator Ron Wyden RE: the proposed RISE Act of 2016

Recent News, Self Directed IRA, Tax


As some of my readers are aware, Senator Ron Wyden (D-Oregon; Ranking Member of the Senate Finance Committee) has been very interested in the self-directed IRA market for some time.  For example, his office commissioned the two Government Accountability Office (GAO) reports that are focused on retirement accounts that purchase “nontraditional” assets (e.g., real estate, private equity, etc.).  The first GAO report (on “large balance IRAs”) was published in late 2014; the second report (on various self-directed accounts – e.g., SDIRAs, Solo 401k, ROBS) is still pending.  In somewhat of a culmination of these efforts, Senator Wyden’s office recently released proposed legislation, called The Retirement Improvements and Savings Enhancements (RISE) Act of 2016.  If enacted, this legislation would eliminate Roth Conversions, limit the maximum size of Roth IRAs, and likely, in an indirect way, eliminate ALL non-traditional investments within any type of IRA.  In other words, this legislation would likely have profound impacts on one trillion dollars of retirement assets (assuming non-traditional assists make up approximately 14% of retirement assets).  Senator Wyden’s office requested “public comment” on the proposed legislation.  Below is my complete email to Senator Wyden


Dear Senator Ron Wyden,

I am writing as a practitioner (and academic) in the area of individual retirement accounts.  More specifically, my tax law practice focuses almost entirely on the legal, tax, and estate planning aspects of investing IRAs into “non-traditional” assets (i.e., assets that are not sold on a public exchange) – and I believe that I am generally regarded as an authority on the topic.  In general, I take the view that investing an IRA into non-traditional assets can make financial sense for some clients (although I am not my client’s financial advisor and do not make investment recommendation), but extreme caution must be taken to abide by the complex legal framework.  I do not represent IRA custodians and/or “facilitators” (e.g., non-attorney “facilitators” that promote IRA-owned LLCs, IRA-owned trusts, Solo 401k, and/or “ROBS”), because doing so could easily result in a conflict of interest as it relates to individual IRA owners.  I have been interviewed by the GAO prior to the publication of both of their reports (as you know, one has been published and one is pending) and I have also connected with Ms. Getz (Senior Tax Counsel in your office), for the purpose of offering your office with commentary and general guidance on these matters.  [Side note: I find the term “self-directed IRA” inherently confusing because, in a sense, all IRAs are “self-directed”; thus, it is unwise to try and put any group of IRA accounts into a specific “box” – and doing so within legislation would likely lead to very harmful results, as I will discuss more below].

The purpose of this email is to provide several comments regarding your discussion draft (dated September 8, 2016) of The Retirement Improvements and Savings Enhancements (RISE) Act of 2016.  Please keep in mind that these comments are based on my experience “in the trenches” with thousands of individual IRA investors, so I am hoping to give you a practical perspective that you might not otherwise receive from either the GAO, IRA custodians, and/or organizations that represent IRA custodians (e.g., RITA).  The majority of my clients would likely be categorized as “middle class” (or perhaps “upper middle class”, depending on where these people live), but I have represented clients with self-directed IRA account balances ranging anywhere from $20,000 to $70,000,000 – and the vast majority of these clients invest some IRA money in “traditional” investments (publicly-traded stocks, bonds, mutual funds, etc.) and the remainder in “non-traditional” investments (e.g., real estate, private equity, Promissory Notes, etc.).

Expressing whether I agree or disagree with the general policies behind the proposed the RISE Act provisions is not my general intent here – rather, I want to provide additional education regarding the likely consequences of these proposed changes.  I find from talking with attorneys, CPAs, and financial professionals throughout the country that unless someone works in this area on a daily basis (which is very rare), it’s hard to see all the potential downstream consequences – both related to the current rules (e.g., prohibited transaction) and potential new legislation.

With the above being said, below is a list of comments (in no particular order) that I hope you will find useful and/or informative:

  1. The vast majority of “self-directed IRA” investors are investing amounts ranging from $50,000 to $500,000.  These investors typically have a general uneasiness with regards to publicly-traded markets, either because they have felt “burned” before (e.g., 2000-2002; 2008-2009) or because they believe the long-term prospects of the public market is shaky.  Many of the investors have had success (or have at least felt more comfortable) owning rental real estate investments in their individual name, and thus, they want to get some (or all) of retirement funds into real estate as well.  The vast majority of these people have reported back to me that they are very happy with their decision to buy non-traditional investments, despite the fact that these investments also have their ups and downs (e.g., real estate market 2007-2010).  Also, as a general matter, these people are not “rogue” individuals, but rather, they are people with normal jobs (e.g., teachers, engineers, attorneys, doctors, pilots, etc.) and an intense focus on complying with the IRA-specific rules.
  1. In my opinion, the concerning part of the self-directed IRA marketplace is the companies that promote a specific investment purpose (e.g., “buy gold!”; “buy tax liens!”; “invest offshore!”), yet deflect all responsibility for educating the IRA investor on the risks (both from an investment perspective and also a legal/tax perspective).  However, to be fair, I believe that these unscrupulous tactics are used within the “publicly-traded space” as well.
  1. Although it’s glamorous for publications to write about “Silicon Valley executive with huge Roth IRA!”, the majority of very large IRAs (e.g., $5M+) that I have seen were not created by purchasing an isolated asset (e.g., start-up stock), but rather resulted from an already large qualified plan (e.g., defined benefit plan) that was rolled into an IRA.  I have seen numerous situations where large pre-tax IRAs were converted to a Roth IRA over the course of numerous years and then the Roth IRA continued to grow steadily over the course of many years.  In this way, the “Mega Roth IRAs” that you refer to were the result of basic math (i.e., exponential growth through wise investment; and likely a mix of publicly-traded and non-traditional assets), not some sort of sinister plot (and the federal government received exactly what it asked for – i.e., early tax revenue from the large initial Roth conversion).
  1. I don’t agree with the logic behind forcing Roth IRAs to take RMD.  To me, a pre-tax (not Roth) IRA is essentially a partnership between the federal government and the IRA’s owner [i.e., the IRA’s owner gets a deduction up-front in exchange for granting a “partnership share” (eventual tax) to the federal (and possibly state) government.  In this sense, the federal government has a strong incentive to capture “their share” of the tax revenue, and thus, requiring distributions (RMD) during the IRA owner’s lifetime works to “even out” the partnership.  This concept doesn’t apply to Roth IRAs, because essentially the IRA’s owner “buys out” the federal government’s partnership share at the beginning (e.g., Roth contribution or conversion), which has obvious benefits to the government (e.g., early tax money), so the IRA owner should expect additional benefits (e.g., no RMD) down the road.  To say that the RISE Act would “harmonize the rules” sounds good in theory, but to me, it doesn’t fit with the tradeoffs I described in this paragraph.
  1. Increasing the RMD age and/or slowing down the required distribution rate definitely makes sense – assuming you are looking at the increase of average life expectancy over the past 50 years.  However, as a practical matter, the math behind this proposal does very little – because the rules are already setup to allow the RMD to last well past the point when the vast majority of Americans have passed away.
  1. The “valuation concerns” portion of the proposed RISE Act is the most problematic.  First, as a general matter, the idea of the federal government (via the Tax Code) telling people what “fair market value” means is counter to the basic principal currently in the Tax Code.  By definition, fair market value is a transaction between a willing buyer and willing seller, with neither having a compulsion to act.  Requiring a valuation in all situation leads to bad results – for the IRA owner, the seller of the asset, and the federal government.  Let’s look at several situations that I have seen very recently in practice and examine the potential consequences of this valuation idea:
  • An IRA owner wants to have his IRA buy a rental real estate property from an unrelated third party, and the seller is willing to agree to a price (e.g., $150,000) for numerous reasons (including the fact that the IRA will be using all cash – something that is almost always the case in the non-traditional IRA world).  If the Tax Code forces the IRA owner to have his IRA pay for an appraisal, not only will that slow the transaction (and make it more costly), but it could lead to some very odd results.  For example, if the appraisal came back at $170,000, would the rule mandate that the IRA pay $170,000?  That would be bad for property seller (because the sale would likely never happen), bad for the IRA’s owner, and bad for the federal government (because, at least with regards to a pre-tax IRA, the lack of additional value within the IRA would result in less future income tax revenue – and at ordinary income rates).
  • What about private equity / hedge fund investments using IRAs?  There are likely tens of thousands of investors who are using large brokerage houses (not the mom and pop shops that you might incorrectly assume are holding all non-traditional IRA assets) to purchase very small percentages of private equity investments (via C Corps, LLCs, or LPs).  These funds often involve hundreds of investors and are structured by very large investment managers.  They inherently have “no public market value”, so they would inherently be swept up into the RISE Act as well.  Is that really what is intended here?  If so, this will surely cause a fire storm that is much more broad than you might realize (for example, most investors I come across that have retirement accounts invested into private equity through larger brokers, e.g., Merrill Lynch, UBS, etc., do not consider themselves “self-directed IRA” investors – they just think that illiquid investments in exchange for better long-term results makes sense; I wouldn’t be surprised if many of your colleagues have retirement funds in these types of investments!).  It will also result in the federal government’s future tax revenue within retirement accounts being much less diversified – because it will force all funds into the publicly-traded markets, which tend to move in unison.
  1. There is no need to prohibit IRAs from investing into an entity in which the IRA’s owner (or another “disqualified person”) holds a 10-49% interest, because the IRS/DOL already has the latitude to scrutinize these situations, assuming the situation constitutes a “fiduciary prohibited transaction”.  In addition, because the draft legislation says that the IRA’s investment is attributable to the IRA’s owner for purposes of the “maximum 10%” rule, the rule would effectively disallow an IRA from owning 10% or more of an entity, regardless of whether the IRA’s owner (or any other disqualified person) as also an owner in the entity.  If that is the true intent, then this also raises problems.  For example, what if an IRA buys a piece of real estate, but for liability reasons (that are entirely unrelated to federal tax law), the IRA invests through an LLC (i.e., the LLC holds the real estate).  This 10% rule would effectively mean that an IRA could buy a piece of real estate, but it could not buy it through an LLC – which is completely illogical (and encourages legally dangerous and inefficient behavior).

I would be happy to provide additional commentary on these topics – both now and/or going forward.  Again, the primary purpose of this email was to try and point out several potential problems associated with the discussion draft of the RISE Act.

Thank you for your time.

Very best regards,

Warren L. Baker