Who is IRA custodian?

When saving for retirement, IRAs are one of the retirement vehicles you can use to grow your retirement savings. The most popular IRAs include traditional IRAs and Roth IRAs. However, regardless of the type of IRA you have, the IRS requires that you must have an IRA custodian to manage your IRA investments and provide custodial services for your IRA assets. But who is an IRA custodian?

An IRA custodian is the financial institution that manages your IRA funds and ensures that your IRA investments are approved by the IRS. The custodian acts as the overseer of the IRA account and is required to perform various functions such as buying and selling investments, sending account statements, and ensuring the IRA complies with existing regulatory requirements.

Who is an IRA custodian?

An IRA custodian is a financial institution that is authorized by the IRS to offer custodial services and hold assets on behalf of IRA owners. According to IRS rules, an IRA must have a custodian, which can be a bank, mutual fund company, or brokerage firm. The IRA custodian is responsible for buying and selling investments on behalf of the IRA investor, and ensuring that the IRA complies with IRS rules. The custodian charges a fee for offering custodial services and managing investments on behalf of the investor.

Types of IRA custodians

There are several types of IRA custodians that you can use. Here are the common custodians for standard IRAs:

Banks

If you want to invest your IRA money in FDIC-insured securities or money market funds, you can use a bank as the IRA custodian. Some of the investments you will have access to include certificates of deposits and money market mutual funds. However, banks have limited investment options, and you may not be allowed to hold investments outside marketable securities. Also, banks that offer brokerage services charge higher fees than traditional brokerage firms.

Mutual fund companies

You can use a mutual fund company as the custodian of your IRA to get access to mutual funds. You can also invest in ETFs that are offered by mutual funds. Mutual funds pool funds from multiple investors and invest these funds in various securities like stocks and bonds.

Brokerage firms

If you plan to invest actively in stocks, bonds, ETFs, and mutual funds, a mutual fund can be a good choice for an IRA custodian. The brokerage acts as the middleman by acting as the linkage between sellers and buyers. They earn fees or commissions when the facilitated transactions are completed.

Insurance companies

If you choose an insurance company as your IRA custodian, you can invest your IRA savings in premium annuities. The annuities can be either fixed or variable. Annuities pay investors a stream of payments in the future for a defined period or the remainder of an investor's life.

Robo Advisers

Robo-advisors are automated algorithm-based investment platforms that IRA investors can use to manage their investments. These platforms gather information through an online survey and then invest the IRA money based on the investor's risk profile. Since there are minimal human interactions involved, Robo Advisers charge lower fees than traditional brokerage firms.

IRA Custodian for Self-Directed IRAs

If you opt to open a self-directed IRA, you can choose alternative investments that are different from those available in a standard IRA. Self-directed IRAs can offer alternative investments such as real estate, crypto, and gold, which carry higher risks than stocks and bonds. These investments are available through a self-directed IRA custodian.

The three main types of providers for self-directed IRAs include:

Custodians

A custodian is a financial institution authorized by the IRS to hold assets and offer custodial services. These institutions mainly offer marketable securities, and they tend to avoid holding private investments.

Administrator

An administrator is an intermediary between the IRA owner and a partner custodian that holds the IRA assets. An administrator does the work that a custodian would do were they allowed to hold private investments. These custodians are usually non-bank trust companies that are licensed by specific states.

Facilitator

Similar to an administrator, a facilitator also acts as an intermediary between the IRA owner and the custodian. They can be individuals or small companies, and they help investors navigate the IRS rules and implementation. The facilitator will then pass the IRA owner to a custodian.

Risks of Self-Directed IRAs Custodians

In 2018, the SEC issued an investor alert of potential fraud risk in self-directed IRAs. This is because self-directed IRAs have a broader and riskier portfolio of assets than standard IRAs, hence increasing risks through volatile performance and fraudulent schemes.

When choosing a custodian for a self-directed IRA, you should choose a true custodian to avoid violating IRS rules. You will want to work with a custodian that is aware of the IRS-prohibited investments such as collectibles and certain precious metals. Holding the prohibited investments could trigger severe penalties and additional taxes.

Some fraudsters use self-directed IRAs to legitimize their schemes. These fraudsters claim to vet and approve the underlying investments, but as the SEC notes, IRA custodians don’t evaluate the quality of investments in the self-directed IRA. However, true custodians hold and manage assets in IRA accounts, but they do not offer investment advice or recommend investments.

Key Considerations when choosing an IRA custodian

When choosing a custodian, you should consider the following features:

Investment options

Find IRA custodians with a wide selection of investments comprising stocks, mutual funds, and bonds. A well-diversified portfolio can reduce risk exposure in an IRA. If you have a self-directed IRA, find custodians with alternative non-traditional investments like real estate and private companies to increase potential returns.

Fees

You should consider the commissions and investment fees that IRA custodians charge. Key fees to consider include the annual account maintenance fees, mutual fund loads, and trade commissions. If you are investing in mutual funds, find a custodian with no-load mutual funds.

Customer service

Managing an IRA can be frustrating if there are no knowledgeable specialists to answer your questions. Find custodians with the right technology and expertise to manage your IRA assets. A good custodian should have open channels of communication, either online or telephone, to respond to investor queries.