Why Would You Want a Custodian on Your IRA Account?

Custodians are integral to the establishment of Individual Retirement Accounts (IRAs). Internal Revenue Service rules require you to keep your IRA with a certified custodian -- typically, a bank, credit union, brokerage firm or any agent with IRS approval to administer IRAs. The custodian's job is to make sure your IRA operates within the law and to provide important documentation to you and the IRS.

Documentation Requirements

As per IRS rules, your IRA is created by a document that stipulates, among other things, that your annual contributions and deductions cannot exceed IRS limits, that you must make contributions in cash, that you can roll over assets from other retirement accounts and that you cannot use the account to purchase life insurance. Essentially, the account document binds both you and your custodian to IRS rules.

Custodial Responsibilities

You are not allowed to make IRA transactions yourself. Rather, you must tell your custodian what to do and let the agent act on your behalf. Custodians are responsible for purchasing and selling assets inside IRAs, as well as collecting earnings on your deposits and investments. Custodians are also responsible for making sure accounts in their care do not run afoul of IRS rules.

Reporting Requirements

Your custodian is responsible for issuing both you and the IRS a completed Form 5498, IRA Contribution Information, and, if applicable, a Form 1099-R to record the amount and type of distributions you took from your IRA during the year. Most custodians also issue a statement of Fair Market Value (FMV) that tells you what your account was worth at the end of the previous year. If IRS rules require you to take mandatory distributions from your account, you need an FMV to calculate the amount.

Types of IRA Custodians

Most people use their IRA contributions to invest in traditional securities, such as stocks, bonds and mutual funds. If you want to purchase any of these, you will have no problem finding a reputable financial institution to act as your IRA custodian. However, if you want to invest your IRA in non-traditional assets, such as shares in a business startup, a farm or real estate, you must find a reputable self-directed IRA custodian who is IRS-approved.

Prohibited Transactions

A self-directed custodian should help you avoid violating IRS self-dealing rules that basically prohibit you from benefiting from anything you purchase with your IRA, except to profit from it. For instance, if you purchase shares of a dairy farm, you can profit from the sale of milk and cheese but cannot eat it yourself. If you purchase a vacation real estate property, your IRA can collect rents from the property, but you cannot stay there yourself. If you violate these rules, the IRS will revoke your account's IRA status.

References

• Internal Revenue Service: Publication 590 -- How Can a Traditional IRA Be Set Up?
• Internal Revenue Service: Instructions for Forms 1099-R and 5498
• Internal Revenue Service: Publication 590 -- Prohibited Transactions
• Forbes.com: Rev Up Your IRA
• Financial Web: What Is my IRA's Fair Market Value (FMV)?

Resources

• MoneyGirl: How to Choose an IRA Custodian