Unconventional Assets in DC Plans Remain Poorly Understood

A new report out from the Government Accountability Office (GAO), titled “Improved Guidance Could Help Account Owners Understand the Risks of Investing in Unconventional Assets,” suggests there is a significant lack of reliable data around the use of “unconventional” assets within defined contribution (DC) plans.

“Federal data collection efforts to date have captured little information on retirement accounts holding unconventional assets—such as real estate, precious metals, private equity, and virtual currency,” the report notes, “making the prevalence of such accounts unknown.”

According to GAO, in tax year 2015, the Internal Revenue Service (IRS) began requiring that custodians or trustees of individual retirement accounts (IRA)—including banks or other institutions approved to hold account assets—report selected information on unconventional assets in their clients’ accounts to IRS.

“As of November 2016, IRS plans to begin compiling the new IRA asset data in 2017, but has not specified when the new IRA asset data will be available for analysis,” GAO reports. “Seventeen of the 26 custodians, who GAO identified as allowing retirement accounts with unconventional assets and who participated in GAO’s data collection effort, reported having nearly half a million of these accounts in their custody at the end of calendar year 2015. IRAs made up the vast majority of accounts and assets reported.”

GAO’s review of industry documents found that individuals wanting to invest in unconventional assets through their IRA “generally agree to be responsible for overseeing the selection, management, and monitoring of account investments and shoulder the consequences of most decisions affecting their accounts.” For example, owners of such accounts assume a fiduciary role, which makes them assume greater responsibility for overseeing the selection, management, and monitoring of account investments, and shoulder the consequences of most decisions affecting their accounts.

According to GAO, current IRS guidance “provides little information to help IRA owners understand their expanded responsibilities and potential challenges associated with investing in unconventional assets.”

“Targeted IRS guidance for these IRA owners may help them navigate the potential compliance challenges associated with certain types of unconventional assets,” GAO argues.

NEXT: GAO calls for more guidance 

Among the most common challenges for which GAO would like to see guidance include the difficulty of monitoring such investments for federal tax liabilities.

“IRA owners are not always aware of the need to monitor the gross income from certain unconventional assets in their accounts for ongoing federal tax liability,” GAO warns. “For example, IRA owners who invest in active businesses or debt-financed properties need to monitor their accounts for ongoing tax liability that must be paid from the IRA. Failure to do so can result in underpayment penalties.”

Another challenge named by GAO is obtaining annual fair market valuations for non-publicly traded assets.

“IRA owners investing in hard-to-value unconventional assets can face challenges meeting their responsibilities to provide updated fair market value information to their custodian to meet IRS's annual reporting requirement,” GAO suggests. “Failure to provide an updated fair market value in a timely manner can result in a custodian prematurely distributing account assets to the owner at a fair market value that is not current, potentially incorrect, and which could lead to a loss of tax-favored status for their retirement savings.”

GAO adds that, without further guidance from IRS, people who invest their retirement accounts in unconventional assets may be placing their savings at additional risk.

“Retirement accounts allowing such unconventional investments increase owners' responsibilities in ways they may not understand—and mistakes can trigger taxes and penalties,” GAO concludes. “Moreover, account custodians may prematurely close an account or let valueless assets and fraud go undetected because they did not accurately determine the value of unconventional assets. We recommended that IRS improve guidance for account owners with unconventional retirement assets and clarify how to annually value such assets.”

The full analysis is available for download here.