Retirement Tips: How To Choose the Best IRA Custodian

Understand these options and key features first

Reviewed by Charlene RhinehartFact checked by Ryan Eichler

There are several types of individual retirement accounts (IRAs), but they all have one thing in common. By Internal Revenue Service (IRS) decree, they must have a custodian. Basically, an IRA custodian is a financial institution that holds your account’s investments for safekeeping and sees to it that all IRS and government regulations are adhered to at all times.

Custodians aren’t hard to find. But to choose the best one for you, you first have to decide which sort of IRA you need and the type of investments you wish to make in it.

Key Takeaways

• To find the right custodian to maintain your account you need to first decide which sort of IRA you need and the type of investments you want to make.
• Self-directed IRAs require a different type of custodian than typical traditional and Roth IRAs, because they allow for investments beyond stock, bonds, and funds.
• Features that good custodians offer should include a wide range of investment options, low fees, good customer service, and a user-friendly website.

Traditional IRAs vs. Roth IRAs

The two main types of IRA accounts set up by individual investors are the traditional IRA and the Roth IRA. Both allow the money within the accounts to grow free of income tax.

The basic difference is that a traditional IRA reduces your taxable income in the year you make contributions, deferring any tax payments until you start withdrawing funds years later. In other words, this type of IRA is tax-deferred.

With a Roth IRA, there is no tax break on the sums you invest but no taxes are owed when you take the money out at retirement. In addition, there are no taxes owed on earnings in most cases.

Self-Directed IRAs

With both traditional and Roth IRAs, you can opt to have the account managed (that is, the custodian makes most of the investment decisions) or self-directed. A self-directed IRA is an IRA in which you choose the funding methods and instruments and it allows for expanded investment options.

Important

Because self-directed IRAs allow for a variety of investment options, they can provide greater diversification than standard IRAs. However, while all investments have risk, self-directed IRAs’ risks include a lack of legal and regulatory protection and a heightened risk of fraud, particularly when investing in alternative assets.

Technically, any IRA in which you make all of the investment decisions is “self-directed.” In the financial services industry, however, a self-directed IRA typically means an IRA in which the custodian allows you to invest outside the more traditional world of stocks, bonds, mutual funds, and exchange-traded funds (ETFs).

For example, you can invest in real estate, either through a real estate investment trust (REIT) or in actual physical property. Other options include a closely held business, precious metals, and even private mortgages.

Types of Custodians for Standard IRAs

If you are going the non-self-directed IRA route, a number of different financial institutions are available to serve as custodians, once you’ve established your account with them.

Banks

A bank is an option if you want to enjoy the FDIC-insured security of CDs or money market funds within an IRA. In general, however, banks don’t get particularly high marks for IRAs because most don’t offer many investment options outside of the aforementioned vehicles. Those that do offer broker-type services often charge higher fees than brokerages.

Insurance Companies

An insurance company often sells flexible premium annuities as its basic IRA. They can be either fixed or variable and offer account value protection, death benefit options, and automatic account management. However, IRAs are already tax-advantaged, so the tax advantages of annuities aren’t necessary within an IRA and you may pay hefty fees for having one.

Mutual Fund Companies

A mutual fund company allows you to invest in mutual funds or ETFs offered by the firm.

Brokerage Firms

A brokerage could be your IRA entity of choice, if you like the idea of investing in individual stocks or bonds, as well as mutual funds or ETFs.

Robo-Advisors

A relatively new entity, robo-advisors are online investment platforms that provide automated, algorithm-based portfolio management advice. Because these platforms are automated—meaning no human interaction is involved—costs, fees, and other expenses that can eat into the IRA’s rate of return are lower. 

Custodians for the Self-Directed

If you decide to go the self-directed route, things can get more complex. There are three types of providers for self-directed IRAs: custodians, administrators, and facilitators. Of the three, custodians alone are directly approved by the IRS and authorized to hold assets.

Administrators and facilitators act as intermediaries between you and a partner custodian that actually holds the assets. Therefore, if you intend to open a self-directed IRA, it’s best to stick with a true custodian.

When it comes to custodians for self-directed IRAs, all the aforementioned institutions theoretically could serve. But if you’re intrigued by any of the non-traditional investments open to self-directed IRAs, you need to be especially careful in your choice of custodian. It’s far too easy to violate IRS rules and regulations, and the penalties for doing so can be severe.

You’ll want a custodian that’s aware of the types of holdings the IRS prohibits, even for self-directed IRAs, such as collectibles and alcoholic beverages. For more on prohibited types of IRA investments, and other triggers for penalties or additional taxes, see IRS Publication 590-A.

Features of the Best Custodians

When its time to choose a custodian, these are the features to be aware of:

Wide Investment Selection

The greater the selection of investment options, the better. This applies to all types of investments, but especially to individual stocks and bonds as well as mutual funds and ETFs. If you are a self-directed IRA investor, look for non-traditional investment opportunities including real estate or privately held companies.

Low Fees

Fees come in many shapes and sizes and include annual account maintenance fees, loads (for mutual funds), and commissions charged for making trades. Just because one custodian charges a specific type of fee doesn’t mean all do. Maintenance fees, for example, aren’t a given. One important area, if you are considering mutual funds, is to look for a custodian that offers a variety of no-load mutual funds.

Good Customer Service

Unless you’re comfortable with a robo-advisor, the availability of knowledgeable specialists to answer your questions—online or by telephone—is very important. Nothing is more frustrating (especially if you are managing a self-directed IRA) than receiving incomplete or confusing answers to your questions.

User-Friendly Website

Make sure the website is easy to use and that you can monitor your investments and make transactions efficiently. Even without committing to investments, you should be able to navigate the custodian’s online site extensively enough to determine if it is a comfortable fit for you. 

Consolidation Savvy

If you already have multiple IRA accounts, some experts advise that you consolidate them into a single account and custodian, if possible.

Seek out a custodian that is knowledgeable about the rules regarding consolidation and understands which types of IRAs can’t be combined. 

Restricted Investment Options

Watch out for custodians that restrict your investment options because of the nature of their charter. It’s important to note that IRA custodian restrictions aren’t the same as IRS restrictions on IRAs themselves or rules based in tax law. 

What Is a Retirement Account Custodian?

All IRAs, by IRS decree, must have a custodian. Basically, it is a financial institution that holds your account’s investments for safekeeping and sees to it that all IRS and government regulations are adhered to at all times. A custodian may or may not advise on or manage your IRA investments.

Do Self-Directed IRAs Use the Same Type of Custodian as Traditional and Roth IRAs?

No, self-directed IRAs require a different type of custodian than typical traditional and Roth IRAs, because they allow for investments beyond stock, bonds, and funds.

What Types of Financial Institutions Provide Custodial Services for IRAs?

Many different financial institutions can serve as IRA custodians, once you’ve established an account with them. Banks, insurance and mutual fund companies, brokerage firms and online robo-advisors are among the options you can choose from.

The Bottom Line

When opening an IRA, it’s important to ask yourself several questions before choosing a custodian. Do you prefer a traditional or Roth account? Or both? Are you happy investing in CDs, mutual funds, stocks, and bonds or do you yearn for the more adventurous options available with a self-directed IRA?

Once you’ve made those decisions, it’s time to consider custodians and factors that distinguish one from another such as investment options, fees, and customer service.

Read the original article on Investopedia.