In today’s modern economy, investors have a plethora of investment options at their disposal, each with their own associated risk/return profile.
With such a wide variety of choices, it can be difficult for investors to select the most appropriate option for their needs. In this article, we will be providing our readers with information on an increasingly common type of investment: the Gold Backed IRA.
We will be answering the following frequently asked questions:
- What is a Gold Backed IRA and how does it differ from a regular IRA?
- What are some of the advantages and disadvantages of this type of IRA?
- Is this type of IRA suitable for me?
- What do I need to do if I want to open such an account?
What is a Gold Backed IRA and how does it differ from a regular IRA?
This type of IRA falls under two categories: the ‘self-directed IRA’ and the ‘precious metals IRA’. A self-directed IRA is simply an IRA in which the owner of the IRA is in charge of all the investment decisions related to that account. A precious metals IRA is a type of IRA in which the funds in said account can be invested in precious metals; currently there are four types of precious metals which are permitted to be invested in by the IRS: gold, silver, platinum, and palladium. The funds must also be used to directly own the physical commodities themselves (for example, investing in Gold Exchange Traded Funds is not permitted). The specific requirements for the allowed precious metals can be found here.
Similar to a regular IRA, precious metals IRAs also fall into two types: traditional and Roth. In the former, contributions are tax-deductible in the year they were made while withdrawals in retirement are taxed at ordinary income tax rates. In the latter, it is the opposite, with no tax deductions for contributions but generally tax-free withdrawals. This is no different for precious metals IRA. However, because the IRS does not permit the investor to have actual physical possession of the gold, a trustee will have to be appointed to hold the physical gold, usually in a licensed depository. As such, administration and storage fees are applicable, with annual fees typically being in the $250 range.
What are some of the advantages and disadvantages of this type of IRA?
This type of IRA is just one vehicle for investors to obtain physical commodities (in this case, gold) in their portfolio. Adding gold to one’s portfolio can have several benefits, namely:
Providing a safe haven component to a portfolio due to its capability as a store of value.
One needs to only have a cursory knowledge of history to know that gold has been used as a form of currency for thousands of years. Even paper money’s value was initially backed by gold, although that is no longer the case. As such, the money supply can and is easily manipulated, which may affect the long term value of the currency as a whole. Investing in gold provides a hedge against inflation and currency depreciation; further, while stocks can go to zero and bonds can default, gold will always have value.
Adding a good level of portfolio diversification due to its low or negative correlation with other traditional investments such as stocks and bonds.
The theory of portfolio diversification states that an ideal diversified portfolio contains investments which are only loosely correlated with each other, resulting in the overall risk of the portfolio being lower than the sum of its parts. Gold’s correlation with the price of stocks and bonds has historically ranged from the negative (particularly during recessions) to low positives that usually remain below the 40% mark.
Good historical returns over the long-term.
While over the past 5 years, gold prices have been volatile and generally on a negative trend, on a longer-term (10 year) basis, its average annual returns stood at 5.71% (as at Dec 2015), far above for example, 10-year US Treasury yields.
For further details on the above, kindly refer to our article ‘Why Invest in Gold?’ However, it is our responsibility to ensure that you are also aware that Gold IRAs are not without its risks, such as:
Price Volatility Risk
While gold’s function as a store of value is undeniable, it is still subject to the same market forces that affect the prices of all commodities and financial assets. As mentioned, gold prices have exhibited significant volatility, with many analysts pinpointing speculative forces behind this volatility. As such, gold may not be a viable short-term investment, although as previously shown, it can and has demonstrated good long-term returns.
Risk of Fraud or Theft
Because the IRA investor is not permitted to physically possess the gold, a broker and custodian is required in the process, exposing the investor to counterparty risk. This comes mainly in two forms, namely fraud and theft. Some companies may issue ‘gold certificates’ to the investor which may or may not be reflective of the amount of physical gold they actually have. In the latter, gold is always subject to the risk of theft. This risk can be mostly mitigated by choosing the right gold investing company, for more on how to do that, refer to our guide here.
Risk of Regulatory Changes
While the aforementioned four precious metals are currently allowed by the IRS, there is no guarantee that this will not change in the future. After all, IRS regulatory decisions can often be highly vague and seemingly arbitrary without any benefit to the common taxpayer. Unfortunately, there is nothing we can really do to manage this risk, however we assess this risk as very small and it would be unwise to not take advantage of some of the benefits of Gold IRAs because of this!
Is this type of IRA suitable for me?
Each investor is unique, with individual financial goals and resources. As such, careful consideration and evaluation of the advantages and disadvantages of such an IRA as elaborated above and elsewhere on this site should be made prior to making any investment decisions. However, we would like to dispel the notion that investing in gold is a complicated investment that is suitable only for highly sophisticated individuals. That is not true in the least; in fact it is quite common for ‘regular investors’ with only basic retirement accounts such as 401(k) and Thrift Savings Plans rolling over said accounts into gold backed IRAs in order to obtain said benefits. You can also chat with expert advisors from our gold company of choice here to ensure you have all the information you need before making any decision.
What do I need to do if I want to open such an account?
If you have made the decision to invest in a Gold IRA, the process of doing so is actually very simple. Once you have chosen the ideal Gold IRA custodian, everything is as simple as filling out a few forms. For example, if you wish to do a 401(k) to gold IRA rollover your current plan into a Gold IRA, the safest and fastest method is a direct rollover.
Today’s economy can be highly uncertain, and with globalization increasing the inter-connectedness between individual economies, the butterfly flapping its wings in China can indeed cause a hurricane here in America. Gold investments can offer the smart investor protection over his or her portfolio in such times, in addition to its other benefits. Fortunately for us, with the IRS liberalization on owing precious metals in our IRAs, owning gold has never been easier. We encourage everyone to look closer into Gold IRAs, and we hope that this article has helped furnish you with some of the information you would need to make the right investment decision for your needs.