The Internal Revenue Service prohibits investors from buying certain kinds of assets, such as rugs and collectibles, with individual retirement arrangement funds. From a legal perspective, because currencies are not included on the prohibited list of investments, nothing prevents you from buying foreign currency or exchanging currency inside your IRA. However, IRA custodians can enforce additional rules, and many custodians would not allow you to trade currencies inside your IRA.
Your IRA contributions are tax-sheltered, which means you do not have to pay taxes on your pretax contributions or the account's earnings until you make withdrawals. To prevent investors from misusing these tax-deferred funds, the IRS requires you to establish an IRA account with a trustee, such as an investment firm or bank that acts as the custodian of your IRA money. Generally, IRA custodians allow IRAs to hold only certain kinds of securities, such as certificates of deposit or stocks. Custodians enforce such rules because holding assets such as real estate or foreign currency would increase the custodian's administrative costs. However, some firms offer self-directed IRAs in which you can hold any assets that do not appear on the IRS's list of prohibited IRA investments.
You must fund your self-directed IRA with domestic currency, but you can instruct the IRA custodian to buy foreign currency with that cash. The custodian physically takes possession of the cash, which might entail storing it in a safe-deposit box or vault. At any time you can instruct the custodian to exchange the currency for money from another nation. Alternatively, you can buy CDs or other types of securities that are denominated in foreign currency. When you redeem the CDs or sell these assets, the proceeds are converted back into U.S. dollars. Transactions involving certain nations, including North Korea and Sudan, are prohibited under federally imposed sanctions. You cannot buy currency or securities from those countries.
When you trade currency inside an IRA, you have to pay the same kind of fees and commissions that you pay to change currency for traveling. Investors who buy and sell foreign funds have to contend with currency exchange risk. The value of the dollar fluctuates on a daily basis, which means your foreign currency investment could lose value if the dollar rose in value. Conversely, your currency could rise in value if the dollar weakened. Some investors buy foreign currency when economic factors suggest that the dollar will weaken.
Some investors prefer self-directed IRAs because aside from buying currency, they can buy other types of assets such as precious metals, tax liens and shares in hedge funds. However, these accounts require active management, and firms that offer self-directed IRAs charge hefty administrative fees that could deplete your earnings. Furthermore, you cannot use real estate that you hold in an IRA for your personal use, nor could you freely use the foreign currency you bought. IRA withdrawals before age 59 1/2 are subject to a 10 percent tax penalty as well as income tax, although some exceptions apply. Make sure you understand the fees and the rules before you commit yourself to a self-directed IRA.
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