Energy, Oil, & Gas IRA

The beauty of a self-directed IRA is the fact that you can invest in a much wider array of investment options than you could opt for with traditional stocks and bonds. You truly do get to direct the selection of your investments beyond the boundaries of Wall Street or the Securities and Exchange Commission.

Investors who engage in the opportunity of self-directed Individual Retirement Accounts use their IRA funds to fund start-up companies and private placements, accrue real estate or precious metals, or proffer private loans. Another popular choice is investment in energy assets such as oil, gas, biofuels, and solar, water, and wind power.

As you can see, the traditional designation of “oil and gas” IRA is misleadingly narrow; the energy field encompasses a far greater array of options than just petroleum products or fossil fuels!

How it Works: the Energy, Oil, & Gas IRA

The first step of a self-directed IRA is setting up the Individual Retirement Account itself. Since you are planning to invest with an eye to growing your IRA, you may want to consider the Roth IRA over the traditional IRA. The Roth requires you to pay taxes on the amount you contribute to the IRA, rather than the (presumably larger) amount you will withdraw later. In other words, once you’ve paid the up-front tax on your contribution, all of your earnings are effectively tax exempt.

The second step is to fund your new IRA. You can deposit your own money, up to the allowable contribution amount, and you can also roll over funds from other IRAs (tax free) if you want to build up your resources for use in the self-directed IRA.

The next, often ongoing, step is to start selecting the energy commodities in which you would like to invest. It is often advisable to invite the help of a professional broker who specializes in the use of self-directed IRAs in the energy arena. This is one of the more complex areas in which to invest, and extra insight never hurts. Just remember that you get to make the final judgment call when it comes time to add assets to your portfolio.

Energy Options for the Self-Directed IRA

Because the options for energy investments are so diverse, it is worth taking a minute to contemplate what those choices really are.

These are just some of the possibilities.

• Commodities or futures contracts in oil and gas
• Shares in drilling and refining companies
• Real estate investments in land where oil drilling is scheduled (or likely)
• Mineral interests
• Investment in pipelines
• Wind farms
• Coal and natural gas
• Battery and power-storage technology
• Solar power ventures
• Biofuels
• Geothermal energy
• Hydroelectric energy, wave power, and hydropower
• Energy-efficient housing
• Foreign energy investments.

 

Challenges with the Energy, Oil, & Gas IRA

Energy assets are among the most complicated ventures for investment. It pays to be well versed in issues like surface rights, mineral interests, royalty streams, and working interests, just for a start. If you don’t yet know what those terms mean (or how they apply) you’ll definitely want to do some reading and be open to input from experienced experts.

Another challenge with energy investments is the fact that they are considerably less liquid than some other types of assets. An agreement on an oil well, for example, can continue for the full life of that well. With that in mind, you want to do your due diligence and make sure you completely understand the nature of the deal, as well as all of the relevant risks, provisions, and terms.

You should also be aware that some interests will be subject to the UBIT, or Unrelated Business Income Tax, even though you are operating from the shelter of your IRA. Application of the UBIT will depend on whether yours is a royalty interest or a working interest, so be sure you know where your investments fall.

Some subsets of the energy arena (like solar power) are less susceptible than others (like oil) to possible political upheaval. If you are focusing your resources on the gas and oil, your investments can be affected by factors ranging from domestic drilling to Middle East conflicts. A royalty trust in an oil well will also diminish in value over time, as the well becomes exhausted. (Obviously that is not a problem with investments in renewable energy sources.)

Advantages of the Energy, Oil, & Gas IRA

Until recently, there were plenty of tax incentives available to promote the use of personal funds in energy investments, and it’s worth looking into these to see if you qualify. (If you do, you might consider using money outside your IRA for energy investments.) However, the number of these incentives has dwindled in recent years, and there are plenty of avenues for investment that benefit from the tax-sheltered nature of a self-directed IRA, where you won’t be paying the income tax or capital gains taxes.

Publicly traded assets include closed-end funds and exchange-traded funds (ETFs) related to energy resources, or American Depositary Receipts (ADRs) that enable you to purchase shares in other regions’ oil companies, such as PetroChina, Britain’s BP, Royal Dutch Shell, or Russia’s Lukoil. Most of these options, however, are C-corporations whose dividends get doubly taxed. With the flexibility of your Self-Directed IRA, you can steer clear of the publicly traded options and get more creative.

For many investors, an attractive aspect of the energy arena is the opportunity to “go green.” Investing in renewable energy sources and technology will not only grow your IRA, but they can further the development of clean energy and a healthier environment. If environmentalism is important to you, you can further the cause of eco-engineering by investing your IRA funds in green energy.