What Are the IRA Custodian Requirements?

An Individual Retirement Arrangement (IRA) is a tax-advantaged savings plan that individuals use to build a nest egg for their later years. An IRA custodian is a financial institution responsible for holding and administering the assets within the account. Federal law mandates that an IRA must be held by a qualified custodian. This entity acts as a gatekeeper, processing transactions and maintaining the integrity of the retirement account on behalf of the owner.

The role of the custodian is strictly administrative and custodial. They are tasked with executing the account owner’s instructions for contributions, distributions, and investments, all while adhering to a framework established by the Internal Revenue Service (IRS). This structure is designed to safeguard the assets and ensure proper tax treatment. Without a custodian, an IRA cannot legally exist, and the relationship between the account holder and the custodian is formalized through a custodial agreement.

Eligible Entities and IRS Approval

The IRS has specific requirements for entities that wish to serve as IRA custodians. Certain types of institutions are automatically eligible to act as custodians without needing special approval. These include banks, federally insured credit unions, and savings and loan associations.

Other entities, such as brokerage firms, mutual fund companies, and specialized trust companies, can also become custodians, but they must first apply for and receive approval from the IRS. This process is detailed in Treasury Regulation 1.408-2, which outlines the criteria an applicant must meet. The IRS evaluates several factors to determine if a nonbank entity is fit to be a custodian. Applicants must demonstrate:

• Continuity of business
• Experience and competence in handling retirement funds
• Adequate net worth to ensure financial stability
• Robust auditing and accounting systems
• Established rules of fiduciary conduct, ensuring they will act in the best interest of the account holders

Core Fiduciary and Administrative Duties

An IRA custodian has several core responsibilities. The most fundamental duty is to safeguard the investments held within the IRA. This means ensuring the assets are properly titled and held separately from the custodian’s own assets and the assets of other clients, except when pooled in a common investment fund.

The custodian is also responsible for processing all financial transactions as directed by the IRA owner. This includes accepting and recording all types of contributions, whether they are annual contributions, rollovers from other retirement plans, or employer contributions to SEP or SIMPLE IRAs. Similarly, the custodian must process distribution requests from the account owner, ensuring the withdrawals are executed correctly and in a timely manner.

Maintaining accurate and detailed records is another primary duty. The custodian must keep a precise history of all activity within the account, including every contribution, distribution, investment purchase, sale, and any associated earnings or losses. Based on these records, the custodian provides regular statements to the IRA owner on a quarterly and annual basis. These statements offer a transparent view of the account’s performance and transaction history.

Mandatory IRS Reporting

A significant responsibility of an IRA custodian is to report account information to both the IRA owner and the IRS. This reporting is done through specific tax forms that are essential for tax compliance. The information provided on these forms helps the IRS track tax-deferred savings and ensures that account holders report their contributions and distributions correctly on their personal income tax returns.

One of the primary forms is Form 5498, IRA Contribution Information. The custodian files this form with the IRS and sends a copy to the account holder by May 31 of each year. It details all contributions made to the IRA for the prior tax year, breaking them down by type, such as traditional IRA contributions, Roth IRA contributions, rollovers, SEP contributions, and SIMPLE contributions. Form 5498 also reports the fair market value of the account as of the end of the year, which is used for calculating required minimum distributions (RMDs).

When money is withdrawn from an IRA, the custodian must report the event using Form 1099-R. This form is sent to the recipient and the IRS early in the year following the distribution. It shows the gross amount of the distribution and indicates how much of it may be taxable. A piece of information on Form 1099-R is the distribution code in Box 7, which tells the IRS the reason for the withdrawal, such as a normal distribution, an early distribution, a rollover, or a distribution due to death or disability.

Custodial Limitations and Prohibited Transactions

While a custodian’s duties are extensive, their role is also strictly defined and limited. A standard IRA custodian is an administrator, not an advisor. They are prohibited from providing investment, legal, or tax advice to the IRA owner. This distinction is particularly important for individuals with self-directed IRAs, where the account owner has complete control over investment choices.

The custodian also plays a role in preventing prohibited transactions, which are dealings that could improperly benefit the IRA owner or other disqualified persons. As defined by the Internal Revenue Code, these transactions include actions like borrowing money from the IRA, selling personal property to the IRA, or using the IRA as security for a loan. Engaging in a prohibited transaction can have severe consequences, potentially causing the entire IRA to be treated as distributed and fully taxable.

If an IRA owner directs the custodian to undertake a transaction that the custodian knows is prohibited, the custodian is required to refuse it. This gatekeeping function helps protect the tax-advantaged status of the IRA.