If you want to use your IRA to invest in something other than stock market based investments you can open a self directed IRA with a custodian that will allow you to invest in alternative investments. While this type of retirement account will give you more control over where your money is invested, it may be risky for the average investor. It has the same advantages and disadvantages that a stock market based retirement account has if you as the investor makes uneducated investment decisions. Any financial planner worth his salt would tell you to invest in what you know and understand. In classes I teach I will ask my students “who in here has mutual funds?” most everyone in the room will raise their hand. Then I will ask “who can tell me the name of your mutual fund and who can tell me the name of the fund manager?” No one knows that. The point is we put our retirement futures into the hands of someone we don’t know and into something we don’t understand.
You can invest in a wide variety of choices which is one of the biggest pros associated with a self directed IRA. These investment choices include but are not limited to real estate, tax liens, private companies and even gold and silver bullion coins. The truth is you can invest in anything that isn’t on the IRS’ list of “prohibited transaction.” About the only investments that aren’t allowed are life insurance, S-Corporation stock and collectibles, that’s it.
Another obvious pro is diversification. If you have your IRA truly diversified across many asset classes you would have less exposure to the different markets as they fluctuate. If you have a portion in stock market based investments, a portion in real estate, a portion in loans, and a portion in precious metals you have less exposure to any one particular market.
One of the cons associated with taking control of your retirement account is you need to educate yourself regarding the rules of investing. What you can invest in and who you can invest with. It is your responsibility to understand the rules and to follow them. One of the biggest things you want to avoid is what the IRS calls self-dealing, which can result in large penalties. This refers to receiving a benefit today from the transaction your IRA has engaged in.
Another Con associated with a self directed IRA is higher fees. The few custodians that offer a truly self directed IRA tend to charge more because of the extra work associated with handling alternative assets. It’s important that you find a custodian that has experience working with the specific alternative investment you are interested in.
Only you can weigh the pros and the cons. Only you can decide if self direction is right for you. Remember it’s your retirement future we are talking about. I don’t know about you but as for me I want to be in control of my retirement future. I will do my homework and know the rules so I don’t commit a prohibited transaction. I can’t leave my retirement future in the hands of someone else, it’s mine.
For more information on taking total control your retirement funds contact us today.
Timothy Schubert CISP
When choosing a Self Directed IRA Custodian here are a few points you will want to keep in mind. First and foremost, you want a custodian that you can have a long term relationship with. You need to feel comfortable with how your communication is with your custodian. Do they answer the phone when you call? Do they call you back when you leave a message? You want a custodian that you feel you can trust and has the experience needed to manage your specific type of alternative investments successfully.
There are many SDIRA custodians to choose from, but their services and fees can vary considerably. Be sure to read the fine print on the custodians’ fee schedules. Take your time comparing the services they provide and the fees they charge. There is nothing worse than hidden fees, like termination fees or transaction fees that are in the fine print you never read or asked about. If you are not careful all of your profits can be gobbled up in your custodians’ fees. Know the fee schedule and ask them to explain all of their fees to you before you move your IRA funds to any custodian.
Typically a SDIRA custodian will not offer investments; they just manage the alternative investment that you choose to invest in. They also will do all the required reporting to the IRS on a yearly basis like the 5498, this reports the value of your retirement account and it also reports if you did any rollovers and contributions into your IRA. They are also responsible to report any distributions out of your IRA on form 1099R.
And finally you want to choose an SDIRA Custodian that has a clear understanding of the complex rules and regulations when investing in alternative investments. They should be able to provide you with good information concerning these rules and regulations. If you are asking basic questions on self dealing and prohibited people and they do not know how to explain it to you, keep searching. You want a staff that is competent when it comes to the rules and regulations and can articulate what those rules and regulations are.
We here at Blue Diamond Documents have formulated relationships with a number of SDIRA custodians that we can refer you to. Remember, read the fine print, ask the right questions and do good due diligence on any company you are going to trust with your retirement funds.
Timothy Schubert CISP
There are a lot of would be investors that want to get their retirement funds out of the stock market and into alternative tangible assets like real estate. But a lot of account holders have a problem; they don’t have enough funds in their retirement account to buy a rental property. Sure there are great deals in real estate today, but that doesn’t matter if you don’t have enough money to grab those good deals.
Today we are going to explore ways to use other people’s money in your self directed retirement account so that you can invest in this buyers market.
The first method is partnerships. Partnerships are probably the most common way of raising capital and for me it is the easiest way to raise capital. A partnership is created when there is more than one person or IRA investing together to buy an asset. I have used the IRA owned LLC method to create partnerships and it has worked very effectively. We have created a Limited Liability Company and have added those IRA accounts as members for example a member would be ABC Custodian FBO John Smith IRA and ABC Custodian Jane Smith IRA and so on. I have an LLC that I manage that has eight different members. Ownership of the LLC is determined by capital contribution. If my IRA has contributed 50% of the total capital to the LLC then my IRA owns 50% of the LLC and would receive 50% of the profits from the investments the LLC makes.
The best way to create partnerships is to talk to your friends and family. More often than not they are unaware that they can use their retirement accounts for alternative investments. Most Americans think that their only investment choices are in the stock market. If you talk to your circle of friends about their ability to get out of the stock market and into assets they control and manage they will thank you for it.
Another way to use other people’s money in your retirement account is through non-recourse loans. These are loans that your retirement account would obtain; remember it is prohibited for you to extend credit to your IRA. So you are not able to get a loan for your retirement account based on your good credit history. Let’s go thru the steps that it takes to get a non-recourse loan. First there are certain lenders out there that understand this concept and will lend to an IRA, not very many lenders understand this concept and will not lend to your retirement account. What the bank will be looking at is the value of the property, how much can the property rent for and how much cash is in your IRA. They typically require 50-60% down they are usually 2 to 3 percent higher than a typical loan with their interest rate and they want you to have in your cash reserves 10-20% of the loan amount after you close. It sounds like it has a lot of requirements but you must remember the bank is not lending you the money to buy the investment property, there is no recourse against you in the event of a default. The bank is lending to your IRA and your IRA owned LLC will now have a property titled to it and it will now have a mortgage. I have two mortgages in my IRA owned LLC, without the help of non-recourse loans there is no way that I would be able to invest in two rental properties. It’s a great way to use other people’s money.
Another way to use other people’s money is thru the use of a simple prom note. Mostly this is done without collateral, so it could be a little more risky. Most people I know that do this are doing this with people they know and have a good comfort level with. My IRA borrowed funds from my brothers IRA and that allowed me to invest in a project that required me to be a qualified investor. I was a qualified investor but I had no cash in my IRA. So with the help of my brother and his IRA I was able to take advantage of a great investment opportunity. Prom notes are easy and quick. Most self directed custodians just require that you create a promissory note and both parties sign and deliver it to the custodian. Of course for me I have checkbook control of my IRA funds and I never ask my custodian to get involved in the transactions my LLC are engaging in. I always have a good paper trail for all of my transactions that includes good well written promissory notes.
If your strategy is to fix and flip then you may consider a hard money loan. You will pay anywhere from 13-18% for this type of loan. But you are typically out of these loans in 90 days or less. I know of a hard money lender that charges 18% guaranteed 90 days of interest in other words you have to pay him at least 90 days worth of interest. Let’s say you identify a property that cost 100K and this lender requires 40% down that would require you to come up with 40k to purchase this property. He will put in 60k and will require a minimum of 90 days worth of interest at 18% that equals $2700.00. Let’s assume you sell the property in 70 days for 150k. Your lender will be paid back their principal of 60k and interest of $2700.00 for a total of $62,700.00. After your original $40k your profit in a 70 day loan is $47,300.00. Hard money loans are great for short term loans and if structured right it is good for both the borrower and the lender.
An important reminder that if you are considering using other people’s money in your IRA you need to familiarize yourself with the UBIT rules. Always continue to educate yourself about the power of self directed IRA and ease of an IRA owned LLC.
Timothy Schubert CISP