Inside the Little-Known Self-Directed IRA

By Heather Taylor0 Comments

Many investors don’t realize that you’re not limited to stocks, bonds and mutual funds when it comes to retirement investing. Susan and Dale of New York were under that impression until they began to research alternatives.

“To my surprise, I discovered there were many non-traditional assets such as real estate, tax liens and promissory notes that our retirement dollars could invest in using a self-directed IRA,” she says.

Susan opened a self-directed IRA and has been utilizing her account to invest in promissory notes.

Real estate investor Lowell of California learned about the concept in 2013 and decided to transfer his 403(b) account into a self-directed IRA.

Lowell used his account to acquire a bank-owned property for just over $85,000 which provided rental income for two years, before generating nearly 77-percent return1 on investment (ROI) when he decided to sell the property.

As a real estate investor, Lowell prefers the idea of using his retirement account over borrowing to fund his investments. 
 
Best-kept secret for investors?
Investors can use self-directed qualified retirement accounts to invest in a variety of assets, in addition to stocks and bonds. Allowable investments include real estate, tax liens, promissory notes, private entities, and more.

Self-directed accounts include the Individual Retirement Account (IRA), Roth IRA, 401(k), Simplified Employee Plan (SEP), and Savings Incentive Match Plan for Employees (SIMPLE), as well as Health Savings Account (HSA) and Coverdell Education Savings Account (CESA).
 
When investing in alternative assets with a qualified retirement account all profits and expenses flow through the account. Tax advantages may include tax-free or tax-deferred growth within the account depending on account type.

Though some investors have never heard of the concept, self-directed investing is nothing new. Since IRAs were established by the government in 1974, the IRS has listed items that are not permitted in an IRA (the entire list can be found in IRS Publication 590).

Think you don’t have enough to invest? You’d be surprised
Some investors mistakenly think self-directed investing isn’t an option because they don’t have enough in their retirement account. Susan thought this was the case until she learned that she could partner her IRA with other self-directed retirement accounts.

She partnered with family members’ IRAs (three total) to loan funds to a real estate investor to complete a rehab. She utilized a third-party servicer to structure the promissory note. During a 14-month term, the note yielded a return of over $42,000, a 25-percent ROI1. The return must be split according to the percentage loaned from each account and returned to the accounts accordingly.

How to get started with self-directed investing
The first step to self-directed investing is opening and funding a self-directed retirement account. There are a few ways to do this, including:
  • Open an account and fund with an out-of-pocket contribution. Assuming you or your spouse earned taxable compensation for the year, you can make a contribution to your qualified retirement account from your personal checking or savings account, or by credit card.
  • Move funds or assets from an existing qualified retirement account to a new qualified retirement account. The funds or assets are transferred directly from your current financial institution to the self-directed custodian.
  • Complete a rollover, which involves moving funds from a qualified plan, such as a 401(k), 403(b), Thrift Savings Plan or other qualified plan, to an IRA. A rollover typically occurs when you receive a personal distribution from your previous employer or current provider of your plan and deposit it into the new account.  Consult with your financial professional to determine if a rollover is appropriate.
Not all custodians offer self-directed qualified retirement accounts; Equity Trust Company is one such custodian. IRS Publication 590 provides guidelines for owning and investing with an IRA. In addition to the list of investments not permitted in an IRA, the publication provides information about:
  • Disqualified individuals
  • Indirect benefits
  • Unqualified Business Income Tax (UBIT)
As with any investment, your due diligence is key. Before making an investment decision consult with a tax, legal or financial professional.

1The case studies are for educational purposes only. Past performance is not indicative of future results. Investing involves risk, including possible loss of principal. Information included in the above case studies were provided by the investor and included with permission. Equity Trust Company does not independently verify all information provided by third parties.

Want to learn more about opening a self-directed IRA? Request a free consultation with one of our Senior Account Executives.