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Financial
Aug 15, 2014

Self-Directed IRAs – A New Trend In Retirement Wealth Building

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In this article, I’d like to discuss some of the core differences between self-directed IRAs and traditional IRAs, and explore some of the ways a self-directed IRA can be used as a powerful investment tool. But before we delve into this topic, let me be clear in saying that self-directed IRAs are not for everyone. Before you consider taking the path of a self-directed IRA, I strongly recommend that you consult with your financial adviser and discuss your intentions for leveraging your retirement savings in this way.
 
The reason that I chose this topic is that self-directed IRAs have become somewhat of a hot trend lately in the investment arena, and yet I still interact with many folks that are unaware that self-directed IRAs are even an option. I’m not saying a self-directed IRA is the best option for you, but I do think that everyone should at least be aware that this option exists. In the past it seemed as if self-directed IRAs were reserved for and used exclusively by the wealthy elite. But today, they are more commonplace, and many people are discovering smart ways to leverage them to produce attractive investment returns with the same valuable tax advantages as traditional IRAs.
 
So what is the difference between a traditional IRA and a self-directed IRA?
 
A traditional IRA is a tax-deferred retirement account made up of various securities, such as stocks, bonds and mutual funds, which are registered with state and federal authorities. A self-directed IRA is still a tax-deferred account, but it comes with added flexibility that allows you to invest in things other than securities. Instead of the usual stocks, bonds and mutual funds, you may choose, for example, to invest in commercial or residential property, a small business, or unregistered securities. Some people are rolling over traditional IRAs into self directed IRAs, while others are opening new self-directed IRA accounts with the intention of using them for a variety of investment purposes.
 
While there are many types of investments for which self-directed IRAs may be used, the trend I’m seeing the most is people leveraging their retirement savings to purchase real estate and rental properties. If there is a good deal on property, these accounts can provide the cash flow needed to make the investment. Self-directed IRAs also can be used as a down payment for a mortgage on a property, but because cash buyers typically get the best deals, I’m seeing a lot of investors using this tool as a resource for buying real estate in cash. A self-directed IRA can provide capital and an effective channel for investing, and in many cases the return on investment is higher than what you might get from a traditional IRA. However, there are several important things to consider before choosing this financial tactic:

Restrictions. There are many restrictions and tight guidelines that limit the use of self-directed IRAs and the money made off the investments. For example: 

  • A self-directed IRA will shelter gains on account transactions, but if you lose money, you can't deduct your losses.
  • You are only allowed to use the money as direct capital for investing and to cover administrative costs.
  • Money from self-directed IRAs cannot be used to make improvements on an existing structure.
  • You can’t stay, live or work in the investment property.
  • All of the profits must go back into the account until retirement to avoid tax penalties.
  • You must have an official third-party custodian for the IRA. 
Risk. A self-directed IRA is inherently riskier than the registered securities that make up most traditional IRAs. Plus, the very fact that the money you are using is intended to fund your retirement makes it even riskier. Leveraging your retirement savings to invest in property (or anything else for that matter) is basically a high-risk, high-reward investment strategy. So, it’s important that you manage that risk by having confidence in the investment you choose and the people involved in it. I also want to note here that investment fraud and scams related to self directed IRAs have become a growing problem, so I urge you to do your due diligence before investing.
 
Many investors will start an limited-liability compnay with a dedicated business checking account under the self-directed IRA business name. This makes it easy to track and manage all investments and profits related to the account and keep the transactions separate from other financial accounts and activities. Most investors assign a special administrator to handle the account to avoid accidental transactions that could jeopardize the tax advantages.
 
Let me reiterate; self directed IRAs are not for everyone. If you’re not interested in proactively investing money, and that includes the required upfront research and ongoing management of your investments, then this is probably not the right choice for you. However, if you are interested in investing in your future retirement a little more aggressively, and you’ve identified a promising opportunity, a self-directed IRA can serve as an excellent source of capital. Everyone’s individual situation is unique, which is why I will repeat the importance of consulting a financial expert.
 
 Patrick Stoy has 15 years of mortgage lending experience. Patrick is CEO of Wilmington-based Market Consulting Mortgage, which he started in 2005 with a mission to build lifelong customer relationships by providing real value. To learn more about Marketing Consulting Mortgage, visit www.macmtg.com. Patrick can be reached at [email protected] or 910-509-7105.

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