In the past couple months, we met quite a few potential investors who were very excited about the asset classes we invest in. However, some of them told us that they don’t have a lot of cash at hand to invest. But then the conversation goes:
“I see. What do you do currently with your old 401K plan or IRA money?”
“Not much.. invest in a bunch of stocks or bond funds”
“What if you could use that money to invest in these workforce housing assets?”
“Really?!”
“Yep, you just need to convert it to a self-directed IRA account.”
You see, sometimes a 1-minute conversation could make a big difference in your financial wealth.
So… WHAT is Self-Directed IRA?
A self-directed IRA is a type of traditional or Roth IRA that permits the account owner to invest in assets that are usually not allowed in a household brokerage company such as Fidelity or Charles Schwab. Using self-directed IRA, you could invest in a rental property, a private note or something as exotic as a coffee farm (if you prefer).
Aside from that, it is exactly the same as other IRAs and allows you to save for retirement on a tax-advantaged basis and has the same IRA contribution limits.
WHY investing using Self-Directed IRA?
Wide Range of Asset Selection. A typical 401K fund only offers 10-15 funds to choose from. While a regular IRA can give you more choices, it is usually limited to only stocks, bonds, mutual funds and other common investments. On the other hand, self-directed IRAs permits the account owner to invest their hard-earned money in the broadest spectrum of investments. As a matter of fact, the only assets that are explicitly prohibited by IRS are: life insurance contracts, collectibles (i.e. antiques) and certain derivative positions.
Take Back Control of Your Investments. When self-directed IRA opens doors to many different asset classes, it really put you back on the driving seat with regard to what to invest and where to invest. As long as you can find a custodian to agree to the asset of your choice, you’re good to go. (With any type of IRA, you need a custodian or trustee to hold the account for you.) Thanks to the flexibility of self-directed IRA, we see a growing number of investors employing retirement funds to invest in apartment complexes and manufactured home communities.
Liquidity. Besides the wide range of asset selection, investing using self directed IRA will not take away any liquidity you need for daily use. Since you cannot easily withdraw the money out of retirement account without penalty, that money is better suited for long term investment. With self-directed IRA, You can preserve cash liquidity while enjoying the benefit of investing in attractive private investments such as workforce housing.
A few things to know before opening Self-Directed IRA
Restrictions on Self-Directed IRA Investments. As per IRS rule, the account owner is not allowed to personally benefit from the IRA asset you invest in. For example, if you buy real estate using IRA, you cannot live in there, not even for one day! In addition any investment with a related party or disqualified person (i.e. any family member) is prohibited. You can find more detailed explanation here, but it is a best practice to consult with your CPA to understand all the relevant regulations.
Liquidity. If you are self-employed and have a legitimate business, you can also consider open a solo 401K plan which is similar to self-directed IRA but allows two additional benefits:
- You can contribute more in solo 401K than IRA. In 2019, you are allowed to contribute up to $19,000 in 401K vs. $6,000 in IRA.
- Solo 401K allows checkbook control, which means it doesn’t require a custodian approval to hold your investments.
Custodian Selection. There are quite a few custodians out there that offers self-directed IRA accounts. You should do your research to choose the right custodian. One thing to keep in mind is that there are fees associated with setting up the self-directed IRA, which includes account opening fee, asset investment fee and annual asset holding fee. So it’s best to compare the fees across different custodians. Also different custodian may have different process in accepting investments, so it is also important to understand their process before you choose one. We are also happy to provide recommendations if needed.
Conclusion
It is important to pick the right investments for your long term wealth growth, but it is equally important to make sure your investments reside in the appropriate investment vehicle. Self-directed IRA is one of these vehicles that can expand your the investment horizon and help accelerate your wealth growth, if used properly. There are a lot more about it than what we can cover in this short article, so we strongly suggest you to do your own research, but we are here to help if you have any questions!
