Wednesday, September 12, 2007

Beyond staid IRAs

The Journal has an article on self-directed IRAs (free WSJ Digg link), specifically delving into making home loans in an IRA.

Through a little-known tool known as a self-directed individual retirement account, individuals can pursue a wide variety of investments, from real estate to businesses. Now, at least several thousand people are trying to goose their retirement savings by using self-directed IRAs to invest in mortgages, according to companies that promote the strategy.


IRA owners pay an annual custodial fee and transaction fees, ranging from $50 to a few thousand dollars a year, depending on asset size and activity. They typically charge borrowers a rate of at least 10%. If the borrower defaults, the IRA can wind up owning the property at a deep discount, since these deals are typically structured with the property as collateral.
But these investments aren't without risk.
For investors, one risk in foreclosing on a house is racking up so many expenses -- from legal fees to repair bills -- that the IRA runs out of money. If that happens, the IRA owner faces a difficult choice: Get a loan, or close out your IRA and pay any taxes or penalties.
Yet they are growing in popularity.
Self-directed IRAs make up less than 2% of the overall $4.2 trillion IRA market, but they are increasing in popularity. And the handful of firms that handle such accounts are logging increased usage by self-styled mortgage lenders.
Self-directed IRAs allow you to invest in other things besides real estate, such as a business, but you have to follow the rules for them set up by the IRS.
Another risk to investors is running afoul of the Internal Revenue Service's rules for IRAs. "You cannot take any kind of fee from your IRA for doing something inside your IRA, and if you have to start using money from other sources to bail out something happening with the loan inside the IRA, that's a big problem," says Natalie Choate, a Boston tax attorney. So it's important to make sure the IRA has enough money in it to pay any legal fees involved in foreclosure, or property taxes and insurance costs if you wind up owning a house for a while before you can sell it.
Investing in real estate or a business would take a considerable amount of capital, more than the $4000 you can put into an IRA in a single year. Presumably, you'd want to use an IRA that had grown into a nice sum, or a rollover from a large workplace retirement plan to fund the self-directed IRA. Self-directed IRAs look to be a way for the mass affluent to attempt to get greater returns and diversify from just stocks and mutual funds.

While doing more research on this topic, I also found this Business Week article from 2006. It talks about some more of the rules you must adhere to:
The biggest risk is "self-dealing," meaning that you've effectively used these tax-deferred funds for current use. Say you take $100,000 from your $1 million IRA to buy property on which you hunt and fish. If the Internal Revenue Service finds out about your personal use of the land, the entire $1 million could be considered distributed, and all the money subject to income tax and withdrawal penalties for account owners younger than 59 1/2. Slott says you shouldn't even let family members use the property, or any other asset in a self-directed IRA. The IRS may decide that there is a benefit to you.
I checked out the site of one of the companies that will help you set up a self-directed IRA, Guidant Financial Group. They offer a number of webinars which I might check out if I have time. Another site to explore is

Yet another resource I've been reviewing is IRS Publication 590 (The IRS publications are excellent resources). According to the publication, there are penalties and taxes for investing in collectibles, borrowing money from an IRA, selling property to an IRA. in a prohibited transaction, that person may be liable for receiving unreasonable compensation for managing the IRA, using the IRA as security for a loan or buying property for personal use (present or future) an IRA with IRA funds. It's a good idea to be familiar with this publication.