self-directed IRA is the focus of this guide for passive real estate investors. First, it highlights the main idea behind the topic. It also outlines the risks and questions worth reviewing. As a result, you can approach the discussion with a clearer framework.
What to know about self-directed IRA
When I started self-directing my retirement funds in 2016 to invest in real estate, I had many questions.
I wish I had had a “go-to resource” to get my basic questions answered. That said, I’m pleased to provide you with a synopsis of my Passive Investing Masterclass episode with Scott Maurer of Advanta IRA to provide you with answers to some questions you may have.
What is a self-directed IRA (SDIRA)?
A self-directed IRA is a tax-advantaged plan that allows you to control what investments you invest in with your retirement funds beyond publicly traded assets. Just like a regular IRA, your SDIRA can be a traditional IRA (offering tax-deferred earnings) or a Roth IRA (where all earnings grow tax free). There are also solo-401K and SEP IRAs for those who own their own business. Be sure to partner with a self-directed custodian, like Advanta IRA, to find the best solution for your needs.
Regular IRAs may say you can “self-direct” (think Vanguard, Fidelity, and Schwab); however, they only allow you to invest in stocks, bonds, ETFs, and mutual funds.
What this means for investors
What are the benefits of an SDIRA?
With an SDIRA, you have the flexibility and choice of how to diversify your portfolio by investing in alternative assets like real estate, private equity placements (think syndications!), IRA LLCs (this gives you checkbook control), private notes, precious metals, and much more to build retirement income.
Your SDIRA can also borrow money through a non-recourse loan to finance the purchase of an asset.
SDIRAs also give you greater investing flexibility as you can partner with your personal funds, another person, and/or entity.
What can’t you invest in with an SDIRA?
In short, you can’t use your SDIRA to invest in life insurance or collectibles (coins, stamps, air, wine, cars, etc.).
Naturally, the next question is “why?” In my conversation with Scott Maurer with Advanta IRA, life insurance already has a tax-advantaged structure. Additionally, the life insurance policy is tilted to a person, not to the SDIRA account. The
reason you can’t invest in collectibles is that you can’t take possession or have a benefit from owning the asset (anyone want a glass of wine?).
Questions to ask before acting
The key here is the asset must be tilted to the SDIRA account and you can’t take possession of the asset.
Lastly, SDIRA funds can’t be lent to a “disqualified person.” That includes you, your spouse, your kids, or your parents.
I heard you can no longer have a “checkbook IRA” within your SDIRA… is that true?
The answer to this question lies in the response above. In December 2021, the courts handed down a decision in the case of McNulty vs Commissioner that stated that McNulty committed a prohibited transaction in her SDIRA by purchasing gold coins with her checkbook IRA.
On the surface, this would indicate that the IRS may be chipping away at the “checkbook IRA.” However, when you dig into the court case further, what landed McNulty in hot water was that she purchased the coins in her personal name using her checkbook IRA funds, then took physical possession of them, violating the two principles stated above. Had she “titled” the coins properly to the IRA and not taken physical possession of them (stored them in a vault), she would not have been found to have committed a prohibited transaction.
Risks and tradeoffs to review
How much money can I put in an SDIRA?
There is no limit to how much you can move from one retirement account to an SDIRA. If you have an existing IRA or old 401K, you can move all or part of the funds. There is a limit to how much you can contribute annually. This limit is set by the IRS and differs based on what kind of SDIRA you set up (i.e., traditional, Roth, solo-401K, SEP, etc.).
How do you open an SDIRA?
There are many SDIRA providers out there (one of our favs is Advanta IRA). The process to open an account is fairly straightforward.
1. Research SDIRA custodians and contact them to get your questions answered.
2. Complete the custodian’s application process to open your account (you will need to provide a government ID).
3. Fund your account. (If you are rolling over funds from another provider, allow for a couple of weeks for this to happen. No company likes handing over money.)
4. Start investing!
How do you invest in a syndication or fund with your SDIRA?
Practical next steps
Each SDIRA provider has a slightly different process to invest. However, the basic steps are the same.
1. You identify an asset to invest in.
2. Confirm you have enough funds to make the investment.
3. Send the private placement memorandum (PPM) forms to your SDIRA custodian to review and/or
complete. Each SDIRA custodian will have their own internal process for completing the PPM forms. Be certain to follow their process accurately and in a timely manner. This step alone can take 2-3 weeks, depending on the custodian.
4. Return the completed PPM forms to the operator you are investing with.
5. Fund your investment. Again, each SDIRA custodian will have their own internal process to follow.
Wrapping Up
Remember, your SDIRA custodian is NOT a financial advisor and they do not complete due diligence on any asset. Due diligence falls to you as the investor.
Summing up, SDIRAs can be a great solution for you to take greater control of your retirement funds and invest in alternative assets that can generate true passive income and wealth. Yet, with greater control, comes greater responsibility. As of today, I’ve made over 15 investments through my self-directed IRA accounts in various real estate-backed assets and I wouldn’t have control any other way!
Key takeaways for self-directed IRA
- Start with the goal and timeline that fit your wider financial plan.
- Next, review the assumptions, risks, fees, and possible outcomes.
- Finally, compare the opportunity with other ways to use your capital.
Put self-directed IRA in context
Core ideas for self-directed IRA
Every investment decision depends on the investor, the deal, and the market. Therefore, use the ideas above as a starting point for deeper due diligence. Review source documents, ask direct questions, and seek qualified advice when needed. For more guidance, explore our passive real estate investing education.
A clear review of self-directed IRA
self-directed IRA deserves a clear and practical review. These short checks can support a more informed decision.
- Start with a clear goal.
- Next, define the time horizon.
- Review each key assumption.
- Compare the likely outcomes.
- Test a less favorable case.
- Ask who controls each decision.
- Confirm the fees and incentives.
- Study the market and the deal.
- Check the supporting documents.
- Look for clear communication.
- Compare other choices.
- Keep the full plan in view.
- Write down the main risks.
- Review the source of returns.
- Check the exit assumptions.
- Understand the tax questions.
- Consider the need for liquidity.
- Match the choice to your goals.
- Ask direct follow-up questions.
- Confirm the reporting process.
- Review the operating plan.
- Check the team’s experience.
- Compare the best and worst cases.
- Keep expectations realistic.
- Use qualified advice when needed.
- Document the final decision.
- Review the decision over time.
- Watch for changing conditions.
- Stay focused on the long term.
- Finally, act with a clear reason.
A practical review of Self-Directed IRA FAQ’s for Passive Investors
First, define the goal for this decision. Next, write down the result you expect. Then, identify the facts that support that result. Finally, note any facts that could change your view.
For example, compare the likely return with the main risks. In addition, check the timeline and the amount of control you will have. However, do not rely on one attractive number. Instead, review the assumptions behind every estimate.
Before you act, ask who will manage the work. Also, confirm how that team will report progress. If conditions change, decide how the plan can adapt. As a result, you can judge the opportunity with more confidence.
Moreover, compare this choice with realistic alternatives. For instance, consider liquidity, taxes, fees, and timing. Likewise, review the downside as closely as the upside. Therefore, your final decision can reflect both your goals and your limits.
In short, use a clear process. First, gather the facts. Next, test the plan. Then, ask direct questions. Finally, choose only when the answers support your strategy.
Related passive investing resources
Continue your research with these related guides:
- For a broader overview, see Tax-Free Wealth: How to Use a Roth IRA to Invest in Debt Funds and Promissory Notes.