Self-Directed IRAs and How They Work
Note: This article is designed to provide a broad overview of using and SDIRA in your real estate investing strategy. Please consult your investment advisor and accountant to discuss a self-directed IRA before taking action.
What is an SDIRA?
A self-directed individual retirement account (SDIRA) is a type of IRA that can hold a variety of investments not usually permitted in traditional IRAs. SDIRAs are administered by a trustee or custodian (third party and required by the IRS) with the investment selections guided by the account holder.
SDIRAs can be either traditional IRAs with tax-deductible contributions or Roth IRAs for tax-free distributions. SDIRAs offer greater flexibility, however, since the investments are directed by the account holder, there needs to be a degree of investment knowledge to make the right choices for investments that will yield desired income.
SDIRAs can also carry greater risks and the potential for fraud from the custodian. So if you are going to go the SDIRA route, make sure you’ve done your research. We’ve done some for you here.
SDIRA Facts
SDIRAs allow you to expand your choices of investments to include real estate, start-ups, franchises, precious metals and private equity funds
The most common form of creating an SDIRA is to roll over an existing IRA into the SDIRA
It can take a custodian two weeks on average to set up your SDIRA account
Defer to your custodian for advice on whether or not your investment classes qualify and will work for your SDIRA
An SDIRA custodian will charge a percentage fee or a flat fee for setting up and managing your SDIRA as well as for transactions so be aware of the fee schedule of your custodian to manage your SDIRA over time
You can roll over a 401(k) from a former employer by contacting the 401(k) plan’s administrator to wire transfer the funds
Once the account is set up, you instruct the custodian to wire the funds to the investment(s) of your choice
Be aware of income limitations of Roth IRAs versus traditional IRAs, and that with traditional IRAs, tax is deferred
SDIRAs, like IRAs in general, are a way to diversify and lower exposure to stock market volatility
SDIRAs and Real Estate Investing
SDIRAs offer real estate investors the ability to direct investments into REITs or real estate funds similar to the Empire Capital Fund as well as other investment types such as fix-and-flips, commercial real estate, land, rental properties and others. Many investors have their cash tied up in properties and are unable to diversify into other types of real estate investments. Setting up an SDIRA allows investors to redirect funds to earn income through the fund versus in traditional stocks or bonds.
When considering an SDIRA to provide additional flexibility plus the option to leverage your retirement funds into alternative investments, here are a few steps to get you started:
Consult your financial advisor (who may be biased against SDIRAs if they are earning commissions managing your retirement account, so keep that in mind) and tax advisor to discuss SDIRA options.
Do an assessment of what is actually in your retirement portfolio, regardless of whether it’s made up of annuities, stocks, bonds, mutual funds or other investments.
If you have a 401(k) with an existing employer and want to roll over a portion or all of that 401(k), you’ll need to check with your administrator to find out what limitations exist as well as any tax implications.
Decide how much of your existing retirement funds you wish to allocate to your new SDIRA and what they’ll be used for (real estate, etc.). Note that there is a limit to the amount you can contribute to an SDIRA, but there is no limit to a rollover of funds coming from another retirement account.
Research SDIRA custodians—check within your network of fellow real estate investors for referrals and make sure they will be able to work with your type of asset allocation.
Once you’ve selected a custodian, they will help you with much of the journey and work with you to set up your SDIRA and coordinate the transfer funds between parties.
You may already know where you want to direct your funds, but this is where you decide how much and where to allocate your funds.
Some investors will use their SDIRA to do hard money loans or make loans to earn interest. Others invest in businesses, as long as they are C Corps or LLCs. (Learn the limitations of what you can invest in with your SDIRA.
Once you’ve decided, you engage your custodian with a Direction Letter (or a Direction Letter online form that they may use as part of their service) to make investments on your behalf.
SDIRA—One of Many Options for Funding Your Investment Strategy
Self-directed IRAs offer flexibility to diversifying your portfolio and provide access to capital to make the investments you want. As with any investment, there’s risk. But if you have a choice as to where your retirement funds and IRAs are earning income, wouldn’t you explore it if it helps you build your real estate investment portfolio? Since you will be directing your own funds into your chosen investment vehicles, make sure you have researched the deal or the fund manager to reduce as much risk as possible.