Maximizing Your Retirement Strategy
The Power of Self-Directed Accounts
by John “Jack” Kiley, CPA, CISP
I have been working with retirement accounts for a long time. As a young CPA, at the first CPA practice I worked for, I learned about self-directed retirement accounts. The firm’s basic recipe was to provide bookkeeping services for its clients’ business activities and then prepare the business and individual tax returns. As a client’s business became more profitable and cash flowed, we would layer a retirement plan into the mix, and the business would make tax deductible contributions to the plan.
Effectively, the client was moving money from his ‘taxable pocket’ to his ‘tax deferred pocket.’ Many of these clients were involved in real estate in some fashion, either as developers, brokers, or investors. These clients were familiar with self-direction and were constantly asking how they could utilize these types of plans. Being the young (and stupid) guy at the firm, I was tasked with figuring out how to do this. It was at this time I became intimately familiar with self-direction. I learned very quickly that what self-direction really meant was the ability to invest in a vast array of asset classes beyond stocks and bonds.
It was about this time when I also became familiar with investing in promissory notes. As an avid real estate investor myself, and being a numbers guy, I understood the financing of real estate and took an interest in it. Even back in those days, there was a dizzying array of financing products and lenders to choose from.
I learned to marry promissory note investments and retirement plans. For me this was a perfect mix; and for you, it may be as well.
Playing 3D Tax Chess
First, the combination of your preferred investment, lending, along with self-directed retirement plans (SDIRAs) allows you to play three dimensional ‘tax’ chess. First, because SDIRAs allow for a wider spectrum of investment options, you can lend on your terms: tax deferred or tax free (Roth).
Secondarily, you can also lend as you currently do in a taxable environment. This allows you to strategically lend. For instance, for opportunities that you feel have a high likelihood of success, you may choose to invest in the tax deferred or tax-free environment to maximize return. The opportunities that you might consider to be more risky or may need a little finesse, you might choose to do in a taxable environment. Careful planning is important because if you lose money in a retirement plan, you just lose. There is no tax deduction.
Self-direction allows you to use your team to identify investments and perform due diligence. The custodian does not tell you to who you must use so long as they are not identified as ‘disqualified persons’ (A classification of people and entities the SDIRA cannot transact business with). This group is made up primarily of family members and you can contact your custodian for more information. This allows you to use vendors and professionals that you know and trust.
Micro vs Macro Level
Self-direction gives you the flexibility to invest in notes either on a micro or macro level. On a micro level, you are able to pick and choose debtors you wish to lend to and require whatever information you feel is relevant in making that decision. You control all the inputs including the amount, term, interest rate, and form of collateral. You are able to tailor these to give you the level of comfort you feel is necessary. This also gives you the ability to build your portfolio as you see fit.
On a macro level, you are able to partner your capital alongside other capital to participate in larger loans or pools of loans. This allows you to tap into the expertise of others and gain access to transactions that you may not otherwise be able to reach. In fact, many of the large lenders in our field pool capital in this fashion and a significant percentage of that comes from retirement plans. Involvement in some of these investments may require you to certify that you have a certain level of assets to participate in the transaction (accredited investor status) so be prepared to provide this data.
Lastly, there are a number of retirement plan options available to you. For individuals, there are Traditional and Roth IRAs. Most people are familiar with these. Traditional IRA earnings are tax deferred and Roth IRA earnings are tax free after a seasoning period.
For business owners, there are a couple other plan options; SEPs, SIMPLE IRAs and 401k plans, among others. Many of these plans may have Roth components which gives you even greater flexibility. These plans also have higher contribution limits allowing for an accelerated ability to move capital from your taxable ‘bucket’ to your tax deferred or tax free ‘bucket.’
Self-directed retirement accounts give you the opportunity to use your expertise and knowledge to invest in assets that you may feel more comfortable with than marketable securities or at a minimum, not put all your eggs in one basket. Through careful thought and planning you are able to build the retirement nest egg you desire.
