Using Retirement Assets to Invest in Real Estate
There’s a little known fact about traditional retirement accounts – they can be used to invest directly in real estate! It’s not surprising that the financial industry has kept this secret in the dark; most retirement custodians make their living on the commissions they make whenever they buy or sell investment tools within your retirement account.
Because the vast majority of financial advisors are not experienced with investing in real estate, most money managers discount this powerful and conservative retirement tool.
Let’s see how Strongbrook’s real estate strategies stack up to other options for building wealth:
30-Year Annualized Returns by Asset Class1
Based on this chart, you can see that Strongbrook’s growth strategy has the potential to outpace typical returns in other types of traditional investments. The particular strategy demonstrated here is a combination of the cash flow and growth strategies. For more details about this strategy and rates of return, see Strongbrook’s Game Plan Framework document.
You can see that real estate done the right way can be a powerful investment option to build wealth and prepare for retirement. Retirement accounts have two basic options to invest in real estate. Either they can buy the property outright (no mortgage), or they can invest in a business that can obtain financing for real estate. These options are permissible under IRS regulations involving retirement accounts.
While investing in real estate is a permissible option for retirement accounts, most custodians are not equipped to facilitate these types of transactions. If you already have an IRA or ROTH IRA, ask your current custodian if they have options for directing your IRA into individual real estate purchases (as opposed to REITs or real estate funds).
Remember unlike a 401k, an IRA or a ROTH IRA is your money and if your current custodian is not serving you effectively, you have the right to move your assets to one that will.
Many Strongbrook clients have used a specific type of IRA custodian to help facilitate investing in real estate. They use a tool called a Self-Directed IRA (or Self-Directed ROTH IRA). Like a traditional IRA, your account will still have a custodian that handles the account on your behalf. Unlike a traditional IRA, the custodian’s job is not to invest in your behalf, but rather to invest at your specific direction. The best SDIRA custodians merely act as a keeper of your vault, offering no advice or opinions as to what you store there but simply facilitating your directions to place things in and take things out. Our clients have worked with several different SDIRA custodians, and can supply referrals to these custodians upon request.
Cardinal Rules for Self Directed IRAs
In a Self-Directed IRA, you act as the account manager and determine how your money is used and invested. There are a few cardinal rules that any IRA manager has to abide by, and it is your responsibility to stay within these rules if you choose to manage the resources in your SDIRA.
First: Never mix retirement assets with personal assets. One of our affiliate attorneys, Matt Sorenson of KKOS, states the rule like this: “A self-dealing prohibited transaction occurs when the IRA owner or other disqualified person benefits from the IRA’s investments. This means that you cannot do anything with retirement assets that benefit you – the person. If your IRA buys a house, you cannot live in it or use it for a vacation home. If your IRA buys a store membership, you cannot use it for personal purchases. Construct a giant wall in your mind and place it between your personal life and your retirement assets, and never breach it. If you do, the IRS may invalidate the whole IRA account and levy taxes and penalties as if you had withdrawn the whole amount at once. This rule directly effects how your IRA needs to interact with the real estate it owns. Because you cannot mix personal and retirement assets, the rents from the property must go directly into the IRA bank account. Your emergency fund must also be stored within the IRA because you cannot cut a personal check to pay a mortgage, or fix a sink. You may also choose to have a larger emergency fund, in excess of 6 months reserves, to ensure that your IRA can handle any of the bumps in the road that are intrinsic to any real estate investment.
Second: Use appropriate business entities for legal protection. Retirement accounts have a certain level of bankruptcy and legal protections afforded to them by their nature. Typically, if you run into financial or legal trouble, retirement assets are not on the table to square with personal debts or legal claims. However, investing in real estate has its own set of unique risk factors that are appropriate to segregate from your other retirement assets in the slim chance that you ever have a lawsuit in connection with your property.
We strongly encourages that our clients work with an appropriately licensed and experienced attorney to determine the appropriate type of business structure to use and how to use it. Generally, an attorney will recommend building a separate business structure owned by the retirement account, and have that business own the real estate and handle all of the day to day operations of the real estate investment. This provides a ‘corporate veil’ between the real estate investment and the rest of the assets held by the IRA. A good attorney will also provide training on how to maintain the strength of the business entity by holding annual business meetings, keeping minutes, and maintaining other business records.
Third: Keep appropriate bookkeeping and business records. These are good business practices for any investor, but they are even more crucial when using retirement funds. These records are your proof that you have not comingled retirement and personal assets. You may consider hiring an accountant to assist you in keeping these records, to ensure that they are kept properly.
Fourth: Take distributions properly. The whole point of investing in real estate using retirement funds is so you and your family can use the monthly rental income to supplement your retirement income. Before shifting any funds from your retirement account to your personal checking or savings accounts seek the advice of the custodian of your IRA. He or she will assist you in properly documenting these distributions so that you stay compliant with IRS regulations. Never, under any circumstance, short-circuit this process by cutting a check from the business account or accepting the rents from the property with your personal bank accounts.
Self-Directed IRAs are a great tool with a very specific purpose. Some people value ease of use and personal flexibility over the tax advantages of retirement accounts. For these individuals, liquidation of the retirement account to bring the assets into your personal name may be more valuable to them. This can be a great option because it eliminates the additional complications and red tape inherent in retirement accounts, as well as opens up the option to finance real estate in your own name. The downside is that liquidating retirement accounts can trigger a taxable event, as well as early withdrawal penalties if you’re under 59 ½ years old. Depending on your age and tax bracket, you may lose 20 – 30% of the value of your retirement accounts if you choose to liquidate. Consult with a licensed tax advisor before making this decision, so you know what your tax liability will be in advance. He or she may also recommend splitting the liquidation over two separate tax years to minimize your tax burden.
Investing in real estate is a powerful way to use retirement assets to create an income stream that can create a real retirement lifestyle, while preserving assets for the next generation or for a charitable cause that you wish to patron. Unlike most retirement strategies which can supply you a paltry 3-5% of its value while depleting your nest egg, investment real estate within your retirement account can give you 10% of its value in rental income without ever depleting your assets. This gives you a retirement income that you cannot outlive, and will leave a powerful legacy when you no longer need it.
Strongbrook specializes in conservative real estate strategies, and has the Power Team to assist you in building the type of nest egg and retirement income you need.
This Special Report was designed for educational purposes only. As with any investment strategy, please seek the advice of appropriately licensed professionals to determine if it is right for you and your unique financial situation. Strongbrook’s Game PlanSpecialists and Project Managers are not licensed financial, legal, or tax advisors giving financial, legal, or tax advice but rather they explain, outline, and coordinate the execution of investment options available to you with Strongbrook. Please consult with the appropriately licensed professionals before implementing any of the strategies outlined in this Special Report.