Don't Overlook Alternative Assets in Retirement Investment Planning

By: Art Of Saving Investments 1 Follower


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If you are interested in purchasing real estate, private stock or a private note for investment purposes, but don't think you have enough cash on hand consider the following. The Internal Revenue Service has an Internal Revenue Code regulation that allows all Americans to invest their IRA funds, or 401(k) funds rolled into a Self-Directed IRA, in a wide variety of non-traditional investment types. With a Self-Directed IRA, retirement account funds can be invested in such non-traditional assets as mortgages, raw land, commercial buildings, vacation rentals, and multifamily homes, just to name a few.

Keep in mind that you do not have to "cash out" your IRA to do this type of investing - these investments are made within a Self-Directed IRA. Rolling current retirement funds from an existing IRA for 401(k) account into a Self-Directed IRA to do this type of investing is penalty-free. Additionally, the taxes due on the growth of the investments are deferred until distribution begins at retirement. If the Self-Directed Roth IRA is involved, the principal and earnings are tax-free when distributed at retirement.

I spoke to executives at PENSCO Trust Company. PENSCO Trust is a regulated IRA custodian that exclusively focuses their services on the administration and custody of non-traded and non-traditional assets, such as real estate and private placements.

They gave me an example of how investing directly into Real Estate within a Self-Directed IRA can be a lucrative retirement strategy:

Steve is interested in purchasing an office building with his IRA funds. He has found a building in a growing executive park, which is 100% occupied. The asking price is $400,000 but he only has $200,000 in his IRA. The current owner of the office building is willing to do seller carry-back for the balance of the loan. Therefore, Steve’s IRA has directly funded 50% of the purchase price and has financed the remaining 50% with the seller carry-back mortgage of $200,000.

Rental income from the office building now flows directly back to Steve’s IRA as a return on investment. His IRA uses a portion of that income to pay off expenses related to the running and maintenance of the building, such as the monthly mortgage payment to the seller, insurance coverage, property taxes, snow plowing and so forth. At the end of the year, Steve’s IRA will have a net income of $20,000, after all expenses are paid.

However, since Steve’s IRA used financing to make the purchase, the portion of the income that is attributable to the financing is subject to Unrelated Debt-Financed Income, or UDFI. In Steve’s case, since his IRA financed 50% of the purchase price, then 50% of his net income, or $10,000, would be subject to UDFI tax. Since UDFI taxed at trust rates, generally around 40%, he will end up paying approximately $4,000 in UDFI taxes. However, his IRA will still end up with a net gain of $16,000 for the year. Even though his total IRA income was impacted by the UDFI tax, his net gain is still much more than his annual contribution of $4000 would have added, or even the return on most publicly-traded investments. Twelve months after the debt is paid off, UDFI ceases to apply to rental income generated. Steve’s IRA will then continue to earn rental income and years down the road, when he is ready to retire, his IRA can sell the office building for a nice profit and all capital gains from the sale flow back to his IRA as a return on investment. When he retires, his IRA distributions are taxed at his lower, retired tax bracket. If he makes this investment with a Self-Directed Roth IRA, all of the return on investment is tax free upon distribution.

As we now know, beginning in March 2000 the stock market began its bear market that lasted for over two years. At the same time the real estate market began its bull run for almost five years. This proves that diversification in all asset classes should be considered. Make sure you ask your financial advisor about alternative investments and self directed IRAs for your retirement.

Bruce Sankin is an arbitrator and mediator for the National Association of Securities Dealers (NASD), a consumer advocate on investor education and author of the best selling financial book "WHAT ALL STOCK AND MUTUAL FUND INVESTORS SHOULD KNOW!". Bruce Sankin's book is used by State Regulatory Agencies, Attorney General Offices as 'investor educational material'. To receive a free PDF copy of his book go to financialhelpcenters.com.
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