Prior to its crash in 2000, investors were content to keep 100% of their retirement assets in the stock market. It wasn't until the market collapsed that investors began looking for safer vehicles for their retirement investing. Enter the self-directed IRA or real estate IRA - a vehicle that allows investors the opportunity to diversify their investments into real property, securities, tax liens, businesses and much more. The self-directed IRA is not a new investment product; however, it had remained relatively unknown until 2000. In the past five years, the self-directed IRA industry has exploded as investors are targeting secured investments, such as real estate, rather than securities. According to industry experts, self-directed IRAs accounted for less than two percent of retirement account investments in 1999.
"[Before the year 2000] investors didn't know they could use their retirement account to diversify outside of the stock market, and if they did know, they couldn't justify leaving it," says David Nilssen, co-founder of Guidant Financial Group, a Bellevue-based IRA Facilitator that specializes in self-directed IRAs. "The industry has more than doubled since that time."
Self-directed IRA investing can produce great returns for investors; however, there are specific guidelines an investor must adhere to. The Internal Revenue Code 4975 defines what are called prohibited transactions for IRAs. These rules were established to maintain that any investment the IRA participates in is for the exclusive benefit of the IRA. For instance, your IRA cannot buy a home for your mother to rent. The rules were established to disallow investments that could create a conflict of interest for the IRA holder. If your IRA purchased a home for the IRA holder's mother, then there is a potential conflict of interest to act in the best interest of the IRA (eviction) should she failed to make the rental payments. "The parameters [for prohibited transactions] are defined not by what you can do, but by that which you cannot," says Nilssen. "This is why we recommend that people shouldn't attempt to structure these investments themselves without the help of a qualified professional."
After conducting extensive research on self-directed IRAs, Corrie Anders of the Los Angeles Times stated that "if you're interested in diversifying your IRA portfolio with real estate [or other non-traditional investments], begin by finding an IRA facilitator to help set up and administer [your] real estate [non-traditional] IRA." Anders also cautions in her article that investing in real estate or non-traditional IRAs is not a do-it-yourself proposition. As the chief executive of a firm specializing in the administration of real-estate IRAs said, "we don't recommend this for people who are not sophisticated investors or who are not working with advisors."
Gregory Olsen, formerly with Silicon Valley Bank, always wanted to use funds from his previous employer's 401(k) for different investments than his 401(k) provider would allow. "I had absolutely no idea I could invest in real estate using my retirement funds," said Olsen.
According to Nilssen, Olsen's mentality is common among investors. "We have seen our clientele change significantly in the past few years," he says. "It used to be that we dealt primarily with Accredited Investors; people whose advisors typically are much more savvy than the general public. Now we are seeing many do-it-yourself investors deciding to take a more active role in the investment of their retirement funds. Our clientele has become much more diverse as our industry has received increased interest."
One of Guidant Financial Group's clients, from Las Vegas, NV decided to go the self-directed route after losing a substantial amount of his savings investing in securities. "I lost $150,000 in my 401(k) investing in the (safe) stock market. I only had $120,000 left for retirement," the client said. "I now have my first rental home that can be sold at any time for more than I paid, and is generating a $700/month positive cash flow back into my retirement fund. I will be looking for another home to add to my IRA. I am off to a good start, with a higher return on my money than stocks!"
Real estate seems to be one of the most popular investments for self-directed IRA holders. When asked which investments are most popular with clients, Nilssen said "real estate is obviously up there. One of the benefits of using your IRA to purchase real estate is that you can absorb some of the ups and downs that are present with most investments. Real estate has an advantage because it has the ability to produce consistent cash flow which can mitigate any perceived loss in the event there is a correction in the real estate market." He continued to explain that "recently I have seen more and more of our clients moving toward tax liens and businesses as an alternative to real estate - I think people are applying the lessons they learned about the importance of true diversification when the stock market took a nose dive."
More Information: Self Directed IRA LLC & Small Business Financing
