A Self-Directed IRA For Your Retirement Planning

Check Book And PenThe following is a guest post from Broad Financial LLC about self-directed IRAs for those who want more options in their retirement portfolios. They will be answering your questions after reading the post.

Picture the scenario: You’ve been a virtual slave to your office. (Hard to imagine, right?) There’s always some paper to be filed, some phone call that needs to be taken, some meeting that will-just-be-a-few-minutes and isn’t. You have acquiesced to such demands because at the end of every two weeks you receive a piece of paper which has less zeros than you were expecting, but still manages to put food on your table. And by making sacrifices on par with the giving over of your first born, you have somehow managed to put aside a few dollars toward your retirement.

With pride you enter the office of your retirement account provider. Glorious visions dance through your head of what awaits you on the other side of your working career. Luxuriously tranquil blue skies, warm white sand, and a dorky little umbrella drink marking permanent time by your beach-chaired body.

With a little smart investing your retirement funds will be growing every year, and soon enough they should be able to set you comfortably afloat. Maybe if you’re lucky you could even buy the island. The propitious looking gentleman in the nice suit shakes your hand as you come in. He gestures for you to take a seat, as he himself settles comfortably behind his polished teak desk.

“So what can we do for you today?”

You don’t let him know of your island buying aspirations, but you do tell him that you would like to invest your retirement funds.

“Well, then, you’ve come to the right place.”

He tells you of the various funds that you can place your money in so that you may watch it live long and prosper. And then he stops. As you patiently wait for other investment opportunities, it soon becomes abundantly clear that his spiel is over. And quickly a little flag goes up in your head. That’s it? A few mutual funds that are dependent on the health of the stock market to make even nominal returns?

“Excuse me,” you say with your best oh-humble-me grin, “but aren’t mutual funds tied to the stock market?”

He looks at you like he would look at a koala bear who had just recently acquired the faculty of speech. “Of course.”

“If I put my retirement money into one of these funds, then it will have roughly the same stability as the rest of the stock market. A little risky and not so unique don’t you think”

The salesman chuckles in perhaps the most condescending tone that you have ever heard in your entire life.

“Although the stock market occasionally has its up and down days, a mutual fund is still by far the safest haven for your retirement savings.”

He continues to offer soft platitudes, and as he does so, you feel that your mind is beginning to bend. You begin to wonder if there is any way to take control of your retirement funds.

HOW RETIREMENT ACCOUNT MANAGERS MAKE MONEY

Let’s take a step back, and try to understand why the world is the way it is. When you sign up for an account with a third-party provider like Fidelity, what do they get out of it? The one word answer is: money. (But you knew that already)

How do they get your money? With your provider you can choose to have your retirement money go in one of three directions.

1) You can buy stocks, in which case you will be charged a low fee for every transaction.

2) You can hold it in cash, in which case they get access to your money to invest it at a better rate for themselves.

3) You can put it in one of their funds (the most popular choice), which means that they get to invest your money AND charge fees out the wazoo. This is very profitable for them. So much so that they would prefer not to give you any other alternatives.

Hence, the emphasis on the inevitability of the mutual fund as a retirement plan. Which, of course, leaves you gritting your teeth. Because you know that a mutual fund in good times gives you an okay return, and in roller coaster times (which, last we checked, has become the new norm,) will give you Richter-scale heart palpitations every time you look at your statement.

What you really want is a platform where you can put your retirement funds into sensible investments and not have to worry about a random banker falling on your head. You want to self-direct.

A SELF-DIRECTED IRA GIVES YOU MORE FLEXIBILITY

For the more sophisticated investor, a self-directed IRA gives you the tools you need to put your retirement funds in investments that you know and understand. This could be local real estate (foreclosures and rentals are popular choices), a private business that you have experience with, or even a personal mortgage.

Whichever direction you go, you will always have complete control over your retirement funds and decide the where, when, and how of investing them.

Choosing a self-directed IRA facilitator requires doing a little homework as different companies offer differing platforms and pricing structures. There is one key feature, however, which is a must- have. That’s the feature of Checkbook Control. To understand why this is such an important feature, let’s run through the self-directed IRA process to find out how it all works.

Most self-directed IRAs function by setting up a dedicated LLC. This new LLC can place virtually any investment with the IRA funds. That’s the basis for all of the standard platforms. Where the platforms differ, though, is in who controls the process. In the Custodian model, the investor must go through the custodian for all investments and transactions. The investor fills out a form, sends it in, and the waits for the Custodian to execute the transaction. As you can imagine, this process can be frustratingly slow and paperwork heavy. Additionally, the Custodian often has an extensive fee schedule for each of the transactions that it will be performing for the investor.

In the Checkbook Control model, the investor effectively cuts out the middleman Custodian (along with all accompanying hassles and fees!) The Checkbook Control model accomplishes this by appointing the investor as the uncompensated manager of the LLC, and then opening a checking account in the name of the LLC. Now the investor can place investments by simply writing a check. It’s a rare win-win situation as the investor receives greater control at a more economical price.

As the stock market continues its long term volatility, it pays to look beyond Wall Street when planning your retirement strategy. With a self-directed IRA, you can finally be in control of creating your own prosperity.

INVESTMENT PLATFORM RECOMMENDATION

Invest In Ideas Not Stocks: Motif Investing is a terrific company based right here in the San Francisco Bay Area. They’ve raised over $60 million dollars from smart investors such as JP Morgan and Goldman Sachs because they are innovating the investment landscape with their “motifs.” A motif is a basket of 30 stocks you can invest in, which are aimed to profit from a specific idea or underlying theme. Let’s say you think new housing construction is going to quicken in the US next year. You could buy a housing motif which might contains Lennar, KBH, Home Depot, Bed, Bath, and Beyond, Zillow, and more in various weightings.

You can buy a basket of 30 stocks for only $9.95, instead of buying them individually for $7.95 through a typical broker. You can build your own motif, buy one of the motifs created by Motif Investing, or buy a motif by a fellow Motif Investor with a great track record. You can even buy retirement motifs, much like target date funds, except you don’t have to pay the 1% management fee. You get up to $150 free when you start trading with Motif Investing. Given my focus on buying winning long-term ideas and ignoring the short-term volatility, I really like Motif Investing’s value proposition for retail investors.

Updated on 12/1/2014. The bull market is alive and well. Don’t forget to rebalance and manage your risk exposure. Everybody feels like a genius during good times.

Sam started Financial Samurai in 2009 during the depths of the financial crisis as a way to make sense of chaos. After 13 years working on Wall Street, Sam decided to retire in 2012 to utilize everything he learned in business school to focus on online entrepreneurship.

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Comments

  1. Greg says

    The problem with the self directed IRA is the cumbersome nature that some assets have if you need to move quickly or have a lot of small investments such as tax liens. The other option is to get checkbook control but the issue here is that it is based on one court case and I predict will be an auditor’s dream, especially if you don’t document well. The concept is appealing with the crazy nature of the stock market but a lot of uncertainty for retirement my funds IMO. I’ve done a lot of reserach and there are some expensive outfits helping people get into these but if you are intent on doing it there are a lot of lower cost options that do the same thing.

    • says

      You’re right that the Custodian models make it a hassle to invest in assets, especially when there’s a significant rush factor. That’s why we favor the Checkbook Control model – it allows for Real Time investing at a more economical cost than the Custodian model.

      As for legality, that’s an old straw that a few Custodians are still grasping at. The IRS has given its explicit approval to the basic structure in Field Service Advisory 200128011. You can find other legal issues and how the government has addressed them here: http://www.broadfinancial.com/legal-guidelines

  2. Brian says

    So is this saying I could use money in my self-directed IRA to buy real estate? And essentially the IRA owns the property?

    • says

      That’s exactly how it works. The property becomes an asset of the IRA just like any other asset it may invest in. For instance, if your invest your IRA in Apple stock, that stock now becomes an asset of your IRA. A self-directed platform allows you to extend that asset-purchasing power beyond stocks and into alternative assets such as real estate.

  3. Joshua Liu says

    I’ve looked into self-directed IRAs and 401k’s at length. Most providers make it sound like you have a lot of freedom but don’t warn about prohibited transactions and self-dealing. For example, you can invest in real estate, but you cannot do work for it (repair, improve, manage) or derive benefit from it (live in it, rent to a family member). There are ways to invest in your own business, but all methods are complex and considered “questionable” bawldguy.com/self-directed-iras-irs-and-business-startups-robs/

    • says

      Educating clients about Prohibited Transactions is actually one of the most important roles of the self-directed facilitator. Consequences for engaging in one can be severe, and it would definitely not be a wise business model to allow clients to engage in illegal behavior. That being said, however, the rules governing Prohibited Transactions are fairly easy to learn, and it’s rare once you know them to ever run into a problem.

  4. says

    I used to have a self directed 401K. It was a choice the company made with my influence to allow employees to have more say in their investment choices. It was through Schwab which has a large number of choices in mutual funds, ETFs and other financial instruments.

    • says

      It’s true that brokers often offer a self-directed 401(k), but it’s usually stuck in the stock-and-bond asset class. To get true self direction, i.e. the ability to invest in real estate and other alternative assets, you have to go to a company which allows for full self-direction.

  5. says

    Hi Daniel,

    Thanks for the insights. I’d like to follow up with some more questions please.

    1) You talk about setting up a dedicated LLC to house the purchases of various assets through the self-direct IRA. Who sets up the LLC, and how much does it cost on average?

    2) Can you discuss the fees associated with setting up a self-directed IRA? How does Broad Financial make money? Is there scale involved where if someone brings a bigger portfolio, they can get a discount?

    3) What are the advantages and differences of a self-directed IRA through Broad Financial vs. opening up an IRA through Etrade for example.

    Thanks!

    Sam

    • says

      Hi Sam,
      Here’s the answers:

      1. Broad sets up the LLC for your IRA under the name that you choose, e.g. Sam Holdings. The LLC cost is included as part of the one-time set-up fee. The one time set-up fee ranges from $1295 to $1495. The difference in price is due to the fact that LLC costs vary from state to state. (In California, the state charges $800 for LLC set-up!) If you live in a state where the LLC fee is exorbitant and recurring, there are a few different money saving options available. These include becoming qualified for the Solo 401(k) which is cheaper to set up as it uses a Trust instead of an LLC. Also, it’s sometimes possible to use a registered agent in a different state. You can give us a call at 800.395.5200 with specific details and one of our specialists will let you know what the options are.

      2. As mentioned above, Broad charges a one time setup fee. In addition to that fee there is a low annual fee – $115 for the IRA and $125 for the Solo (for government mandated administrative duties.) There are no transaction fees and no asset-based fees. The reason for this is because you the investor control everything in a dedicated checking account. You perform your own transactions by just writing a check, and nobody (except for yourself) has access to the checking account. That’s why on the flip side there is no discount for a bigger portfolio. Broad doesn’t get a piece of your portfolio no matter how big it is.

      3. Etrade will allow you quick and easy access to stocks and other market products. It will not allow you to buy real estate, personally hold gold, or invest in a private business. Investors usually go with a company like Broad because they want to go beyond Wall Street.

      • says

        Hi Daniel,

        Thanks for the info. If there are no transaction fees, does that mean I can buy and sell individual stocks as many times as I want at no charge?

        Good to know you guys set up the LLC for your client as part of the set-up fee.

        Easy to roll over a 401K or other IRAs to your system I assume?

        Regards, Sam

        • says

          You may buy and sell as often as you want with no extra fees at all. That’s because you control the transactions through your checkbook. There is no third party who is executing the transaction, or is even aware of it.

          As for rollover the process is actually fairly simple depending on the assets that you plan on rolling over.

  6. Janine says

    I do not have a self directed IRA yet but it is something that I have considered and probably will do once I have accumulated some more funds in my ROTH IRA. I have learned a lot about investing in real estate through SDIRAs via bawldguy.com which I stumbled upon on biggerpockets.com (real estate investing site- and they also have some forums regarding this investments).

    • says

      Hi,
      Here’s two links with practical info regarding investing in real estate with a self-directed plan:
      broadfinancial.com/real-estate
      broadfinancial.com/real-estate-retirement

      If you have a specific question, I’d love to answer it. Youn can reach me at 800.395.5200

      Thanks

    • says

      We actually encourage investors to invest in what they know. If they have a certain professional expertise, a good feel for properties in their town, or a solid loan opportunity, then they should definitely pursue that as an investment. Few people are experts on stock picking, but usually everybody has a feel for something in which they could be considered an expert.

  7. says

    I used to have a self directed IRA when I worked for a firm that didn’t offer 401ks. The fees were bad so I didn’t really use it but I was glad that I atleast had a account for keeping retirement savings in one place. Now I just use my 401k because the company matching helps a lot.

    • says

      Sounds good. A self-directed IRA looks to be for someone who is very knowledgeable and eclectic with their investments, and has a relatively large portfolio. For the average person, probably best to stick with a normal IRA and 401k.

  8. says

    Self Directed IRAs still have the 5k contribution limit, correct? So you really need seasoned money if you are going to do anything significant with it? Also if you run a business housed in a Self Directed IRA you basically have to give yourself a pretty big salary since you can’t take contributions from the IRA if you are younger (ignoring 72t distributions), right?

    • says

      Hi Evan,

      IRAs do have a 5k annual contribution limit, and if this is your first year making a contribution, then you’re right that it might be hard to do something significant right now. However, we have found that most clients don’t run into this problem. There are two reasons for this:
      1. Many clients rollover funds from a previously existing account – IRA or 401(k) – and there are no limits on the amount of money that can be rolled over.
      2. If you qualify for the self-directed Solo 401(k) (via some self-employed income) then the annual contribution limit jumps to upwards of $50k.

      As for taking a salary from your IRA’s business, that’s actually not allowed and is considered a Prohibited Transaction. The relationship of the investor to his/her IRA is as a non-compensated manager. There is a platform which allows for a salary known as ROBS (Roll Over Business Start-up), but it costs significantly more to set up and implement.

      If you’d like to ask a question about your specific situation, just give a call at 800.395.5200.

      Thanks

  9. Kevin Patton says

    I will be retiring from the Federal Government and have a considerable amount in my Thrift Savings Plan. I really want to consider a self directed IRA as I want to make my own decisions on what I invest (which will be stocks).
    1. Is the process fairly easy to convert my TSP to Broad Financial (using my own bank acccount).
    2. Again, can you specify the one time fee in the state of Illinois and exactly the annual fees.
    3. Is there any other fee’s I will have to pay for using the Broad Financial services?

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