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Self directing your IRA to real estate
CFPs: Bad Guys?Self directing your IRA to real estate
Does your IRA grow at a rate that is less than inflation? Are you dissatisfied with its growth? Maybe the time has come for your impatience to turn to action. Time for you to plan and self-direct your own destiny.
Individual Retirement Arrangements (IRAs) are included in the Employee Retirement Income Security Act (ERISA) of 1974. The intent of the Act is to encourage individuals to establish tax-sheltered retirement accounts for themselves and/or their non-employed spouses. Self-direction is a meaningful part of the Act, yet, how many of us really self-direct?
The popularity of the IRA is overwhelming; millions of taxpayers now have IRAs. The test though, is not only to set up a retirement plan, but to make it grow to the extent that it substantially enhances your retirement years. Many plans have failed this test through simple neglect.
Statistics show that Americans spend only 10 hours in their lifetimes preparing for retirement and that 96 percent of Americans retire flat broke. The purpose of the IRA is to help those numbers, but most IRAs are neglected and left to languish at the direction of others. The taxpayer dutifully makes his annual $2,000 tax deductible contribution to his IRA, leaves it to an administrator to invest, and complains at the end of the year about the poor return. And then does the same thing the next year.
IRAs established with banks are traditionally limited to investing in funds that are subscribed to by that bank. IRAs set up with brokerage houses are normally limited to investing in stocks, mutual funds, etc., that are marketed by that brokerage house. Don't confuse this with self-direction.
ERISA put a limit on investing with IRAs and it is not, "invest only in mutual funds." Generally speaking, one may not invest in a life insurance policy or collectibles (paintings, oriental rugs, etc.). That's it. Everything else is fair game.
What does that leave? Real estate (bare land, subdivision properties, improved properties, leases, free and clear and leveraged properties), trust deeds, unsecured notes, annuities, treasuries, stocks, real estate investment trusts, money market funds, limited partnerships (both private and public), bonds, mutual funds, and certificates of deposit to name a few.
You can take control of your retirement and direct your IRA to the level of risk and return that fits your comfort zone and grow at a rate that will cause it to be self sustaining in your retirement years. Or, you can continue to let it grow at the rate it is now and hope that Social Security or some other source will help when the time comes.
Who has not seen the real estate investment that you could have bought for pennies "back then" and can't afford to buy now? Who can be satisfied with their mutual fund breaking even or being slightly profitable when trust deeds or real estate contracts could have been purchased with a 15 to 20 percent yield?
Outline a plan
First, determine the types of investments that you would make if you were in control of your IRA funds, keeping in mind the frequency with which you would make them. Planning is a very important step to lowered costs and increased returns , and you will need this information when you compare administrators.
Research administrators
Second, contact several self-directed IRA administrators and compare flexibility, durability, ability and cost. Since administrators establish different in-house rules and fee schedules, comparison is a must. I recently conducted a survey of six administrators using the same investment plan, which included the purchase of real estate, a trust deed, limited partnership interest, and mutual funds, only to find that they varied in the fees they charge by 477 percent.
Establish an IRA
Third, establish an IRA with the self-directed administrator of you choice. This can be done in several ways. You can open a new IRA and deposit your annual $2,000 contribution. If you already have an IRA, you can establish a new self-directed IRA by simply transferring a portion of the funds or assets from your old one. A third way is to use a rollover from a qualified plan to establish the self-directed IRA. There is no limit to the number of IRAs one may have.
Purchase the property
Fourth, purchase the real estate of your choice, always using the counsel of your attorney, accountant and investment advisor. Suppose you wanted to purchase a 20-acre tract in Clark County and the purchase price was $50,000. To initiate the purchase, a direction letter is sent to the administrator. Assume you keep your excess IRA funds in a money market account with Broker Joe. You direct your administrator to sell $50,000 from Broker Joe's account and buy the lot for $50,000.
Self-direction of IRA money into real estate can be the perfect match. Typically, IRA funds are captive for a considerable length of time and typically, real estate is considered a not-so-liquid asset. A real benefit of the IRA is the nontaxable event that occurs when IRA assets increase in value, and a real benefit of real estate is the sometimes dramatic jump the values can take in a short period of time. The IRA is your security for the future and what better security than owning a piece of the rock?
Self-directing takes some coordination and planning and it can be very rewarding. Is it really this simple? Almost. Compare the return you received over the last couple of years on your IRA to the 15 to 20 percent annual return properties in Clark County have appreciated over the same period, and you can easily decide.
Real estate investment with IRA self-direction is a viable productive alternative to mutual funds and brokerage accounts. After all, which do you really know the most about, the lot down the street or the NYSE? Has the time come for your impatience to turn to action? Is it time for you to plan and self-direct your own destiny? The choice really is yours.
Copyright © 1995 by Patrick W. Rice
A good CFP can be very beneficial to your investment plans. The trick is finding a good CFP. A CFP is to the stock market what a realtor is to real estate. A CFP usually gets paid regardless of how well your stock market related investments perform. A CFP is usually more focused on earning their commission than earning your return.
How do you find a good
one?
A good CFP is one whose top priority is your return on
investment… because they know your long-term loyalty is to them if they truly
look out for YOU first. How do you find out whether they are more focused on
YOUR return or THEIR commission? Ask them a simple question: I’m considering converting my IRA to a passive
custodian who will let me invest in almost anything I want. This way I can
dabble in real estate and private equities, while still allocating a portion of
my assets to an investment account with you. What do you think? Now sit
back and see what they say.
A good CFP says: How much are you thinking of allocating into real estate and private equities? Who are you going to have helping you with those investments? At this point, a good CFP should primarily show their concern of you involving a real estate expert and/or private equities expert in your plans since they are probably not an expert in those fields themselves. A good CFP is fully aware of and admits that private equities outperform
publicly traded securities and that the worlds wealthiest people hold only 34% of their wealth in publicly traded equities. They are willing to handle only a third of your assets if it creates long term loyalty to them.
A selfish CFP says: That’s risky. You should keep all your money with me. Consider REITS instead. Over the long term, the stock market has risen by 9% per year, while real estate has appreciated less than 9% per year. This is a very good point for a person who plans to buy the whole stock market or the whole real estate market. This response from your CFP really indicates that they know how to invest your money into the stock market, but they don’t know how to invest your money into real estate. A selfish CFP wants to handle ALL of your assets which creates the highest possible commission for them now.
Depending on what your investment objectives are, a CFP or financial advisor can be very valuable. If you are going to involve a CFP in your investments, make the extra effort to find a good one.