2014 has ended and it’s that time of year again to think about investing in your retirement accounts. When I finished residency back in 2002, I knew very little about retirement accounts. I was young, single, and making more money that I’d ever made in my life.
I was also working in the middle of nowhere.
My first job as a full-fledged emergency medicine physician was in an isolated rural community. Being a physician to an underserved population was very rewarding. It was also kind of lonely.
There was no night life, professional sports teams, museums or other things to entertain me. My family was two states away and the dating pool was very limited.
Consequently, I worked. The more shifts I worked, the more money I made. The hospital had a 403b plan that I contributed to. Unfortunately, the investment options within that plan were very limited and highly volatile. This was my first experience with the ups and downs of the stock market.
After maxing out my 403b, I still had plenty of excess money each month. Therefore, I decided to take up a hobby. As a kid, I was a baseball player, but in this desert southwest community, grass didn’t really grow. One of the Internists I worked with was a private pilot and was willing to recommend an excellent instructor. I don’t think I would like to pilot a small plane in even ideal weather conditions let alone the high wind gusts that frequently plague New Mexico.
Then one night while driving home from the grocery store, it hit me like a big neon light. Well actually, it WAS a big neon light and it read, “Bowling”.
Why not?!!
I wasn’t a bad bowler as a kid and there was nothing else to do. I was making good money and I was going to splurge. Consequently, I bought a ball, a bag to carry it in, and my own pair of bowling shoes. Don’t judge me, I did what I had to do.
In all, I think I spent $200 for all of that equipment and around $2 a game thereafter. Not surprisingly, I still had money left over. It was time to learn about investing and these things called individual retirement accounts (IRAs).
As the name implies, IRAs are for individuals. While they do have some restrictions, in general these are opened up by you for your retirement. The point of an IRA is to allow your money to grow tax-free.
When discussing IRAs, most people think of traditional IRAs versus Roth IRAs. The difference between these two comes down to taxes and when you pay them. With a traditional IRA, you contribute pre-tax money and grow it tax-free. The tax hit comes at the back-end when you withdraw it.
The Roth IRA, on the other hand, requires you pay your taxes upfront and then you can grow your money and withdraw it without any further tax hit. Since the government has already received your tax money from a Roth IRA, they tend to be more lenient with the rules. For example, you can take your “contributed” money out at any time and for any reason without penalty. However, the “earnings” on your contributions must stay in the account until you are at least 59 years old to avoid a 10% penalty.
Traditional IRAs are stricter. While there are some exceptions, in general, the government will charge a 10% penalty on any money withdrawn before age 59. Qualified distributions can be withdrawn without penalty from a traditional IRA starting at age 59. For those who are not taking distributions the government wants their tax money and therefore requires that a “minimum distribution” be made from a traditional IRA starting at the age of 70.
Now if that wasn’t complicated enough, there is a special type of IRA called a SEP IRA or simplified employee pension individual retirement account. The SEP IRA is for the self-employed or those with freelance income. It has the same rules as a traditional IRA, but allows for higher contribution limits.
Allow me to summarize the above information below:
- Traditional IRA
- Tax-Free Contributions
- Tax-Free Growth
- Taxed Withdrawals
- Roth IRA
- Taxed Contributions
- Tax-Free Growth
- Tax-Free Withdrawals
- SEP IRA
- Traditional IRA with higher contributions for self-employed individuals
This was all well and good, but how could I use these accounts to invest in real estate? The answer was a self-directed IRA. A self-directed IRA is one that allows for “alternative investments.”
Turns out that many investors, myself included, want to invest at least a portion of their nest egg in things other than stocks, bonds, and cash. Most of us put that money in real estate because it is a proven wealth building asset class. However, multiple alternatives exist. Things like oil and gas, precious metals, commodities, intellectual properties, and other investments are all possible within a self-directed IRA.
However, to stay within the rules you need to make sure that you cannot get direct benefit from the investment, it is not a consumable, and it has a verifiable value. For these reasons, things like fine wines and your personal residence would not qualify.
Now that we have that established, lets discuss how I went about setting up my self-directed IRA.
The laws governing self-directed IRA’s say that I must have a custodian or qualified trustee. These companies do not give investment advice, but rather have the specialized knowledge and experience in dealing with the paperwork and regulations necessary to carry out my investment decisions. While this list is by no means all-encompassing, nor is it intended as a recommendation, here are a few names of companies that I am aware of who act as IRA Custodians.
I have never used Pensco, Provident Trust, or Sunwest Trust. I am currently with IRA Services and have been satisfied. I previously had money with Equity Trust and found their services lacking. Whether you decide to use one of these companies or find another one on your own, it is important to keep a few things in mind when looking for an IRA Custodian.
- Time in Business (I prefer one with at least 15 years in business)
- Assets Under Administration (I prefer a $1 billion minimum)
- Good Service Record (no ERISA or BBB complaints and a good reputation)
- Fee Structure (avoid Custodians that charge you based on a percentage of your assets under administrations. Instead go with a reasonable flat-fee structure with minimum transaction fees)
Be aware that there is a special type of IRA in the self-directed IRA space. It is called a Checkbook IRA. These IRA’s give the owner actual checkbook control of their retirement funds. Instead of having to invest through their Custodian, these investors have a checkbook that allows them to invest on the spot. Unfortunately, these IRA’s tend to be associated with high fees. Therefore, they frequently don’t make sense for the long-term holder of real estate.
For those who invest in short-term things like private notes, wholesaling, and fix and flip real estate, these may be something to look into. Take a long look at their fee structure before opening one of these up. Unless your situation fits, you will be paying a lot of money for flexibility that you probably don’t need.
I haven’t been bowling in years. The ball, shoes, and bag I bought over a decade ago sits somewhere in my storage shed. However, a few weeks ago I took my 7-year-old son to his friend’s birthday party which just so happened to be at a bowling alley. I watched his face light up every time he knocked the pins down. I couldn’t help but get a bit nostalgic.
I’m grateful for that little town in the middle of nowhere? I’m grateful for having a job that paid me more money than I needed. I’m grateful that I learned about IRAs and investing. Most of all, I’m grateful that I discovered how easy it is to invest in commercial multifamily real estate using a self-directed IRA.
P.S. If you want to learn more about how to invest in commercial multifamily real estate using a self-directed IRA or if you need help setting up a self-directed IRA feel free to contact me.
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