Today I signed papers to close on a rental property. A first in my retirement account! Say what?
You’ve heard the mantra that when you are invested, you should be diversified, right? Well, most people who have retirement accounts start by investing through a plan offered by an employer and the primary investment is stocks, bonds, and mutual funds. The big reason for this is that stocks and bonds are very liquid and selling one is a fairly simple activity. The trading of stocks and bonds can be done through retirement vehicles with names such as 401k, IRA, Roth, etc.
I started my investment savings through a 401k savings plan as an employee when I worked at Intel Corporation. It got my retirement nest egg started, but when I left I wasn’t retired so I still had a job to grow my retirement accounts from the $400k that I had accumulated to an amount that will sustain my lifestyle in retirement. Since I made a career change to real estate, I became aware of an even greater opportunity to diversify in retirement vehicles that I’d like to share with you. You don’t need to be in real estate to take advantage of these to benefit.
What are the other investment vehicles?
The IRS allows small businesses as well as individuals to set up retirement accounts that allow a person to diversify their investment opportunities beyond the traditional stock and bond investments. There are different means to get there from here. In this post, I’m going to talk about two. The Self-directed IRA and solo 401k.
Self-directed IRA. Allows the holder of this type of account to invest in options outside of stocks, mutual funds, and bonds. This account is managed by a 3rd party fiduciary. In 2018, the maximum self-directed IRA and self-directed IRA is $5,500 or $6,500 if 50 and over.
Solo 401k (also known as One Participant 401k) Plan. Allows a business owner with no full-time employees other than the business owner and their spouse to start and contribute to a qualified retirement plan. Here’s the interesting part – you can be a full time employee and have a side gig which could qualify you to participate – a consultant getting paid on a 1099, an Etsy vendor, or dog sitter.
The distinction that the IRS makes on this is that the activity to qualify as a business must not be a hobby and there must be intent to make a profit. W-2 employees on their own do not qualify for this type of plan but can if they also generate income outside of the employee status. A unique feature of this plan unlike going through a fiduciary like Schwab or Polycomp, is that a trustee of the plan may have checkbook control. Contribution limits can be higher than other qualified plans but it is dependent on income. According to IRS Section 415(c) limit is $55,000 for those under the age of 50 years of age and $61,000 for those 50 and older.
What are the investment options?
These alternate plans allow investments in real estate, precious metals, promissory notes, deeds of trust, privately held stock, and funds or entities structured as limited liability companies. Because of the added level of expertise and specialization along with the complexity of buying and selling, traditional brokerage firms such as Fidelity, Schwab, etc. do not offer these types of accounts to their clients so you have to get set up with a company that specializes in these types of plans. In the case of the self-directed IRA, to manage your account for you. In the case of the solo 401k, you get control and with it you have greater responsibility to manage your record keeping for audit purposes. Of course, you also have to know about what you’re investing in, but then you should also know that when you’re invested in the stock market as well.
I’ve utilized both plans myself personally and I’m quite pleased with the latitude that enables me to grow my retirement accounts. On the first leg of my divergent investment journey outside of corporate America, I started with a regular rollover from my 401k at Intel Corporation to an IRA and Roth accounts at Schwab. From there, I rolled over a portion of monies from the IRA account at Schwab to the Self-directed IRA at a local administrative company called Polycomp to diversify my investments. The operative word here is a “rollover” so as not to trigger a taxable event. From the self-directed IRA at PolyComp, I started to loan money out to a local flipper who works in the Sacramento area. All notes and control of the money went through Polycomp. My interest was recorded as a lienholder for the flipped property. This type of lending on homes was conducted through a normal escrow process where I was the lender of record. This is known as hard money lending and the rates are generally higher than what a regular lender would get for a 30 year mortgage today. These notes have a quicker turnaround – usually 3 months or less. Although I had one loan go a full 12 months at 12% interest on a principal balance of $165,000 which was more profitable. I spent time learning each investment option before I moved on to the next so that I could grow my investment acumen as well as helping myself to diversify my investments.
About 2 years ago, I discovered the solo 401k vehicle for which I’m qualified because I’m a business owner and not a W-2 employee. I rolled over my money from the Self-directed IRA to the solo 401k through a company called Sense Financial and things got even more interesting. First, I continued to lend on short term notes for flips, but also invested in a local business that went bankrupt halfway through repayment. I loaned money to two individuals to buy homes as a short term solution until they could get financed under regular lending, and my latest foray has been to purchase my first rental property off-market.
Just like any investment, there’s risk and reward. I lost half of my investment with the company that went bankrupt 1 year into their repayment, but for the most part my money has been working hard for me and growing inside my retirement accounts. I still hold a regular stock account with Schwab with rollovers of IRA, Roth, and even a SEP but this year, my contributions will be going into my solo 401k to allow me to continue to build my rental inventory.
The home that my 401k purchased will close on Monday. The home itself is really disgusting and reminds me a lot of the Flip or Flop episodes where Tarek and Christina of HGTV fame say something like the greater the disaster, the greater the reward. I’ll keep you posted. My solo 401k will be on record to own its first rental property Monday morning and my contractor is going in to do a complete gut job and renovation. The home is a Mid-century modern and should be a lot of fun.
If you’ve ever considered how you can diversify into real estate within a qualified retirement vehicle, I’d be more than happy to provide more information. What I stated here is only tip of the iceberg, the “reveal” so to speak. I would also provide you more information on what to look for in the companies qualified to administer or set up these alternate plans. The idea here is to enable you as an investor to diversify your investments. Please reach out if you’d like more information. You see, I’m a real estate professional that goes the extra distance with my own money so that I can teach from experience. Experience is priceless.