Thinking about dumping my IRA to start real estate investing

Rental Property Investor · Louisville, KY · Member since 2019 · 14 posts · 3 votes

Looking for your thoughts- I have both a Roth and Traditional IRA. I'm considering rolling them into a self directed IRA or solo 401k but hate the thought of a custodian. I'm also considering just pulling it all out and taking the penalty, paying the taxes and then investing. Yes I will be losing some money but will have full control of my assets. Why would or wouldn't you do this?

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Dmitriy Fomichenko

Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes

Originally posted by @David Carroll:

@Dmitriy Fomichenko Thanks for the reply. I do have an S Corp and am eligible for a solo 401k. So how can I avoid a custodian?

David, in order to avoid the custodian you need to establish truly self-directed Solo 401k. Here is how it works:

1. Your S Corp will act as plan sponsor

2. Your S Corp will adopt Qualified Retirement Plan (Solo 401k)

3. Plan is created, instead of using a custodian, 401k Trust will be used as a vehicle to hold plan assets. As trustee you control it.

4. As plan trustee you will open business checking account for your Solo 401k Trust, fund it with rollover or contributions and start investing. Investing will be as simple as writing a check. All income will flow back to the 401k trust business bank account and all investment related expenses will be paid from this account.

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Taylor L.
Rental Property Investor · RVA · Member since 2016 · 5k+ posts · 4k+ votes
6y
It depends on your goals. If you're going to burn the ships and go all in NOW, then maybe paying the penalty makes sense for you. If you're more focused on the long run, then tax advantaged retirement accounts can be a great part of your strategy.
However, you can still invest in real estate with a SDIRA or solo-401k. Not everyone is eligible for a solo 401k, so that's an important thing to look out for.
Ultimately, custodians don't do a whole heck of a lot. They push paper, move the money around, take a small fee, and follow your instruction.
I'm not a tax advisor or anything like that, but you're going to pay big on the Traditional IRA. You'll pay regular income taxes in addition to the penalty. If you're pulling out 6 figures, the tax bill will be huge.
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Carl FischerPro Member
Rental Property Investor · Ambler, PA · Member since 2015 · 2k+ posts · 1k+ votes
6y
@David Carroll
How much $$$ are you talking about? I’m really good with IRAs and most likely wouldn’t get rid of my IRAs. Why go from Never taxed to forever taxed. I would most likely convert the traditional to a Roth, help my parents and kids get Roth’s and make great re purchases that throw off a lot of cash. However, I’m not you and not sure if your plans or goals.
[email protected]215-283-2868
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Dmitriy Fomichenko
Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
6y
David,

I agree with @Taylor L., being hit with taxes and penalties on premature distribution would not be wise, you will end up giving uncle Sam 40-50% of the distribution amount upfront. Why would you do that if you have other options?
Traditional or Roth IRA can be converted to Checkbook IRA (aka IRA owned LLC) and as a result the assets will not be in the hands of a custodian and be solely under your control.

If you are eligible for a Solo 401k that would be even better option. With truly self-directed Solo 401k there is no custodian period!

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David Carroll
OP
Rental Property Investor · Louisville, KY · Member since 2019 · 14 posts · 3 votes
6y
@Dmitriy Fomichenko Thanks for the reply. I do have an S Corp and am eligible for a solo 401k. So how can I avoid a custodian?
0 Reply
David Carroll
OP
Rental Property Investor · Louisville, KY · Member since 2019 · 14 posts · 3 votes
6y
@Taylor L. I’m actually new to real estate and my goal is to acquire 6-10 single family units in 2020.
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David Carroll
OP
Rental Property Investor · Louisville, KY · Member since 2019 · 14 posts · 3 votes
6y
@Carl Fischer Total is around 200k my goal is to acquire 6-10 single family units in 2020 and expand from there.
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Carl FischerPro Member
Rental Property Investor · Ambler, PA · Member since 2015 · 2k+ posts · 1k+ votes
6y
@David Carroll
Not sure how much of $200k is Roth or traditional or what your age is but that all factors in to your decision. (Penalties, taxes, rate of return, etc) I would connect with @Mike Butler in Louisville and attend some of his classes. Great ideas come from his meetingstelecons and he is and has been buying properties for decades. At minimum you will learn a few things as it seems I do every time I talk to him.
[email protected]215-283-2868
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David Carroll
OP
Rental Property Investor · Louisville, KY · Member since 2019 · 14 posts · 3 votes
6y
@Carl Fischer I sure will thanks.
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Kat McReynolds
Member since 2019 · 23 posts · 22 votes
6y
I was just reading about this topic last night in the BP-published book "Tax Strategies for the Savvy Real Estate Investor." Let's see if I can summarize for anyone else that's learning. Please tell me if I've gone astray anywhere...

IRA's that are not self-directed can only be used to invest in stocks, bonds and mutual funds. Most financial planners are only paid when clients pursue these kinds of investments, so they don't educate many people on alternative investments that self-directed IRAs allow.

With self-directed IRAs, you have wider investment options like real estate and investing in other businesses. When you choose these options, money from the IRA is used to fund the investment, and all resulting income from the investment must go back into the IRA. The advantage created here is that an IRA owner can take a tax deduction for IRA contributions (up to the maximum annual amount), and subsequently invest that money without paying withdrawal penalties to fund the investment and without paying taxes on the investment's income streams, as long as the investment and its cash flows remain in the account (i.e. funds aren't withdrawn before retirement).

Some banks will even lend money to a self-directed IRA to leverage the amount the IRA owner has accumulated. However, taxable income earned as a result of the debt will incur higher (up to 39.6%) taxes, via the "Unrelated Debt Financed Income" or UDFI tax. So, if you buy RE with 50% IRA funds and 50% debt, half of your income from that venture (the half that was funded by debt) will be taxed at this high rate.

Solo 401(k)s are a special breed of retirement accounts that avoid this UDFI tax. They have other advantages, too. You can borrow money from the account, as long as you repay with interest within 5 years (see question 1 below). Also, the maximum annual contribution is higher at $27,500 per year (if under 50 years old), which allows the IRA owner to take a larger deduction on income taxes.

___

My questions:

1.) Are there restrictions on what you can use funds for when you give yourself a loan from a Solo(k) account? Business expenses that are not related to property owned through the IRA? Personal expenses?

2.) What is the money in a Solo(k) doing before you withdraw it for a REI? Does it bear any interest at all? Is it at any risk of declining in balance? If not, I would love to put cash reserves here and simply borrow when needed.
3.) If I'm understanding correctly, traditional IRA funds are taxed when withdrawn, and Roth IRA funds are taxed when deposited. When are Solo(k) funds taxed?

4.) I don't understand @David Carroll's concern about the custodian. Is it that the custodian is only paid when a change/transaction is made and that switching to a new IRA type will trigger this transaction fee?

Good times!
1 Reply
Gebson Pinheiro
Member since 2019 · 26 posts · 3 votes
6y
@Dmitriy Fomichenko has the best advice. You'll still need a custodian per IRS regulations, but a Self-Directed IRA with Checkbook control actually allows you to make every transactional decision. As @Carl Fischer recommends, I'd also convert the funds you have in the traditional IRA to a Roth IRA so you won't be subject to the nasty RMD, which is almost a must if you have real estate in the SDIRA.

1 Reply
Daniel Cruz
Knoxville, TN · Member since 2013 · 100 posts · 24 votes
6y
@David Carroll
Hello David, you can move everything to a SDIRA, then create a check book IRA. If I recall correctly this is a corporation that you create and your IRA invests in
0 Reply
David Carroll
OP
Rental Property Investor · Louisville, KY · Member since 2019 · 14 posts · 3 votes
6y
@Kat McReynolds Thanks for your response. Another great thing about a solo 401k is you are allowed to pool your investing power with your spouse. I don’t think you can do that with a SDIRA.
My concern about a custodian comes down to control. For example within the solo 401k I decide to purchase metals such as gold and silver and also invest in real estate. In the case of a custodian all assets would be parked with the custodian. Gold and silver would be physically located with the custodian and the deeds to any properties would also be located with the custodian.
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Carl FischerPro Member
Rental Property Investor · Ambler, PA · Member since 2015 · 2k+ posts · 1k+ votes
6y
@Kat McReynolds
Great summary-fast learner.
no restrictions on the loan from the 401k-use it to pay down debt, vacation, Christmas gifts, buy real estate, etc. Don’t mix up Ira and 401k. They are slightly different plans. Check your contribution limits with your cpa.
most likely the money not invested in an asset is making little to no interest in today’s environment. It should be fdic insured so having the money available to borrow is fine but it will max out are $50k. You may also be taxed twice when borrowing from a 401k.
401k salary deferrals can also be traditional and Roth and the same logic as IRAs applies for when it is taxed. Company contributions are taxed when distributed or converted to Roth.
sometimes a custodian/administrator is helpful and useful and worth the fee. other times a hinderance and time consuming and costly. Your goals, available time, knowledge, etc all play into the equation. Congrats on your synopsis and good luck.
[email protected]215-283-2868
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Kat McReynolds
Member since 2019 · 23 posts · 22 votes
6y
@Carl Fischer Thank you for the info. I was indeed conflating IRA & 401(k). Thanks for the distinction.

@David Carroll Ahhh, I see your concern. You would definitely need to trust this person a great deal. And good tip about pooling funds with the spouse, thanks.
1 Reply
David Carroll
OP
Rental Property Investor · Louisville, KY · Member since 2019 · 14 posts · 3 votes
6y
@Kat McReynolds Also the requirement for a solo 401k is you must be earning non passive income as self employed to be eligible. Within the solo 401k you can invest in real estate, notes, metals, tax liens, and traditional investing in stocks and mutual funds.
2 Reply
Daniel DietzPro Member
Rental Property Investor · Reedsburg, WI · Member since 2011 · 1k+ posts · 857 votes
6y
@David Carroll I wrestled with this too. Like you most of my assets were in retirement accounts when I started in RE Investing.
The conclusion I came to is that, for me at least, it made sense to take out JUST my ROTH contributions, since it had been 5 years so no penalties or taxes due.
The *reason* I look at it this way is that inside of a retirement fund it is hard to find lending with less than 40% down. Outside of one (traditional purchase I can do 20% down all day long and even lower if the cash flow is there.
So I thought of it this way.... say I have 100K in a SOLO401K I can borrow another 150K to make a 250K purchase, a four-plex in my area. Now if I take that 100K out tax and penalty free and invest in traditionallyI can buy TWO four-plexes with it.
From there, just a matter of running the numbers in the BP Calculator to see which makes sense. You also need to figure in the tax if not in a ROTH account. Even looking at all that, after penciling it out if I sold in 10 years the ROTH account might make about 120K, and the cash purchase would make about 190K AFTER taxes, so 70K ahead.
You could run the same numbers figuring your time horizon, tax brackets and long range plans like 1031s etc.....
Hope that helps, Dan Dietz

[email protected]608-524-4899
3 Reply
Dmitriy Fomichenko
Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
6y
Originally posted by @David Carroll:
@Dmitriy Fomichenko Thanks for the reply. I do have an S Corp and am eligible for a solo 401k. So how can I avoid a custodian?

David, in order to avoid the custodian you need to establish truly self-directed Solo 401k. Here is how it works:
1. Your S Corp will act as plan sponsor
2. Your S Corp will adopt Qualified Retirement Plan (Solo 401k)
3. Plan is created, instead of using a custodian, 401k Trust will be used as a vehicle to hold plan assets. As trustee you control it.
4. As plan trustee you will open business checking account for your Solo 401k Trust, fund it with rollover or contributions and start investing. Investing will be as simple as writing a check. All income will flow back to the 401k trust business bank account and all investment related expenses will be paid from this account.

4 Reply
Dmitriy Fomichenko
Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
6y
Originally posted by @Kat McReynolds:
Most financial planners are only paid when clients pursue these kinds of investments, so they don't educate many people on alternative investments that self-directed IRAs allow.

Some banks will even lend money to a self-directed IRA to leverage the amount the IRA owner has accumulated. However, taxable income earned as a result of the debt will incur higher (up to 39.6%) taxes, via the "Unrelated Debt Financed Income" or UDFI tax. So, if you buy RE with 50% IRA funds and 50% debt, half of your income from that venture (the half that was funded by debt) will be taxed at this high rate.

Solo 401(k)s are a special breed of retirement accounts that avoid this UDFI tax. They have other advantages, too. You can borrow money from the account, as long as you repay with interest within 5 years (see question 1 below). Also, the maximum annual contribution is higher at $27,500 per year (if under 50 years old), which allows the IRA owner to take a larger deduction on income taxes.

___

My questions:

1.) Are there restrictions on what you can use funds for when you give yourself a loan from a Solo(k) account? Business expenses that are not related to property owned through the IRA? Personal expenses?

2.) What is the money in a Solo(k) doing before you withdraw it for a REI? Does it bear any interest at all? Is it at any risk of declining in balance? If not, I would love to put cash reserves here and simply borrow when needed.

3.) If I'm understanding correctly, traditional IRA funds are taxed when withdrawn, and Roth IRA funds are taxed when deposited. When are Solo(k) funds taxed?
Kat, good summary, just a couple clarifications:
You are right on when you say that most financial advisors don't get paid when you invest in real estate, but another reason they don't recommend alternative investments is because they have zero experience with them and don't understand them.
UBIT maximum rate is currently at 37%.
Here is a list of lender who will lend to retirement accounts:

https://www.biggerpockets.com/member-blogs/2810/50272-list-of-non-recourse-lenders-for-self-directged-ira-and-401k

Contribution limit for truly self-directed Solo 401k plan is currently $56,000 per year per participant (plus $6,000 catch up for those who are over 50), it has several advantages over SD IRA:

https://www.biggerpockets.com/member-blogs/2810/21298-solo-401k-advantages

To answer your questions:
Loan proceeds become your personal property and can be used for any purpose.
You decide how your 401k balance is invested, while it is in case it does not work for you, so you want to deploy your capital.
Solo 401k allow you to have two buckets of money: traditional pre-tax which grows tax deferred and taxed at distribution and post-tax Roth which is taxed upfront but grows tax-free and qualified distributions are tax free.
Hope this helps!
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Dmitriy Fomichenko
Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
6y
Originally posted by @Daniel Cruz:
@David Carroll Hello David, you can move everything to a SDIRA, then create a check book IRA. If I recall correctly this is a corporation that you create and your IRA invests in

Checkbook IRA (aka IRA owned LLC) uses Limited Liability Company (LLC) not a corporation as a vehicle to hold the assets and gain checkbook control.

0 Reply
Dmitriy Fomichenko
Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
6y
Originally posted by @David Carroll:
Within the solo 401k I decide to purchase metals such as gold and silver and also invest in real estate. In the case of a custodian all assets would be parked with the custodian. Gold and silver would be physically located with the custodian and the deeds to any properties would also be located with the custodian.

You are correct about the properties, the title will be vested in the name of the custodian as follow:
ABC Trust Company, as custodian for David Carroll IRA 1234567
However custodian will not hold precious metals in their possession, you will be required to obtain services of a depository who will hold the metals. With the Solo 401k you would not be allowed to hold precious metals in your possession. Should you invest in precious metals? That is a completely different topic, metals are not an "investment", they don't produce any income. I prefer real investments such as trust deeds: you get guaranteed passive income each month and your investment is secured by real property which minimizes your risk.

1 Reply
Justin WindhamPro Member
Banker · Nationwide · Member since 2015 · 4k+ posts · 1k+ votes
6y
@David Carroll
A lot of the Solo 401k advantages over an IRA come from the fact that a Solo 401k does not require a custodian while an IRA does. Without the custodial requirement, you won't need the additional expense and administration of an LLC to get checkbook control. The Solo 401k can be self-trusteed, giving you, as the trustee, direct control over the assets. A few other Solo 401k advantages:
-Compared to an IRA, Solo 401k contribution limits are roughly ten times higher.

-You can take participant loans from the plan.

-There is a built in-Roth component whereas IRAs are either traditional or Roth, not both.

-A spouse can also participate in the same Solo 401k plan.

-The Solo 401k has additional tax benefits over an IRA when investing into real estate using leverage.

-Solo 401k plans are often quicker to setup and cost less money over time compared to most IRA LLCs.
1 Reply
Daniel DietzPro Member
Rental Property Investor · Reedsburg, WI · Member since 2011 · 1k+ posts · 857 votes
6y
@David Carroll I should add to my example above comparing buying leveraged rentals in a retirement account that part of what makes the option of taking the ROTH funds out in my case, as well as most investors, is that the loan *terms* are very different too.
The best non recourse loan for retirement funds I found this year was 40% down, 6.25% and 20 year amortization. On loans outside of retirement funds I am able to get loans ranging from 25% down, 4% and 30 years to 20% down, 5.125% and 25 years.
So that can obviously can profitability and cash flow. Higher interest is obviously never good, but the 20 year amortization being the longest typically available in retirement funds *can* have the advantage of faster equity build up leading to a paid off rental once you reach retirement. And since if you are not yet retirement age does the lower cash flow really matter since you are not going to be using it right away.
We opted for one non-recourse retirement property loan at just 15 year amortization so the higher cash flow once it is paid off can kick in earlier in retirement than the 20 year loans.

[email protected]608-524-4899
2 Reply
Trevor Brown
Rental Property Investor · San Gabriel, CA · Member since 2019 · 6 posts · 6 votes
6y
I'm not sure if ROBS Will work for a real estate investment business, from the traditional IRA, but when I started another small business we looked into the option of the roll over business start up (ROBS).It seemed to be penalty free up to $50,000, a little bit better than borrowing with less penalties . And for the Roth, we took out up to the limit that we had put in as principal, and left the gains to be taken out after 59 1/2. Might not be enough cash but I would definitely look at as many steps before taking out the final draw with penalties
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Brian Ploszay
Investor · Chicago, IL · Member since 2009 · 1k+ posts · 1k+ votes
6y
I urge caution because the market is rather mature. Top of the cycle.
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Calvin OzanickBusiness Member
Property Manager · Janesville, WI · Member since 2017 · 707 posts · 297 votes
6y
I would always lean towards diversification. I do not know the numbers, but a modest real estate investment, partnered with a healthy retirement account is a recipe for success in my book.
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