Last week I discussed some of the prohibited transaction rules concerning retirement accounts. The point of my post was to make readers aware of the minefields that exist when investing in real estate in these accounts. These rules apply to all forms of retirement accounts, i.e., IRA, 401(k), ROTH IRA, Defined Benefit Plans, ESOP, 401(a), and others. This week I would like to discuss an alternative to the self directed IRA.
The self directed IRA ("SDI") has garnered a lot of attention in the past six years as the investment vehicle of choice for individuals seeking control over their retirement assets. The real estate market explosion in 2004 was a significant factor in the SDI’s popularity. Traditional brokerage firms that hold most IRA monies limit an individual’s investment choices. Taking your IRA funds and investing in an asset not offered by your broker is not an option. Hence, real estate oriented investors turned to those companies that permit such investments through what is referred to as a SDI.
What many investors do not realize is a pension plan (for this post I am referring to a 401(a) plan, i.e., profit sharing plan) offers the same benefits without some of the hassles associated with a SDI.
When investing through a SDI everything is run through the IRA custodian who must sign purchase and sale documents, offers, checks, etc. (The "checkbook IRA" strategy is a solution, but a few concerns exist here so use guidance.) A 401(a) plan does not require the use of a custodian. With this plan you can serve as your own plan trustee. It is the plan trustee who controls the investments and signs on behalf of the plan. Hence, we eliminate the middleman (IRA custodian) and put you in control of your retirement account. Here is how it works:
- An individual establishes a Corporation or LLC for their real estate investing business or uses an existing entity;
- Next he or she establishes a 401(a) plan sponsored by their business and is appointed trustee of the plan;
- An existing IRA (not ROTH) and/or 401(k) monies with previous employers are rolled into a new account established under the 401(a). This account can be setup with several brokers. I use Schwab for my clients. Married couples can pool all of their funds into one account;
- The account will have a checkbook attached to it for control; and the Individual can invest in real estate or any other permissible investments (Note; must adhere to prohibited transaction rules).
The 401(a) in addition to offering greater control also provides for higher contributions ($49,000 each year subject to salary), allows for plan loans of up to $50,000 to participants with adequate balances, and provides ERISA protections if a common law employee is hired (a child will satisfy this test).
A 401(a) plan can be a safer alternative to the SDI with additional benefits. It should be noted that a 401(a) may require an annual tax return depending on the plan value and will come with an annual administrative fee. The annual fees for the 401(a) plan will be comparable or less than the custodian fees for a SDI.