3 Reasons to Use a Self-Directed Retirement Account

I recently interviewed Edwin Kelley, the CEO of Specialized IRA Services. His company is one of a handful of custodians that specializes in self-directed retirement accounts. I don’t know an exact number, but I do know that this segment of the financial services industry is exploding right now. Why? Because the average investor wants more control over their long term investments.

For years, it has been accredited investors who were participating in and profiting from specialized investment projects, while the average investor had the majority of their wealth locked in a retirement account that was almost exclusively tied to the stock market. However, with the current opportunities available to the average investor through a self-directed retirement account, those days are gone. Even a modest retirement account that has been moved to a self-directed custodian can achieve incredible returns through new opportunities combined with creative strategies.

In my conversation with Edwin Kelly, he outlined 3 reasons to me why self-directed accounts make sense, especially for those interested in deploying funds into real estate:

Security, Predictability and Consistency

Anyone with a retirement account can explore the possibility of moving that account to a custodian who specializes in self-directed accounts (here is a list of custodians you may want to look into). Whether it’s a Roth, an IRA, a 401K, etc., you have the ability to convert most of these to a self-directed account and start achieving a much higher level of control over your investments as well as your returns.

For real estate investors, there are typically two strategies that are used to deploy self-directed funds into real estate. The first strategy is simply buying property through your self-directed account. This may simply mean buying a single family home, renting it and collecting the income and appreciation through the retirement account for years to come. However, it may also mean buying an apartment complex using non-recourse financing — the potential is limitless. Either way, this is a game changer for most retirement accounts that are limping along in a handful of conservative stocks, barely keeping up with inflation.

The second strategy that many real estate investors use through their self-directed accounts is private lending and note buying. Rather than owning the real estate, you own the mortgage associated with a piece of real estate. I actually love this strategy and lend to a number of different investors myself through my retirement accounts. However, in my business, I also borrow from a number of private lenders. We are always building relationships with new individuals who want to achieve high yields with the security of a first position lien on single family property.

When compared to a stock that can literally become worth nothing if that company files bankruptcy, when you lend money against a physical asset like a single family property, you have the security of knowing your investment has intrinsic value. In addition, when you work with a reputable provider, you have the consistency and predictability of knowing that your money will continually achieve the high yields that come from private lending.

Tax Benefits

I think most investors would argue that the main objective of investing through your retirement accounts is to accrue wealth in a tax free environment. Most people never truly appreciate how much taxes hinder your ability to accrue wealth. When you unlock the potential of a retirement account to generate income, the sky is truly the limit.

As a simple exercise, let’s look at what happens when you take $100,000 that earns 12%/year (which is fairly typical for a private lender) while earnings are taxed at 33% per year. If no money was added to this account over the next 20 years, but it continued to earn interest at 12% while earnings were reinvested, that account would be worth about $425,000 at the end of 20 years. However, if that same $100,000 had been invested through a self-directed IRA and had not been taxed every year, at year 20 the account would actually be worth $861,000 — over twice as much as when the funds were taxed!

I think it goes without saying that having the ability to earn money in a tax-free environment is critical to accelerating your wealth creation.

Asset Protection

Many people don’t consider this, but building your wealth through a retirement account is also a tremendous asset protection strategy. Without getting into too much detail for specific types of accounts, most accounts provide protection from creditors, bankruptcy and even personal injury lawsuits.

For real estate investors who may feel they have a higher exposure to lawsuits, using self-directed retirement accounts as an asset protection tool probably makes a lot of sense. That said, be sure to speak to your attorney and/or financial advisor to understand the protections afforded to you under your specific type of retirement plan.

As with anything, understanding how to use a self-directed vehicle is just the beginning. I am always learning creative strategies from other investors as to how to get the most out of my retirement account. In fact, in my recent interview with Edwin Kelly, he talks about one of his clients who took a Roth 401k with $100 dollars in it and invested in a property that earned him $40,000 in tax-free income! It’s amazing what you can do when you are armed with a good education and have the right people advising you in your business.

How about you? Have any of you employed creative strategies in your self-directed accounts to achieve significant tax-free returns?

Leave a comment and let me know!

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.