Self-directed IRAs (SDIRAs) can be very effective with online investing to defer taxes on your earnings. This is a second interview by iFunding in our SDIRA series, focusing on selection of an IRA custodian. SDIRAs require that an IRA account holder use a custodian company to administer investments and generate tax reporting. We spoke with Michael McNair – Trust Officer at IRA Services Trust Company about how well this can work with real estate investing online.
Remind us how self-directed IRAs improve the after-tax returns on any investment, including real estate.
In some respects, self-directed IRAs are like any IRA. They defer or eliminate taxes on investment income. SDIRAs can be traditional, taxed-deferred IRAs – including SEP and Simple IRAs – or a Roth IRA. With a traditional IRA, a certain dollar amount each year can be contributed without paying taxes on that income, but eventually, after the participant reaches the age of 70 ½ , they are required to take a distribution each year. The participant will pay taxes on the amount distributed to them. With Roth IRAs, you pay taxes upfront on the contributions, but never pay on the income or growth on the investment, even when withdrawing the money.
The restriction with IRAs that are not self-directed is that you are limited to stocks, bonds and mutual funds. You cannot, for example, invest directly in real estate properties, limited liability companies, promissory notes, crowdfunding opportunities or precious metals. That’s where self-directed IRAs come in. They are especially suited for real estate debt investments, that is, loans to property operators or developers.
Consider that some real estate investment types can average returns that are in the double digits (e.g., over 10%) per year. You can perform quick calculations about your potential savings if you defer taxes on income and growth, or eliminate taxes on asset growth entirely with Roth IRAs.
How did IRA Services Trust Co., and you personally, get involved with SDIRAs?
IRA Services Trust Company originally administered limited partnerships for Wells Fargo. In 2008, we were granted a Trust Charter, which enabled us to act as a custodian of self-directed IRA accounts. Since 2008 we have grown the business from less than 15,000 to over 40,000 accounts. I’ve been with the company since 1995.
Note that some providers in the SDIRA market only are “administrators.” Administrators can perform administrative duties and reporting but need to work with a custodian that is allowed to hold title to investments.
How do fees work with SDIRAs? They must be designed to accommodate the smaller transactions typical of an investment in a crowdfunded property, correct?
You should look for a SDIRA custodian that offers a fee structure compatible with online real estate investing, or crowdfunding. In a traditional, direct property investment, the investor is likely to make one big investment upfront then have a variety of outbound payments or inbound income each month. With crowdfunding, many investors will only put up $5,000 to $20,000 upfront per asset, and receive monthly interest or a lump-sum payment at the end. Our fees at IRA Services Trust are crowdfunding friendly – $35 to set up an account online; $125 one-time to purchase an asset/property; then $100 per year to maintain the account and $80 per real property asset per year. There is a small charge for a wire, while ACH transfers don’t generate a fee [note that iFunding will accept investment contributions, and pay returns, via ACH].
So, the benefits of the SDIRA outweigh the costs?
Very often that’s the case, though it depends upon your situation. SDIRAs tend to shield taxes best on income-generating properties paid for in cash (without debt). The use of SDIRAs has grown exponentially over the past decade.
iFunding suggests considering this simple case: $15,000 invested in each of two real estate crowdfunded properties at the same time. They each have a target return of 12% after one year, or $3,600 total (2 x $15K x 0.12). The one-time fees to open and fund the investments would be $285 and the ongoing maintenance fees would be $260/yr. In this situation, the annual maintenance fees come to .5% of the assets and 7% of the income.
Next, you would make a calculation with respect to your marginal tax rate on the profit of $3,600. This represents the tax savings benefit of using an SDIRA. Many US investors’ marginal tax rate is 25% to 39%. If you calculate the taxes you would not have to pay with a Roth SDIRA, and net out the fees, you arrive at the economic benefit in this example. At the 39% marginal tax rate, the SDIRA would let you keep over roughly $1,000 more of your $3,600 gross profit versus investing with a taxable account (you would keep slightly less than $1,000 in year 1 with the IRA account, and somewhat more thereafter). This is equivalent to a 50% increase in your net profit per year by using the SDIRA.
What else are customers looking for in a SDIRA custodian?
The question about fees usually comes up first. A very close second however, is the helpfulness and promptness of the client service staff. You want to be confident that your custodian can process transactions quickly so that, for example, your real estate deal can close promptly with your available funds. You also want experienced staff that are readily accessible and care about the account holders’ questions and challenges.
At IRA Services Trust, we have 55 employees, many of whom have been with us for 10 to 15 years. We also offer a special Concierge Service, for investment advisors and investment providers who want a single point of contact and often want transactions to be expedited.
How long does it take to set up an SDIRA?
The primary determining factor is where the funds are coming from. One can make a new IRA contribution, roll over funds from a qualified plan (401k, profit sharing plan, etc), or transfer funds from an existing IRA. Making a contribution to fund an IRA is very quick, but it is limited to $5,500 (under 50) or $6,500 (over 50) per year. If you are moving funds from an existing IRA to an SDIRA, the timing depends on how quickly the custodian will process the request. It is our experience that it will take from one to two weeks. In either case, it’s fair to say, a typical set-up time may be a week, but leave a buffer if you have an important investment to fund with a firm deadline.
If you are investing in what’s known as a Reg.D/506(b) investment (ask your real estate investing platform about specific property offerings), then there can be a “cooling off” period after you sign up and before you can invest. The period is intended to protect the investor by reinforcing the need to learn about the offerings and build a relationship with the issuer. This can be perfect timing to establish your SDIRA.
One more note is, that with 401K plans, some employers do not allow plan participants to transfer funds while they remain active employees.
What related services does IRA Services Trust offer?
Our systems are set up so that we can work with a crowdfunding platform to capture and securely share basic SDIRA account set up information from the platform’s website. Alternatively, a visitor to the crowdfunding site can be easily directed to a custom landing page on our site to start the account set-up and account funding processes.