IRA’s and 401ks are both popular retirement investment accounts which provide growth and tax benefits for their holders, typically earning returns through a combination of stocks, bonds, and mutual funds. While average returns from these sources can be acceptable to some, there are many who are constantly searching for higher yields through alternate means. Its totally understandable, you see a large sum of money inside your IRA making 5-6% annually, which can be frustrating when there are opportunities around you which promise 10 or 20% returns annually.
One of those opportunities that investors sometimes come across is the private lending market. This little remarked upon marketplace features many entrepreneurs and investors just like you, who are seeking financing for their projects, and willing to pay significant interest rates on short terms to make them happen. This can be a tempting venture, but if the majority of your assets are tied up in a 401k or IRA, you might throw your hands up and assume that taking that opportunity is impossible. The good news is that that is not actually case.
While it is true that the standard 401k/IRA does not allow you to make such creative investments as private loans, that is not true of self-directed IRA’s and solo 401ks. These special accounts enable the holder to manage their assets in the account for themselves, as long as the investments meet certain requirements and private lending does meet those requirements.
Now that we understand that private lending is a viable investment strategy for those who possess self-directed IRA’s and Solo 401ks, lets talk some more about private lending specifically.
The advantage, but also the complication of private lending is that all of the terms have to be specified between you as the lender and the prospective person taking the loan. This includes repayment schedules, interest rates, and all other specifics, which means you need to understand the specifics of your terms and ensure that everything is legally correct. Another major consideration in private lending is risk, if someone is coming to you rather than a bank, they probably are making riskier investments or are themselves a greater risk than normal. This means that you can charge higher rates, but also need to ensure that you are keeping your risk at acceptable levels. One way that risk can be alleviated is by adding collateral to your loan terms, transforming the loan into a secured instead of a non-secured loan.
For example, let’s say you lend $200,000 from your IRA to person who is purchasing a duplex rental property as an investment. By adding the duplex as the collateral, your risk is greatly reduced. Either you receive your money back with interest, or you get an investment property you can sell or operate.
One final extremely important consideration is that any loan you make to a private person in this way cannot be a disqualified person as defined by the rules of the account. These people include your family, anyone helping administer the account, and any company owned by a disqualified person. Breaking this rule could result in the entire tax burden of the 401k/IRA becoming due at once so avoiding this is very important.
All of this being said, private lending can be a very lucrative investment that could greatly boost the funds in your solo 401k or Self-directed IRA. Due diligence and consultation with an accountant and lawyer would be prudent before embarking on this path, but the potential rewards can well make this worth your time.
- Bray MacIntosh
- Financial Analyst Intern
- Lee-Chandler Enterpri
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