Utilizing Non-Recourse Loans in Your Self-Directed Retirement Plan

Options for Funding Real Estate Investments in a Self-Directed IRA

Self-Directed retirement plans grant investors access to a vast number of investment opportunities. Something that investors may not be aware of, though, is the self-directed account’s ability to leverage investments using non-recourse loans. In this article, we will discuss the definition, benefits, and specifics of non-recourse loans as they pertain to self-directed retirement plans.

What is a Non-Recourse Loan?

A non-recourse loan is a powerful tool that self-directed retirement plan holders can use. They can use this type of loan to borrow money or leverage their investments. A non-recourse loan is a type of leverage where the lender only lends against the asset purchased by the debt. Financing with non-recourse loans means that in the event of default, the lender cannot seize any assets held by you or your retirement plan. Lenders can only seize the asset for which you are borrowing the funds to purchase as you have provided no personal guarantees. For example, non-recourse loan collateral would be the property funded by the loan. This provision is essential for self-directed accounts, as it allows the retirement plan to remain in compliance with IRS guidelines while still utilizing leverage to obtain investments. More on that later.

What Can a Non-Recourse Loan Do for My Self-Directed Retirement Plan?

So why would someone want to utilize a non-recourse loan in their self-directed retirement plan? What benefit could it provide you? First, non-recourse leverage can significantly expand your investment options. Using debt can grant your retirement plan access to assets that it otherwise would not have been able to invest in or purchase. Real estate is one of the most common assets purchased using non-recourse loans in retirement plans. If your self-directed retirement plan is unable to cover the cost of the property in its entirety at closing by only using equity, utilizing a non-recourse loan to raise funds necessary to purchase the property is a way to accomplish that goal.

A second, and closely-associated benefit of a non-recourse loan within your self-directed retirement account, is asset diversification. Imagine you have $100,000 in your self-directed retirement plan. You want to purchase a property worth around $100,000 with your IRA but you do not want to spend the entire balance of your retirement account to obtain the property. You take out a $50,000 non-recourse loan in the name of your retirement account to help purchase the property. By utilizing the powerful tool of a non-recourse loan in your retirement account, you can free up funds in your IRA to invest in other assets to add diversification to your portfolio, which is a vital investment strategy and your portfolio’s best friend.

Can I use a Recourse Loan in My Retirement Plan Instead?

What about traditional recourse loans? Is my retirement plan able to take debt in which I sign personal guarantees? In short, the answer is no. The reason why your retirement plan can only utilize non-recourse loans is thanks to IRC § 4975 (c)(1)(B). In this section of the Internal Revenue Code, the IRS prohibited the extension of credit between a disqualified party and a retirement account. This prohibition means two things: the retirement account cannot loan money to a prohibited party, and a prohibited party cannot loan money to or personally guarantee a loan to your retirement account. Click here to learn more about prohibited parties.

The retirement account is the only qualifying factor in receiving a non-recourse loan. The non-recourse loan is not given based on the account holder’s (or disqualified party’s) personal credit or assets. Taking a loan in your retirement plan for investment purposes that guarantees your personal assets would be considered a prohibited transaction. Personally-guaranteed loans can have significant consequences on how the purchased asset is handled from a tax perspective.

What Should I Keep in Mind Before Taking a Non-Recourse Loan?

When considering a non-recourse loan in your retirement account, you need to consider several factors. The first point to consider is that non-recourse loans to a retirement account are somewhat of a niche undertaking. Not every financial institution that offers loans as a regular part of their business can or should undertake a loan relationship with a retirement plan. A few reasons financial institutions wouldn’t offer non-recourse loans for retirement plans include a lack of administrative feasibility and awareness of the IRS prohibitions. Therefore, it is essential to use a financial institution that regularly handles non-recourse loans to retirement plans or perhaps even specializes in them. Doing this could save you a world of trouble.

A second point to consider is that most non-recourse loans typically require a significant downpayment from the retirement account in order to lend funds. It is not uncommon to require a 30% or 40% downpayment for a non-recourse loan. A large downpayment makes sense because of the limited recourse that the lender has in the event of default. Remember that the lender can only possess the asset used to obtain the loan if there is a default. A larger downpayment also reduces the lender’s exposure in this situation.

A third point to consider before obtaining a non-recourse loan is the tax implications that come into account when leveraging your investments. While the leveraged asset is held within a tax-advantaged account, there can be taxes that apply in certain circumstances when utilizing leverage. When an IRA takes a non-recourse loan, the income associated with the debt taken by the IRA becomes subject to a tax called Unrelated Debt Financed Income Tax (UDFI). However, Individual 401(k) plans are not subject to UDFI, thanks to a provision in IRC Section 514(c)(9). This lack of taxes makes Individual 401(k) plans an exceptionally powerful vehicle for retirement plans. If you are interested in learning more about Individual 401(k) plans, you can do so here.

In conclusion, non-recourse loans are a powerful tool that can help guide you towards bigger and greater opportunities that could have been otherwise unavailable to your retirement account. If you have any questions about this article or would like more information, please feel free to contact Midland at 239-333-1032 or visit www.midlandtrust.com.

MIDLAND TRUST IS NOT A FIDUCIARY: Midland’s role as the custodian of self-directed retirement accounts is non-discretionary and administrative in nature. The account holder or his/her authorized representative must direct all investment transactions and choose the investment(s) for the account. Midland has no responsibility or involvement in selecting or evaluating any investment. Nothing contained herein shall be construed as investment, legal, tax, or financial advice or as a guarantee, endorsement, or certification of any investments.

Foreign Investing IRA

Forex Trading In Your Self-Directed IRA

Diversification is the key to investment success. If your current portfolio holds a variety of publicly traded securities, you can further diversify by adding self-directed assets such as real estate and private placements to the mix. You can take that diversification even further by investing in a combination of domestic and foreign investments in an IRA.

Adding foreign investments to your portfolio may seem intimidating, but in reality, the process doesn’t differ much from a self-directed investment made domestically. Here are some things to consider when looking to use your IRA to invest offshore.

Check to See If the Country Where You Are Looking to Invest Recognizes Foreign Investing IRAs

First, be sure to check if US retirement accounts are acknowledged as eligible investors, as some countries require investments to be held by an entity, such as an LLC.

If you are looking to use your IRA to invest in foreign property and the use of an entity is required, confirm whether you can use a US-based entity or if you will need to establish a foreign entity. This requirement should also be considered when looking at foreign private placements.

If your investment requires you to go through an IRA owned entity, you will want to be sure to familiarize yourself with the IRS rules for IRA investments. You can read more about these rules in our Guide to Prohibited Transactions.

Establish a Network of Professionals Local to Where You Are Looking to Invest

Unless you have lived or transacted business in the country where your investment is located, chances are you may not be too familiar with that country’s laws. To assist you with navigating the legal waters of your foreign investing IRA, consider seeking the help of a local attorney. They will be able to shed some light on how the investment can be structured with consideration to the country’s legal requirements.

If you are looking to invest in foreign real estate, you may also want to consider working with a property manager. Having a property manager can simplify the rent collection process and the upkeep of the property. Be sure to know what the property manager’s services cover before entering into the property management agreement.

Always Request a Translated Copy of the Investment Documents

Not only does Midland require a translated copy of the investment documents to administer the investment, but it is also a good idea, in general, to have a translated copy for your records. This translated copy is particularly essential if you are not fluent in, or only speak the basics of, the primary language of the country where you plan to invest. While you may have foreign legal advisors who can read and understand the original document, you may want to consider hiring a professional translator or interpreter. Getting a translated copy of the investment document allows you to read the documents yourself and review them with your advisors here in the US.

Do Your Due Diligence for Foreign Investingn IRAs

If you are working with an investment company for a foreign investing IRA, be sure to do a review of the company before committing to investing. What is their investment track record? Is the investment illiquid, and if so, are you able to handle not having liquidity or regular returns?

Check to see if the investment company you are looking to work with operates in the US, or solely offshore. For example, do they have satellite offices in the US? Do they have a US bank account? If the investment company banks domestically, this can help save you the international wire fees.

Be mindful that, even though your IRA is considered a tax-sheltered account, your IRA can owe taxes, which is particularly important if the investment is using leverage. When it comes to tax questions, consider seeking the help of a tax professional who is familiar with both IRA and foreign tax laws.

Educate Yourself on the Rules for Foreign Investing IRAs

Whether onshore or offshore, it is vital to understand the IRS rules as a self-directed IRA owner. Some key principles to keep in mind include:

  • All income must flow directly back to the IRA, or IRA owned LLC – you should never take receipt of investment income personally
  • All expenses must be paid for with IRA funds – do not pay expenses for your IRA owned investment personally
  • If partnering on the investment, income and expenses should be split pro-rata according to the percentage of ownership
  • If investing in property, you cannot have any personal use of the property so long as the IRA owns any portion of it
  • If investing in property, you cannot provide any sweat equity. A non-disqualified third party must complete all repairs and services
  • The above extends to disqualified parties

And these rules are just the tip of the iceberg. You can learn more about the IRS rules in our Guide to Prohibited Transactions.

If you have any questions regarding foreign investing IRAs, please contact us at (239) 333-1032 or visit our website at www.midlandtrust.com.

MIDLAND TRUST IS NOT A FIDUCIARY: Midland’s role as the custodian of self-directed retirement accounts is non-discretionary and administrative in nature. The account holder or his/her authorized representative must direct all investment transactions and choose the investment(s) for the account. Midland has no responsibility or involvement in selecting or evaluating any investment. Nothing contained herein shall be construed as investment, legal, tax, or financial advice or as a guarantee, endorsement, or certification of any investments.

Helping Your Child Build Wealth

Helping Your Children Build Wealth

Budgeting, managing debt, saving for big purchases (such as a house or car), and saving for retirement are part of the many things not taught in high school or college. Managing money and preparing for retirement may be rude awakenings at some point in a young adult’s life. But with a little help, there are several ways you can help your child build wealth quickly as they enter the workforce.

Before you can provide guidance in a young adult’s financial future, you first need to make sure you are prepared. You want to make sure you are in a good financial situation for retirement yourself. It would be best if you are financially prepared for medical costs that may arise when you grow older and have an emergency fund established. It’s best to speak with your financial advisor regarding this. The following items highlight ways in which you can help your child prepare for their financial future.

WAYS YOU CAN HELP YOUR CHILD BUILD WEALTH

1. Set up an ESA or 529 plan as soon as your kids are born

These are tax-deferred plans used for educational savings. The sooner you can begin stashing away money for your child’s education, the better, as gains are compounded year over year. The elimination of student debt or even a good chunk of your child’s college tuition will lay the groundwork for financial success. Both offer tax-deferred advantages on growth in the account. According to credit.com, the average college debt is $31,172, so if you can partially or fully fund your child’s education, this can relieve a significant strain on their financial stability. Click here to learn about the comparison between 529 plans and ESAs (Education Savings Accounts).

2. Help them pay off debt

Now, there is a difference between reckless debt and manageable debt. If your credit card is maxed out because you have reckless spending habits, there are bigger issues than simply paying off a credit card. But if your child has debt that is somewhat out of their control, such as student loans, a mortgage, or a car loan, any help you can give will further advance your child’s financial success.

3. Let them live at home

You may be itching to see your kids off (and who could blame you), but there are many advantages of allowing your child to live at home after graduation. Rent can be costly, so living at home will allow your child to save for a downpayment on a house and/or pay off their student loans. Even charging your child a minimal rent fee or being responsible for some utilities while living at home can help them save for their future.

4. Gift up to $15,000

The IRS allows each parent and grandparent to gift up to $15,000 a year to each child and grandchild tax-free (the maximum you can gift in your lifetime is $5.6M as of 2020). You can gift more than $15,000 per year, but you would owe taxes on the portion that exceeds the $15,000. Again, the quicker your child can eliminate debt, the faster you can have your child build wealth.

5. Max out their IRA

If eligible, make your child put your gift of up to $15,000 into a retirement account. Making contributions to Traditional and Roth IRAs (if eligible) allow for earnings to grow tax-deferred. You can contribute up to a maximum of $6,000 to an IRA if under the age of 50. Roth IRAs are an especially powerful tool for saving, retirement, and even an emergency fund. Click here to read our article about the benefits of gifting to a Roth IRA account.

6. Max out their HSAs (if eligible)

Another option for your gift of up to $15,000 is an HSA contribution. You can contribute $3,550 per calendar year to an HSA account (as of 2020). This contribution is tax-deductible, regardless of income level.

7. Max out their 401(k)

Financial advisors suggest contributing to your 401(k) to match your employer’s contribution (if applicable) and/or to the maximum contribution amount. After all, the employer match is essentially free money that can be put away for retirement. 401(k)s have a high contribution limit ($19,500 in 2020 for people under age 50). If you can gift your child money, you may want to ensure they are upping their contribution limits to their 401(k)s.

8. Sell or gift your old vehicle

When you trade-in your vehicle, the dealership will make money by turning around and selling it for a premium to the trade-in value they gave you. When buying used cars, it can be challenging to gauge how well the vehicle was taken care of unless you’re a mechanic. You know your vehicle best and how well it was taken care of, so why not sell it to your child for the trade-in value or less? Doing this could be a win-win as you have the extra cash for the new car purchase, and your child receives a car for less than a used car from a dealership.

9. Lend them an emergency fund

Life is full of surprises. With no emergency fund, an unexpected charge to a credit card can create a snowball effect on wealth as credit cards carry a very high interest rate. Going into credit card debt is one of the last things you would want to happen to your child. If you can, loan them money for the emergency.

Every little bit helps. Just doing one or a few of the above items will help your child stay debt-free and prepare for their financial future. There are also many tax-deferred ways for your child to grow wealth, which should be taken advantage of when they have the income and opportunity to do so. The earlier they can begin saving in tax-deferred accounts such as 401(k)s, IRAs, ESAs, and HSAs, the better as their gains will compound year over year.

If you have any questions regarding helping your child build wealth, please contact us at (239) 333-1032 or visit our website at www.midlandtrust.com.

MIDLAND TRUST IS NOT A FIDUCIARY: Midland’s role as the custodian of self-directed retirement accounts is non-discretionary and administrative in nature. The account holder or his/her authorized representative must direct all investment transactions and choose the investment(s) for the account. Midland has no responsibility or involvement in selecting or evaluating any investment. Nothing contained herein shall be construed as investment, legal, tax, or financial advice or as a guarantee, endorsement, or certification of any investments.