SDIRA experience - is it really worth the hype?

Question

I have been looking opening a SDIRA.  I have read/heard many tout the overall benefits and flexibility of using an SDIRA, but when I looked into it a little more, the SDIRA seemed to lose its luster with several restrictions and underlying fees by custodians.

#1) Restrictions - Cannot "self deal" as this is a conflict of interest - This seemed couter-intuitive to me.  Isn't a retirement all about serving yourself later in life?  This then limits all business activity(other than the initial investment) to be with outside of your own control (i.e. you have no direct control over the investment itself).  That is a bit worrysome - if you are not careful, you could get taken for a ride by a less-than scrupulous business entity/individual.  I have read some horror stories of this (Google SDIRA scams, there are many).  That being said, I realize anyone can get scammed, if not careful.

#2) Fees - While fees are typically not huge, they do add up over time, and even a 1% fee over the life of an IRA can drastically chew up potential returns.

#3) Having faith in your custodial service.  There was a prior post on BP that referred to a litigation case involving a Trust company where the end result was the sentencing of two individuals with fraud, and millions of dollars of SDIRA dollars lost.  That's scary!

So:

For those who have used SDIRAs(or those who avoid them), please comment, as this is an investment that is both intriguing and perhaps mine laden (if not very careful), from what I see.

Thanks,

Dave

Keith Thompson · Answer

@David Cozzi,

Longer post than I anticipated when I began the response, but there are nuggets throughout.

RESTRICTIONS

The restrictions you have cited have not been a problem for me.  At first I looked for a way around the Self-Dealing, Disqualified Person and Prohibited Transaction rules so that I could move current assets into the SDIRAs but failed to find the seams in those rules, resigned myself to only new and conforming activity and moved on.  The decision was a good one and I continue to use the SDIRAs for profitable investing.

I will take issue with the "outside your own control" point since everything that I have done in the SDIRAs has been fully within my control; albeit within the IRS rules, but isn't it that way with every other investment?  Like it or not, the IRS is a partner in every transaction we do, regardless of the mechanics of the investment.  The point of the SD part of the IRA is that we get to control those activities and it has been golden for me.

Does the "unscrupulous" reference refer to partnerships or syndications and such options which limit your control of the investment?  If so, don't be worried, be cautious, informed and meticulous. This situation exists whether the funds are personal or SD related and fall under the caveat emptor rule.

You are correct that the whole point of these mechanisms is to serve us later in life, and they do that very well.  The restrictions on taking distributions of funds or investments from the SDIRA are age and/or length of time related, but these are easily dealt with through strategy diversification and phase planning.  As soon as we learned that disbursements from Roth required that the account be set up for at least 5yrs, we immediately set those up with a bank and xfered only $1K each from Traditional into the Roth accounts.  That started the Roth clock before we even added the SD component. I make that same recommendation to anyone that asks me about how I do my business - even the young folks.Are you aware that you can move a beach rental investment to personal ownership? Simply take it as a distribution when the timing is right - strategy and planning.

FEES

The fees for service do vary and selecting the Custodian is crucial, not just on the fees structure.  It's far more important to find the best fit for your Service needs, then look at fees. When I set up my xSDIRAs (x=Trad or Roth), there were few Custodial options that met my needs. My primary need was instant reaction time which necessitated "checkbook control." I received a lot of "No's" before I found a group that said "Yes" to that element.  This service is more widely available now and my rationale for having that element remains primarily to speed my ability to respond to opportunity since I go to a lot of auctions.  It also relieves me of many of the myriad Custodian transaction fees. I handle (most of) each of the individual transactions myself and just pay from the annual Custodian fees for holding my accounts. To be clear, when I use refer to "checkbook control" I am not referring to a Custodian account that I write checks against, I set up LLC's, that I manage, which are each 100% owned as assets within my xSDIRA accounts.  So I have LLC accounts fully managed by me with full right to act in the interest of the LLCs. I write checks on those accounts.

If 1-ish% fees seems excessive for the expected profit, then then you are correct to wonder if the juice is worth the squeeze. It absolutely has been worth the squeeze for me. There are profit options in SD that FAR outweigh what could be done with a personal track. But SD may not be the route otherwise, we're back to a personal juice/squeeze analysis. My returns have definitely been worth the squeeze - especially when I have leveraged the opportunity to converting Trad assets into Roth prior to realizing the gains.

FAITH

Selecting the right Custodian is a crucial piece of SD strategy. As with all investments, due diligence is up to each of us. I started by figuring out what I needed from them and then worked with my selection at a low-level prior to putting larger chunks into play.  My checkbook control accounts hold the vast majority of my SD funds in bank accounts that the Custodian only adds funds to (at my direction) and cannot withdraw.  Periodically I send funds back to the Custodian account(s) as it makes sense or as needed.  BP used to have and probably still has a list of Custodians which serves as a great starting point.

@Josh Caldwell uses Equity Trust - a fine firm and I looked at them.  At the time I was looking they charged higher fees and did not offer checkbook control.  Josh is also right about the xSRIRA being what you make of it. That part is CRUCIAL!  Have you ever put $xK into an online trading platform only then to allow it to sit fallow?  I have, actually still do to some degree, but I work the xSDs because they offer even greater potential for building tax deferred, and more importantly - Tax Free profits.  I suspect that Josh does some potion of his hard-money lending in an xSDIRA - a stellar strategy.  I hold property, paper and rentals in mine.

@Justin Windham makes excellent points as well.  Structure is critical.  I really like the Solo401K option for these primary reasons:

Higher contribution limits.

Reduced exposure if you inadvertently do a prohibited transaction.

Advantages in supporting the business with the Solo401K itself.

(Justin, correct me if I have erred here.)

I don't have a Solo401K yet, but I expect to set one (or more) up in the not too distant future.

Best of luck in your endeavors David -

Keith

Josh Caldwell · Answer

There are two things to consider. The SDIRA rules, those come from the IRS, and they suck but there is nothing you or anyone you will ever meet can do about that. The IRS is the IRS.

The second part is the SDIRA companies. There are a handful of large, very legit SDIRA companies. I happen to like Equity Trust in OH but there are others that do just as good of a job. they are not there to advise you about investing but to make it possible to do so, tax free or tax differed. This is where a lot of the private lender money comes from.

SDIRA is what you make of it. If you are turning deals you can build a large nest egg without a great deal of risk  You can also lose all of your money if you choose bad deals. In the end it is up to you.

Justin Windham · Answer

@David Cozzi

If you want to have more investment options and control when it comes to your retirement money, self-directed IRAs or a Solo 401k plans are great tools. I agree with @Josh Caldwell when he says "in the end it is up to you." That is the whole idea of self-directed investing- that you are able to make choices that are not available with typical IRAs and 401ks, but it is up to you to make good choices based on your situation and goals.

As for fraud, I believe most of this has to do with the investments that can be made with a self-directed account that are simply not possible with a typically-restrictive IRA or 401k. I consider the type of care that needs to be taken to avoid fraudulent investments in a self-directed retirement account to be on par with the level of care needed to avoid fraudulent investments with non-retirement money.

As for self-dealing, you are correct that these accounts are for your benefit later on (presumably in retirement). The restriction is on you benefiting from the investment while the funds are still in the account. The key is to find good investments (not scams) that don't require your direct involvement to be successful (other than certain managerial or decision-making input). For example, you could not invest your IRA into your operating business, but you could use the IRA to buy a rental property that the IRA rents to a non-disqualified person. You would be able to decide the market rent, choose the tenant, and execute the lease agreement (depending on the specifics of the retirement structure). The rental income would go back to the IRA (you would not receive it, but it would be there for you to distribute to yourself later in life after tax benefits have accrued). You would not be able to go in and perform work on the property, however. So, yes, there are rules to keep in mind, but in my opinion, there is plenty of room to operate within those rules while still building great retirement wealth for yourself along the way.

Make sure you choose the right account structure for you, and you may also want to consider checkbook control if you have reservations about a custodian's role in your investing. A custodian can certainly have a meaningful impact on fees, the types of investments allowed, and the speed with which you can transact. Checkbook control is the common solution for situations in which that impact is undesirable.

Chris C. · Answer

@Justin Windham

So this would basically give you check book control since you managed to LLC, but what if that LLC does repairs on a property owned by your IRA?

Justin Windham · Answer

No, this would be prohibited. The LLC in this scenario is typically wholly owned by the IRA, but managed by the IRA account holder. The profits go back to the LLC (again, owned by the IRA) without needing to be returned to the IRA unless a distribution is taken from the IRA.

Justin Windham · Answer

@Chris C.

In that case, the repairs would be paid for by the IRA-owned LLC. As the LLC manager, you can decide on what repairs should be done, but a non-disqualified person should be hired to carry out the repairs.

Justin Windham · Answer

@Keith Thompson

I agree with most of what you have written in this thread, but I would caution you with regard to any work you do on IRA-owned properties. It seems your opinion was formed with the help of licensed professionals, but a more conservative approach would be to avoid having any disqualified person (including yourself) perform actual work or provide services on these assets. There are many in the industry that plainly consider some of your examples to be prohibited transactions. I don't write this to fully dispute your conclusions, but to share the more conservative outlook with anyone else who may be learning from these discussions. There are gray areas within the subject matter, and by definition, they touch on the unknown and, to some extent, the unknowable. Unless or until better guidance becomes available or an opinion is handed down in an audit, that is.

Keith Thompson · Answer

@David Cozzi

re - this point:1) Real Estate - So far all real estate investing that I have done has involved SF long term rentals/vacation rentals under my own LLCs with my own funding.  So should something go wrong, I have only myself to blame.  Thankfully, I am very diligent, so things have gone well for me.  Obviously, I cannot do this in my SDIRA.You are asking EXACTLY the right questions. You can search for, rent, do minor repairs  and manage the property but you cannot take a fee for any of those activities. You can do some work on the property, such as routine minor maintenance, but not value improving maintenance.  You can paint a wall, but not the whole house.  I use KKOS for counsel when I have such questions, they set up my LLCs and continue to advise whenever I have "grey zone" questions. When I pressed for information on limitations it became clear that the guidance was thin.  Guidance on SD comes from three federal entities (at least), they are IRS, GAO and DOL.  In addition to law, they produce more minor, explanatory publications regarding case results, field guidance documents and such.  When I last looked closely into these, there was nearly zero specific guidance on  how much and what kind of work is allowable by the SD owner on their investment. I'm find working about the edges of the grey areas, but only at the white-ish margins.

I'm sure I'm oversimplifying this, but in my conversations with atty @Mat Sorensen of KKOS and the compliance folks at Specialized Trust Company, the results boiled down this - I can do work, but if the level of work requires me to wear a tool belt, I've probably reached the limit. I literally implement based on that.I manage the properties but hire "tool belt" level repairs.I have been onsite for projects in order to provide guidance to the workers and answer questions about how I'd like the repair done.

I have held the stupid end of a tape measure.

I have held the end of a board, but not used the power tools.

This interpretation was reinforced by a (former?)BP contributor:

@Steven Hamilton II Accountant from Grayslake, IL..."you are allowed to do repairs on the property; however, you are not allowed to upgrade or increase the value of the property. So you can fix the light switch or fixture; you can't remodel the kitchen."

You get the idea. If you want specific guidance on appropriate level of involvement, consult a specialized atty or the Custodian's compliance folks. It is not possible for me to overemphasize the need for good advisors as you navigate the SD rules and regs (refer back to my comments on looking for Services before Fees). My bible for quick reference is: "The Self Directed Handbook; An Authoritative Guide for Self Directed Retirement Plan Investors and Their Advisors", by Mat Sorenson.  I usually keep extra copies on my bookshelf and have given away several copies of this book to friends that have expressed interest and demonstrated intent to use the SD strategies.

If you want to do some research on your own from the Lawmakers, start here:

IRS - Retirement Plans Published Guidance   (Code, Notices, Advisories, etc.)

DOL - Too many links to list, but start here: Field Assistance Bulletins, Private Letter Rulings, Interpretive Bulletins, Advisory Opinions and Retirement Publications

DOL has even issued some Exemptions relating to "Prohibited Transactions", see PTE 80-26 for exemption on Interest Free Loans to Plans experiencing short-term liquidity problems.

GAO - Opinions from IRS Code (IRC) violation cases, IRS Pubs, FSAs, TCMs and Reports GAO-20-210 - IRS Could Better Inform Taxpayers about and Detect Noncompliance Related to Unconventional Assets

The list could go on, but most of you are probably way bored by now.  Me, I love this stuff.  These things define the game boundaries and help us play with the border and close to an edge ot two.

@Chris C. - Sort of, my xSD accounts each have an asset, the LLC, where the account is the sole member and the Custodian appointed me the Manager of the LLCs. The Custodian then executed a letter that defined my responsibilities which covers everything I need to do, including opening a bank account, buying, selling, renting, holding paper and pretty much anything else that an LLC can lawfully do, so long as those actions comply with ERISA.  KKOS prepared the letter, I added bits and pieces and STC executed them.

Yes, the profits remain in the LLCs as long as I want them there. I keep enough to operate and invest and move $ as needed. Including transferring funds from the TradSD to the RothSD, which is a taxable event, but the tax implications are still advantageous (for now).  Eventually the LLC assets will have to go back to the Custodian if I want them distributed from the account to me, personally. That's how you get a house that you get a $XXX,XXX house that you paid $XXX for without paying the profit taxes.  Or sell in within the RSD/LLC and take the profit as distribution, again without taxes.

Inviting @Jared Friedman & @Michael K Gallagher back for the follow-on info.

The xSDIRA strategy is absolutely the BEST investment strategy I've come across in decades of investing.  Unfortunately I only learned about it six years ago, but boy, am I making up for lost time.

Friends help friends invest wisely. BP is the single best source for wise investing that I've found - BAR NONE.

Best of luck to all,

Keith

Justin Windham · Answer

You are able to make decisions related to (and be in control of) all of these activities. You can certainly search for a suitable investment property for your SDIRA. You can decide on any improvements that need to be done, decide who or what company will make those improvements (as long as they are not disqualified persons), and pay for those improvements out of your SDIRA. You can decide who will rent the property (as long as they are not disqualified persons) and at what rate. To be clear, there are some things you cannot do according to the prohibited transaction rules, but you do not have to surrender your control over the investment to follow these rules. You could not run an operating business out of your SDIRA without encountering UBIT and prohibited transaction issues. You would, however, generally handle the managerial role of passive investments in your SDIRA. You would be in charge.

Chris C. · Answer

@Keith Thompson

So you have an LLC wholely owned by you and then just use your SDIRA to entirely fund the LLC?  So you're able to keep all the profits in the LLC without having to go back to the SDIRA

SDIRA experience - is it really worth the hype?

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