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Many companies rely on factoring to help them through a cash flow squeeze. A factoring transaction is one in which a business sells its accounts receivable (its open invoices) to a third-party entity—usually a specialty finance company called a “factor.” Factors are not banks and the funding they provide is not a loan.

The factor pays cash up front to the business for a portion of the receivables and then collects the amounts due on the invoices directly from the customers. The factor then pays any open balances to the business, minus its factoring fees. The service fee is how factors make their money.

Through these transactions, companies receive cash quickly on their receivables which can be used for inventory, payroll, equipment leasing and more. They may choose to factor invoices on a seasonal basis or during an emergent cash crunch, when waiting 60 or 90 days for payment from customers is not financially tenable. Organizations may choose a factor over a lending institution due to issues with credit ratings or an aversion to taking on debt associated with a loan.

These cash advances may be non-recourse or allow for recourse (depending on whether collateral is involved).

  • In recourse factoring, the factoring client ultimately takes responsibility for payment of an invoice if the factor (which could be a self-directed retirement plan owner) cannot collect payment from the customer, or debtor.
  • With non-recourse factoring, companies may sell their invoices to the factoring entity, which then assumes all of the credit risks for collecting on the invoices.

Accounts receivable financing through a self-directed retirement plan

Specialty finance companies are not the only entities that can buy invoices and earn a fee for collecting the payment. Self-directed retirement plans can also include factoring among the many alternative assets these plans allow. As with any factor, the self-directed retirement plan gains value by collecting fees from the client.

As with all self-directed transactions, it’s up to the account holder to work out the terms of the transaction with the business owner whose company is receiving the funds; to conduct due diligence to verify that the invoice is as expected and the customer can pay; and protect against the possibility of non-payment. All expenses and income must flow through the retirement plan.

Here’s one example of how factoring through a self-directed IRA works:

Let’s say your friend owns a commercial painting company and has a contract with the municipality to paint the schools in the district during the December school break and over the summer. Your friend’s company completes the work during these time periods, bills the town for the contracted amount, and then typically waits at least 30 days for those invoices to be paid. Meanwhile, the painter needs supplies or needs cash to make payroll.

You and your friend discuss the situation and you decide, as someone with a self-directed IRA, to advance the cash needed; the retirement plan becomes the factor of these receivables. You and your friend also agree upon the discount (the factoring fee). As the factor, the self-directed retirement plan will receive full payment of the invoice when the municipality pays its bills, and pay the balance owed to the painting company minus the negotiated factoring fee. The investment return comes back into the IRA tax-deferred or, in the case of a Roth IRA, tax-free.

If you already have experience with these types of transactions outside of an existing retirement plan, you might want to consider further diversifying your retirement portfolio by including factoring in a self-directed plan. Our professionals at Next Generation Trust Company can answer any questions you have about the many options and benefits of self-direction as a retirement wealth-building strategy. You’ll find our Starter Kits and other forms on our website, and a team of knowledgeable professionals available to help at our office. Contact us at Info@NextGenerationTrust.com or -888-857-8058 if you need help getting started or want to discuss alternative assets allowed through self-direction.