Investing in Distressed Mortgage Notes with a Self-Directed IRA
We all remember the Great Recession, the housing market crash, and what that wrought for homeowners who could not afford to pay their mortgages. With COVID-19 bringing unemployment and financial hardship to many families, those with mortgages may be struggling to keep up with their payments. These distressed mortgages—also referred to as nonperforming mortgages—can be invested in through a self-directed IRA and create a win-win scenario for both investor and homeowner.
Distressed mortgage notes, like other private lending transactions, are among the alternative assets allowed in a self-directed retirement plan. These nonperforming mortgages are purchased at a discount—typically anywhere from 10 to 50 percent lower than the property’s value—with repayment terms negotiated by the retirement plan owner and the homeowner. This enables the homeowner—who is likely at risk of foreclosure and losing his/her home—to stay in the home and make payments to the self-directed IRA that now holds the note.
Meanwhile, the IRA generates passive income as the full value of the note is repaid, along with the interest agreed upon by both parties. Plus, the investor builds a more diverse retirement portfolio and a hedge against stock market volatility by including private alternate assets in the IRA.
Example of a distressed mortgage note investment:
- John and Lisa owe $250,000 on their home and their mortgage has an interest rate of 3%. However, John lost his job last year due to the pandemic and Lisa’s salary doesn’t cover all household expenses.
- They are unable to make their mortgage payments and are in danger of foreclosure.
- Sandra has a self-directed IRA and picks up that mortgage for $212,500 (a 15% discount) from the lender that is off-loading a “toxic” loan.
- Sandra works out new payment terms with John and Lisa for the full $250,000 mortgage amount but at a lower interest rate, for a longer term to spread out their payments.
- Sandra’s self-directed IRA makes the extra $37,5000 on that loan amount plus interest.
- John and Lisa get to stay in their home while they work out their finances.
Due diligence on distressed mortgages
Self-directed investors are accustomed to doing due diligence on their potential investments, and distressed mortgages should be no exception. Like any investment, these notes can carry risks, especially since the buyer (the self-directed IRA) becomes the creditor.
For example, what if the homeowner defaults? The self-directed investor would be wise to research foreclosure laws in that state to ensure they have a backup plan. In addition:
- Although the loan is secured by the real estate as collateral, it’s critical to know the property’s current value by hiring a professional appraiser.
- Know the original loan terms – it sounds elementary but be sure to have the interest rate, timeline, and amount borrowed documented so you can evaluate the value of the investment opportunity.
- Vet the borrower’s credit history and ability to repay the loan.
- Consult a trusted advisor about any tax liabilities the investment may incur.
If the investor decides not to work with the homeowners, the self-directed IRA can resell the property or retain it as a rental investment. Again, as with any self-directed investment, it is the responsibility of the account holder to ensure due diligence, full transparency, and a clear understanding of all tax and legal ramifications.
Where to find nonperforming mortgages for investment
Although lenders will typically sell these notes to get them off their books, there are also online marketplaces and trading platforms that sell notes. However, expect to pay more for these notes than buying direct, as these are retail resellers. You can also invest in a company that buys nonperforming mortgages from banks at steep discounts.
At Next Generation, many of our clients include real estate as well as secured and unsecured loans within their self-directed retirement portfolios. Adding distressed mortgage debt is another valuable way to build retirement savings through alternative assets—with the potential of helping homeowners stay in their homes. If you have questions about this or other alternative assets allowed through self-direction, feel free to schedule a complimentary education session with someone from our team. You can also email NewAccounts@NextGenerationTrust.com or call 888.857.8058.
Investing in Self-Storage Through a Self-Directed IRA
Did you know you can include self-storage in your retirement portfolio? Real estate is the most popular asset class in self-directed IRAs—including commercial real estate—and self-storage is a growing segment that offers great potential for self-directed investors. In fact, it is a $39.5 billion industry in the U.S., utilized by approximately 10% of all U.S. households (with tremendous growth potential as Generation Z gets older and Generation X starts to downsize). As of this year, the estimated number of self-storage facilities is over 49,200.
The most common avenues for self-directed investments in this asset class are through promissory notes (lending) or private placements—direct investments in a private entity such as a self-storage REIT (real estate investment trust), C-corporation, LLC or fund. The self-directed IRA invests into those entities, with all income and expenses related to the asset flowing in and out of the retirement plan.
Strong asset class with strong ROI
- As of 2019, the National Association of Real Estate Investment Trusts (NAREIT) reported high annual returns of 16.85% over 25 years (NAREIT) – outperforming multifamily, retail and office
- According to Self-Storage Almanac 2021:
- Around 31% of self-storage space by rentable square footage is owned by six of the largest public self-storage companies:
- Public Storage
- Extra Space Storage
- Life Storage
- National Storage Affiliates Trust
- Another 16.5% is owned by the next largest 94 operators
- Mom and pop/small operators own 52.3%
- This leaves a wide-open field for market consolidation through private REITs or funds specializing in self-storage investments
- Around 31% of self-storage space by rentable square footage is owned by six of the largest public self-storage companies:
- Utilization of self-storage units continues to climb as people downsize, are in transition, or simply have too much stuff
- Self-storage facilities generally have low operating costs compared to other real estate assets and lower construction costs than other commercial real estate sectors—with high income potential
Investing in self-storage through a self-directed IRA
Before taking the steps to invest in self-storage through a self-directed IRA, there are a few things to note. This must be a passive investment to meet IRS investing guidelines. You, as the self-directed IRA owner, cannot be an active partner, director, or managing member of the investing entity (REIT, fund, LLC)—this makes you a disqualified person and creates a prohibited transaction which can cause your investment to lose its tax-advantaged status. Also, beware of investing in a private fund or company that is owned 50% or more by disqualified individuals, as this would constitute a prohibited transaction. Disqualified persons for this purpose are the account owner, his/her spouse, lineal descendants or ascendants; a beneficiary of the IRA; or plan service providers and fiduciaries.
At Next Generation, we take steps to make investing in all types of alternative assets as easy as possible. Our Starter Kits contain all the paperwork needed to open and fund a new self-directed retirement plan. After you do your research and identify the entity into which you wish to invest through your IRA, we’ll provide you with a list of the documentation required to process and execute the private placement (or promissory note, if lending). You will need to provide our Next Generation team with a buy direction letter, private placement instruction letter and advisory notice, transaction payment method, and outgoing ACH or wire instructions.
We will review the transaction for compliance with IRS investing guidelines and complete the transaction; our custodial firm, Next Generation Trust Company, holds the assets for our clients.
Want to know more including self-storage in your self-directed IRA? Watch this on-demand webinar on the topic, or schedule a complimentary educational session with Next Generation. You can always contact us by phone at 888.857.8058 or by email to NewAccounts@NextGenerationTrust.com with your questions.
Self-Directing your HSA Can Help Boost Your Savings for Future Medical Expenses, Tax Free
It’s common today for people to have a high-deductible health plan (HDHP)—one with a higher annual deductible and out-of-pocket maximums (and slightly lower premiums) than typical health insurance plans.
Those high deductibles may be a hard pill for many people to swallow, but HDHPs allow individuals to open and fund a health savings account (HSA). HSAs provide three tax-advantaged ways to save and pay for qualified medical expenses. The tax benefits of these accounts are:
- Funds deposited into an HSA are not taxed
- The balance in the HSA grows tax free
- The amount withdrawn to pay for qualified medical expenses (including copays, coinsurance, premiums, dental care, eye care, and prescription drugs) is not taxed
After a person hits 65 years old and is on Medicare, he or she can no longer contribute to the HSA but the funds may be used for other expenses without penalty; however, any non-medical distributions are treated like those from a Traditional IRA and subject to income tax on the distribution. Unlike a Traditional IRA, there are no required minimum distributions.
Your savings can accrue year after year, just like in an IRA. And just as you include alternative assets within your IRA, you can also invest the money you accrue in your health savings account—and purchase alternative assets to build up your savings for the future.
Just as with any self-directed retirement plan, you can give your health savings account a boost by including nontraditional investments such as real estate, precious metals, notes, private equity, and more. Self-direction allows you to use your expertise in the investments you’re passionate about, and may bring you comfort in knowing you’re making your own investment decisions. And, if you have relatively low medical costs and build up a healthy balance in your HSA, you have another avenue for growing your retirement savings with the potential for higher yield than the returns on a typical savings account. The broad array of diverse investments allowed through self-direction also provide a hedge against stock market volatility.
The contribution limits for HSAs in 2020 will be $3,550 for an individual and $7,100 for a family; individuals 55 and older can make an additional $1,000 catchup contribution.
You can have more than one HSA and you can transfer funds between them—so you may choose to use one to cover medical expenses or medical emergencies and another building wealth as a long-term investment for future medical expenses or supplemental retirement income. With health care costs continually rising, and today’s workforce expected to need at least $260,000 to cover medical expenses during retirement, having a self-directed HSA can help.
By including alternative assets and self-directing your health savings account, you’ll have more options for creating a cushion for medical or other expenses when you retire—and you’ll maximize your HSA contributions while you are able.
If you have questions about self-directed HSAs or any self-directed retirement plans, Next Generation can help with one of our complimentary educational sessions. Or, contact our team about self-directed IRAs and the many types of nontraditional investments these plans allow. We’re available via phone at 1-888-857-8058 or email: NewAccounts@NextGenerationTrust.com.
Private Equity Investing Using a Self-Directed IRA
Do you know someone who is starting a company and is seeking investors? Is there an established privately held company you’d like to invest in to help it expand—and earn some equity in the process?
If you have a self-directed IRA, you could include private equity investing for startups and other private companies within your retirement plan. The investment gives you shares that represent ownership or an interest in the entity. Private equity investments are among the many alternative assets in which you can use to build a more diverse retirement portfolio through self-direction.
What is a private equity investment?
Whether via accredited online crowdfunding platforms or direct investment, private equity is a capital investment in an entity that is not publicly traded; rather, it’s an investment in a privately held company. Once only utilized by high-net-worth investors, both accredited and non-accredited investors may now take advantage of this investment opportunity. Including private equity investments in one’s retirement portfolio also provides a hedge against the volatile stock market.
Examples of private equity investments are:
- Private common stock, preferred stock; options, rights, and warrants – shares in a private company, primarily held by its founders, venture capitalists, and private equity firms
- Private hedge funds – investors pool their assets with others to take advantage of investment strategies laid out by the fund manager
- Limited liability corporations (LLCs), limited partnerships (LPs)
- Foreign private equity – investment in privately held in non-U.S. companies
- Convertible notes – relatively short-term loans repaid through conversion to an equity stake in the company
When using a self-directed IRA, the plan invests directly into the business, partnership, or other entity, with terms worked out between the parties (in the case of a private placement, this is typically done via a subscription agreement). The entity gets needed capital and the self-directed investor diversifies his/her retirement portfolio by including this nontraditional investment within the retirement plan.
Ask your financial advisor if a private equity investment is right for you
As with any self-directed investment, account holders should conduct full due diligence about an investment opportunity before sending instructions to the self-directed IRA administrator. At Next Generation, we also strongly recommend that you check with your trusted advisor as to whether private equity and the potential tax liabilities associated with the investment fit with your financial goals. After all, every asset class has its risks – be sure you fully understand the upsides and potential downsides of any self-directed investment before making your decision.
For individuals who would like to invest in private equity, Next Generation offers complimentary educational sessions, so you can learn more about how these investments are structured with a self-directed IRA. Alternatively, you can contact our team with any questions about this or other self-directed investments by phone: 1-888-857-8058 or email: NewAccounts@NextGenerationTrust.com.