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Alternative Asset Purchases In IRA

I want to get you excited about alternative asset investing by showing you some recent examples of deals done in my self directed IRA and solo 401k. I constantly wonder why people are so “stuck” on buy stocks and bonds only and don’t even consider investing in real estate, notes, private lending, tax liens, gold and so on. I know once people see the potential returns and the relatively low risk as compared to the traditional assets they will switch into alternative assets. Let’s look at a few examples of a real estate purchase, note purchase and private lending to an investor.

Real Estate Purchase

I purchased a single family house in South Carolina and after doing cosmetic repairs, the property was rented for 9 months before the tenants purchased the property for $120,000. This resulted in an annual cash on cash return of 36%.

Purchase price: $91,000
Repairs: $5,100
Rental: $1,195/mo
Rental profit: $10,755 (9 months)
Sales price: $120,000
Sales profit: $23,900
Annual return: 36%

Mortgage Note Purchase

I purchased a first lien mortgage note on a single family property in Florida. The note was purchased for $15,900 and the monthly payment was $656/month. The property value is $48,000 which gives a low loan to value of 33%. The note has great upside potential with an UPB (unpaid principal balance) of $79,000.

Note price: $15,900
Property valve: $48,000
LTV: 33%
UPB: $79,000
Payment: $656/month
Annual return: 49%
Upside profit: $63,100

Private Lending

I met a real estate investor who wanted to buy, fix and flip a residential property. The investor had a purchase and sale agreement for $36,000 and the ARV was $79,000. The property needed about $14,000 in repairs. I agreed to lend around $29,000 (a very safe position). The loan was repaid in 6 months for a net annual return of 14%.

Property value: $79,000
Purchase price: $36,000
Loan amount: $28,800
LTV: 37%
Interest rate: 10%
Points : 2%
Term: 6 months
Annual return: 14%

I really hope that these examples and high returns inspire you to go out and think big for your retirement savings plan whether it is in a solo 401k or a Self Directed IRA.


SEP IRA versus Solo 401k

A SEP IRA allows tax-deductible contributions and tax-deferred growth. Easy to set up at basically any broker. Very minimal paperwork involved. In a Solo 401k their are similar tax advantages as with the SEP, however with more paperwork, a more limited number of administrators, and higher contribution limits.

The max for a SEP is up to 25% of compensation with a cap of $49,000 for 2011. Solo 401k allows profit sharing contributions of up to 25% of compensation plus tax-deductible salary deferrals to the plan of up to $16,500 for 2011 ($17,000 for 2012). The cap is now at $49,000 for 2011.

So while the caps are the same, you can make very little self-employed income and basically defer it all, which you can’t do with the SEP. This gives you that added flexibility which is especially beneficial for those who have some self-employed income as secondary income and want to get the most tax advantages.

For example, if you made $16,500 of eligible compensation, you could sock all $16,500 of it away with a Self-Employed 401k, but only $5,000 with a SEP. Of course, if your self-employed income is substantial and/or is your sole source of income, 25% may be plenty and I’d then go with the simplicity of the SEP.

One thing worth mentioning is that the SEP IRA is typically not the best vehicle if you are self-employed and don’t have W2 income. In this case, the SE 401K is almost always better, particularly since the Roth 401K is available as well. In the case of self-employment as a second income, with a 401K and W2 available, the self-employed 401K is not available, but the SEP-IRA is and is a good choice in this case.

A bit of digging revealed that employer SEP contributions don’t appear to count against your limit for Traditional or Roth IRA contributions (again, you’re your own employer, so you can make these contributions on your own behalf). Assuming this to be true, you can max out your regular IRA and contribute to a SEP. In addition, you can also rollover your SEP into your Traditional or Roth IRA. Thus, you can take advantage of the SEP without having to keep track of an extra account over the long term but instead you can open your SEP account, fund it, roll it over into your Traditional or Roth IRA, and then close it. While it’s a bit of extra work, it might be a good way of supercharging your retirement savings if you have any self-employment income lying around.


Differences Between Roth IRA and Roth 401k

The first difference that comes to mind when comparing Roth IRA to a Roth 401k is the contribution amounts. For the Roth IRA you can contribute up to $5,000 to your plan and for workers over 50 may contribute an additional $1,000 per year (i.e. $6,000/yr total). The Roth 401k plan has higher contribution limits, allowing employees to save up to $16,500 per year. For workers over 50, the limit is $22,000. Therefore, the contribution limits for a 401(k) are roughly three times higher than that of an IRA. For the Roth 401k plans, the contribution limits are the same as the traditional 401k limits, so this is a definite benefit.

The next big benefit is the income limits. The higher earners can convert to a Roth IRA from a traditional IRA, but they won’t be able to make contributions if they make over a certain income (see my prior blog post for details). Not so for a Roth 401k, in which there are no such restrictions. For example, Roth IRA contributions are off-limits if your modified adjusted gross income in 2011 is higher than $179,000 for married couples filing jointly or $122,000 for single filers. So for some people the Roth 401k is the only way to go or forfeit any government sponsored savings plan.

A nice benefit and advantage to a Roth IRA is that you don’t have to take distributions and essentially the account can exits forever without taking out any of the money. No RMD (required minimum distributions). The Roth IRA can be passed down to the next generation and provide tax-free earnings for that generation and the next. A Roth 401k, on the other hand, will require minimum distributions (RMD) starting at age 70½. If you need the money, you may not mind taking the distributions. But there is a way around it if you prefer to keep your savings working for you tax-free. You could roll the account over from a 401k directly to a Roth IRA but you would pay tax on any portion that was not Roth dollars.

On the flip side, an advantage of the Roth 401k is that the worker’s contributions can be matched by the employer up to a certain percentage. It’s essentially free money from the employer, on top of the employee’s elective deferrals. Just remember that the match portion of the contribution will be treated as a traditional 401k contribution since it goes in as pretax dollars. This is because the employer contribution can’t be taxed and in turn can’t be a Roth contribution. In other words, every Roth 401k has a Roth portion and a Traditional portion depending on where the dollars are coming from and what you elect.

If not in a self directed IRA or solo 401k plan that specifically allows alternative investments, your investment options would be more limited in a employer 401k since you are limited to the investment choices of that employer. On the other hand, a Roth IRA allows investors a great deal more control over their investment choices since they can choose from the wide range of investments for their own accounts. The best way to avoid the limited choices is to open a Self Directed Roth IRA or a Solo 401k Plan which essentially allows you to invest in anything allowed by the IRS. We will talk more about the Solo 401k in future blog posts.