Aloha, friends! As we head into the last couple months of 2011 (can you believe it??), it’s an opportune time to look back and think about how our investments have fared in the past year. I know for many, it was a rocky year, especially if you were invested heavily in the market. But while it’s important to assess your performance to date, it’s even more important to decide how to invest for the future as we head into 2012. And unless you’re a Mayan doomsdayer, 2012 could present you with some fantastic ways to rebound from a rough year.
A favorite investment vehicle for many of today’s Hawaii real estate investors is a Self-Directed IRA. You can use a SDIRA for private lending, to flip houses and to hold properties for cash flow. We’ve discussed it here before and it’s my pleasure to once again bring back Dan Falardeau of Entrust Hawaii for another Q&A:
Mike: Welcome back, Dan. Since we last spoke, there’s been a big shakeup in the Hawaii real estate scene. Governor Abercrombie recently signed into law a moratorium on non-judicial foreclosures. This is on top of the volatile market returns that still hover around net zero, the failure of record low mortgage rates to stimulate the economy and the new Occupy Wall Street movement that’s recently hit the streets. Have you seen any broad changes in the investment strategies of self-directed IRA holders the last few months? Are they moving into or out of real estate or has there not been much of a noticeable effect?
Dan: The most noticeable effects that I have seen are an increase in out-of-state Real Estate purchases and Precious Metals investments. Our clients have control over their retirement funds and make the decisions to invest in what they feel most comfortable in. The Occupy Wall Street movement has shown a light on how many Americans feel about the financial markets. Self-Directed IRAs can invest in assets that you choose. If you don’t like the Dow Jones, you can get out of stocks and mutual funds and invest in Koa trees on the Big Island or buy a rental property or many other green investments. You can know that in your own small way, your retirement investments are not adding to the greed of Wall Street.
Mike: No doubt the phrase ‘real estate’ has become somewhat polarized over the last few years, depending on whether you’re on the homeowner or the investor side of things. How do you feel real estate ranks in popularity against other investment types like precious metals or stocks for folks with self-directed IRAs? Is it a primary reason that people choose a SDIRA in the first place?
Dan: Real Estate is still the bulk of our business. There are so many different investments that our clients choose for their Self-Directed IRAs, but by far Real Estate is still the most popular. The Precious Metals markets are a close second. Gold and Silver are historically used to hedge losses in times of volatile markets and the world seems to be divided between those people that think Gold is over priced and a bubble about to burst and those who think it has never been this high and is going to continue to increase in price. If we only had a crystal ball…
How to Start a Self-Directed IRA
Mike: Ok let’s change gears slightly. If someone were to want to take charge of their own retirement instead of be handcuffed by the limited funds their current custodian offers, how would they start the process of converting to a self-directed IRA? Is it a simple rollover? Who do they initiate the transfer with, you or their current custodian?
Dan: It’s a 3 step process: Open an account, move the money over to your Self-Directed IRA and find the right investment. I’m here to help new clients with the application to open the account. The moving of funds from their current custodian is either a “transfer” if they have an IRA or a “rollover” if they have a 401k. Either way, there are not any tax or penalties in moving funds to their Self-Directed IRAs and we help with the transfers and rollovers. That step usually takes about 2 weeks. Then once the account is open and funded, the third step of finding the right investment is typically known ahead of time. Often new clients come to me with step 3 done in their minds and just need to get steps 1 & 2 taken care of to move forward with their investment plans.
Traditional or Roth Self-Directed IRA?
Mike: Does it matter if it’s a traditional or Roth IRA? Could someone convert from one to the other and would they convert before or after they rollover their funds?
Dan: Both traditional and Roth IRAs can be Self-Directed. Clients consider converting from a traditional to a Roth for several reasons. It’s not a one size fits all answer to the question of “should I convert my traditional IRA to a Roth IRA?” I explain it this way to my clients. The traditional IRA is pretax and you get to deduct your annual contributions from your Adjusted Gross Income (AGI). This lowers your income on your taxes and may help you to pay less when you file your taxes. Then when you are retired, you will likely be in a lower tax bracket since you will not be making as much earned income as you were before you retired. You will pay tax on your distributions from your traditional IRA as you take money out to live on.
The Roth is the opposite. You already paid your taxes on this income so it does not lower your AGI, but since you already paid your taxes on that money it can grow tax free. The Roth is a great vehicle, but the one thing I have to remind our clients is that you either pay the taxes later with the traditional or now with the Roth. When you “convert” to a Roth, you pay the taxes that year.
Running a Business With Retirement Money??
Mike: Here’s something I was wondering about the other day. Is it permissible to actually form and operate a business entirely owned by a self-directed IRA? Is that done very often here? I mean, could someone start a poi and poke lunch truck totally owned by their SDIRA as long as they’re not the ones pounding the taro or cutting the fish?
Dan: The short answer is Yes, and it is done all the time. Self-Directed IRAs can own businesses. You are not able to work for the company because you are a “disqualified person” from having direct relations with your retirement investments, so you couldn’t work at the lunch truck. You could, in your example, hire the manager and make the menu and prices, design the business model and what color the lunch truck would be. You still make the decisions, but you can not work or get paid. All the expenses and profits are in the name of the IRA because the business is owned by the IRA. This type of investment is often profitable because the client probably knows something about that business.
To use your example again, maybe the client is a fisherman and has been making poke for years and has some great recipes. Or maybe they already own one lunch truck and know how to operate a profitable business. They could use their IRA money and buy another lunch truck under a different business name owned by the IRA and then hire the manager and employees to run the business.
Mike: Let’s take that one step further. Without breaching any client confidentiality, of course, what’s the most creative, interesting or unique use of a SDIRA that you’ve seen? Let’s give our readers some ideas!
Dan: While I would like to share this with your readers, I need to protect our clients’ ideas. We don’t sell any products or give any investment advice, so the great ideas are out there and our clients know them when they see them. The nice thing about Self-Directed IRAs are that our clients are comfortable with their risk levels. They are the “Self” in “Self-Directed IRAs”.
Maybe you’re a Realtor and know a good deal on an investment property when you see one. Maybe you’re a dentist and have been working with Silver for years and know that market. Maybe you have experience loaning money and making a profit on the interest. Maybe you see the value in Koa wood and think investing in timber is the right investment for you. Maybe you’re a world traveler and have intimate knowledge of foreign currency markets. Maybe you have owned a profitable business and think you could duplicate that success with a business owned by your IRA.
We believe that investing in what you know lowers the risk levels and raises the potential for profits, and our clients agree.
Mike: Ok, fantastic. In full disclosure to our audience, I have a self-directed IRA with Entrust Hawaii for Hawaii real estate investment purposes and am very pleased with the decision. If someone else wants to explore this opportunity, what’s the first step?