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Alternative Investments for your Retirement PlanSubmitted by Townsend Asset Management Corp. on June 3rd, 2016
For investors frustrated with interest rates stubbornly sticking near-zero, but unwilling to ride the up and down gyrations of the stock market, are there alternatives?
Most IRAs and 401(k)s are invested in traditional investments such as certificates of deposit, bonds, stocks, or mutual funds; however, those disappointed with low interest rates and volatile equity markets are looking beyond the traditional and opting for some alternative investments for their IRAs.
What are these alternatives? The
Real estate is probably the most popular alternative investment. Obviously, investing in real estate requires an IRA to be pretty large, but by combining IRAs held at various institutions or rolling a 401(k) account from a previous employer into an IRA, sufficient funds may become available. Where it is still not feasible, investing in real estate through a partnership or a limited liability company may be an acceptable alternative.
Before you get too excited about buying a home at the beach with your IRA money, you have to understand a number of no-no’s that are considered “prohibited transactions.” Neither you, your spouse, parents, nor children can use the property (although your brother or sister could). Likewise, you could not use your IRA to buy an office condo to be used by your business.
If you are investing in real estate, many IRA custodians require that a separate property management firm be retained to actually manage the property, which is another expense you have to consider.
Your IRA can use borrowed money to finance the purchase of real estate, but only if it is a non-recourse loan, which means that you, as the IRA owner, have no personal liability on the loan. However, you also need to keep in mind that leveraged real estate producing a profit may be hit with a tax on its “unrelated debt-financed income.”
You will also need to leave enough money in your IRA in cash, so there is money available for repairs, property taxes, insurance, etc. Another consideration is that when you reach age 70 ½ and must commence distributions from your IRA; you will need to have enough liquid funds available.
You should also be aware of fees charged by the IRA custodian. Investing in alternative assets is a more time-consuming and paper-oriented process for custodians, and therefore their fees are higher than fees charged for investing in traditional investments.
Other than real estate, a more recent alternative is using your retirement plan to fund a new business. These arrangements are referred to as “rollovers as business startups” (ROBS). The basic structure of these is that an entrepreneur forms a new corporation which then establishes a 401(k) plan. Next, the entrepreneur rolls an existing IRA or other retirement plan into this new 401(k), which, in turn, buys stock in the newly formed corporation. At this point the new corporation has the capital to acquire a business or a franchise.
With ROBS, given their complexity, there is a much greater risk of inadvertently crossing the line and engaging in a prohibited transaction – and the consequences can be devastating, potentially subjecting the entire rollover to taxes and penalties. Therefore, make sure you obtain professional advice and assistance.
Real estate, ROBS, or other alternative investments may sound interesting, but often involve greater risk and have less disclosure than more traditional investments. For that reason, do your homework prior to committing any funds to them.
Gerald A. Townsend, CPA/PFS/ABV, CFP®, CFA®, CMT is president of Townsend Asset Management Corp., a registered investment advisory firm. Email: Gerald@AssetMgr.com