Asset Optimization Blog - Ken W. Stone

Is a Self Directed IRA Best (part 2)?

In Retirement Planning by Ken Stone (April 24, 2008 10:19 pm)

How does a Self Directed Retirement Account work with investment Real Estate?

The company that taught the training class I attended indicated that the average account size they manage is $70,000.  This is shocking when thinking about using a self directed retirement account to purchase investment real estate.

Here’s why: 

When you opt to self direct a retirement account only the funds contained in said account may be used for activities related to the investments of that account.  So if you invest in real estate with your IRA (or a 401(k), 403(b), or any number of other retirement accounts) all expenditures associated with that property must be paid for out of the IRA.  Closing costs and downpayment are obvious expenditures – but what about negative cash flow?  The money must come from the IRA!  Need a plumber to replace the water heater – again IRA money must be used.

Lest you suggest that the average client has other retirement accounts that can be converted to cover these costs, this company indicated that the average retirement account size nationally is also $70,000 (are you doing better than the average?).  So on average, there’s no other retirement money available to handle the unexpected surprises. 

So if additional cash is needed at any point, where does it come from?  The only place it can:  Additional contributions.  Which begs the question: if additional contributions are no big financial deal, why is there only $70,000 saved for retirement?

How do I put this delicately?  $70,000 probably isn’t enough to retire on regardless of your time horizon to retirement.  Why would you take such tremendous risk with your retirement savings and buy real estate with your retirement money?

For example, let’s say that real estate values decline dramatically and you need to start making withdrawals from your self directed retirement account.  The rent on your investment property is paying for the mortgage only.  I know it’s the holy grail of investment real estate to have positive cash flow – but that’s atypical for many real estate investors these days.  So the property needs to be sold to create liquidity in the retirement account so distributions (also known as retirement income!) can take place.  But to sell would be to take a loss (requiring more money from the retirement account – additional contributions when you’re needing to take distributions) or break even – meaning you walk away with nothing from that investment.  No liquidity – no retirement income. 

Of course it can happen the other way too – and that’s much more fun to think about.  Still, isn’t it important to evaluate all the ramifications of an investment approach?

Speaking of retirement planning – if you’re learning lots from this post – you’ll learn even more – including strategies for optimizing your retirement planning approach – with my DVD workshop and Workbook here

I’ll post more on this topic soon!

To your optimized financial health,

Ken

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