How Do Timber Investments Work in a Self-Directed IRA?

Self-directed IRAs and solo 401(k)s allow account owners to use alternative investments to build retirement wealth. Timber investments fall into this asset class, presenting income versatility and portfolio diversification. Additionally, timberland is generally considered a potential hedge against inflation and stock market volatility.

This article covers ways to invest in timber, the benefits and risks, and how to invest using a self-directed retirement plan.

Types of Timber Investments

There are multiple ways to take advantage of the potential timberland presents.

Indirect investments

These assets include:

  • acquisitions within pension funds (private and public)
  • private equity investments via limited partnerships
  • commingled funds such as timber real estate investment trusts (REITs)
  • stocks, forestry funds, and other passive avenues

As passive investments, these assets require less work outside of the due diligence you should perform before buying any investment. This is an attractive benefit for many individuals. However, your returns depend on the timber market, which is great when prices are up. And companies often sell timber when the market is down to satisfy consistent dividend payments and related requirements.

Direct investments

Investors earn income in various ways, including:

  • ownership of land where trees are grown and harvested by the owner
  • leasing land to or from other investors
  • granting or receiving cutting rights to harvest existing timber for profit

The above strategies require more work from the investor. If you prefer direct ownership of timberland, you must find, purchase, and manage the property. You’re responsible for financing harvests and plantings for future yields. There are also expenses when you lease land from someone to grow timber or receive cutting rights to harvest timber. However, these strategies allow you to control harvest times to a degree—meaning you can generally wait to harvest and sell if the demand for the product is down. But this takes time, requires more hands-on involvement, and you’ll incur costs associated with maintaining the trees until you can harvest to reap more significant gains.

Risks of Investing in Timberland

Harvests typically occur approximately once every 15 to 30 years, depending on the purpose soft or hardwood is to serve. This is why trees are considered a long-term investment. While indirect investments bear little of this burden (stock may be diversified in several different companies with multiple timber assets), direct investors must take note.A blue sky framed by a lush, green row of trees planted as timber investments.

Savvy investors often acquire interests in tracts of land across different regions that mature in varying time frames to reap consistent benefits of multiple harvests. Additionally, some uses for wood products (such as paper) do not require trees to be fully mature, and those used for these purposes are harvested in a shorter amount of time than others.

Industry experts like Acretrader say that historically, the timberland space is resilient and presents a hedge against inflation worthy of consideration. However, natural disasters such as fires or floods can wipe out forests. Markets can and do fluctuate. Wood prices can rise and fall during inflation, low demand for housing, and other conditions in the U.S. and globally.

Is Timber a Good Investment?

While no investment is guaranteed—and we aren’t here to give you investment advice—timber reportedly has a good track record according to experts like the CAIA AssociationÒ, founded by the Alternative Investment Management Association. They provide history and projections, backed by data, in their recent article “Will Recent Economic Headwinds Threaten U.S. Timberland Returns?” In that article, they explain their position regarding timber as a viable long-term investment.

Their research “suggests that over the long run, there is only a moderate connection between economic health and timberland returns in the United States. The limited link is due in part to biological growth of trees, which drives a significant portion of returns for timberland. In addition, many end-use markets for wood are resilient to a slowing economy, such as packaging, tissue, wood pellets, and infrastructure (e.g., railroad ties, utility poles). That helps buffer timberland against economic downturns.”

Regardless of what the experts say, it’s critical to weigh the benefits and risks carefully before investing. What’s your risk tolerance? What are your goals? Perform due diligence, which includes seeking the advice of industry professionals as well as your tax and investment advisors.

How Timber Investments Work in a Self-Directed IRA

Self-direction provides a hands-on approach for people who want to control their retirement funds and investing decisions. These plans allow alternative investments—like timber—that aren’t available for conventional retirement plans. And some non-traditional assets offer more security than stocks, with the potential to earn income at a faster pace than bonds, CDs, and mutual funds.

You choose the assets for your plan.

Whether you prefer direct or indirect timber investments, you invest in familiar things, at a pace that makes you comfortable. You decide when to buy, sell, and hold, and you don’t depend on an investment broker or bank to make these decisions for you.

Expenses are paid with retirement funds.

Your retirement plan must pay for all expenses. You cannot pay expenses with personal money and reimburse yourself from the account. Doing so is a prohibited transaction that can result in penalties and impact your account’s tax-sheltered status. This is especially important with direct timber investments when you have ongoing management and maintenance expenses over long periods of time. So, make sure your plan has enough funds to cover costs after purchasing an investment.

All income is deposited directly into your self-directed plan.

This protects the tax-sheltered status of all earnings, including capital gains. Those earnings grow tax free or tax deferred, depending on the type of plan you have. For example, when you retire, you pay tax on distributions from self-directed traditional IRAs. Distributions of income from Roth IRAs are tax free.

There are prohibited transactions you must avoid.

Self-directed accounts must follow IRS rules for retirement plans. And since you’re in control, you are responsible for understanding prohibited transactions and disqualified persons. For example, you cannot personally perform labor or maintenance (i.e., harvesting trees, maintaining the land) on assets your IRA owns. Your IRA cannot purchase or lease timberland from disqualified persons, including yourself and your lineal ascendants and descendants.

Final Thoughts on Timber Investments

Investments in a self-directed IRA have the same chances of success or failure as assets you invest in with your personal money. The investment risks carry the same weight whether you invest with personal or IRA funds. But the goal differs a bit. Instead of depositing income into your bank account and paying taxes on that profit in the year it’s earned, all gains flow into your retirement plan on a tax-sheltered basis. Those gains have the potential to grow year over year, continuing to enjoy that tax-sheltered status. This creates more capital to reinvest and presents the opportunity to build significant retirement income.

When considering any investment, seek the advice of qualified and reputable experts who can provide the information you need to make sound decisions. Some resources that may be helpful regarding timber investments are the Forest Service division of the U.S. Department of Agriculture and state forestry associations. Like-minded investors are great resources. And, of course, your financial advisor and tax professional can help you determine what assets suit your needs and goals.

If you have any questions about this article or wish to learn more about alternative investments in a self-directed retirement plan, contact Advanta IRA today.

Resources on investing in real estate in an IRA:

Invest in Real Estate in an IRA: A Beginner’s Guide

Commercial Real Estate Investing as an IRA Diversification Strategy

5 Reasons to Invest in Multifamily Real Estate in an SDIRA

 

 

 

 

 

About Scott Maurer

Scott Maurer, Vice President of Sales for Advanta IRA, is a recognized expert in the field of self-directed IRAs. With a law degree from the University of Florida and as a designated Certified IRA Services Professional (CISP), Scott’s keen understanding of rules and regulations fuels his passion to educate others on the power of investing in alternative assets using self-directed IRAs. Scott is a frequent guest on retirement and investing webinars and podcasts, and he has shown thousands of individuals how to achieve financial freedom by teaching them how to use their retirement funds to invest in private placements, real estate, private lending, and more. Throughout his two decades in the industry, he has watched numerous unique investments unfold, giving him great perspective of what is possible when people take control of their retirement funds and investing decisions.