Private lending from your IRA is a simple way to earn tax-advantaged income for retirement with minimal work involved. Your IRA is the bank and extends loans to individuals and other investors. The most common investment an IRA lends funds for is real estate. However, your IRA can also loan funds to friends or others, especially those who may be (or are) experiencing adverse financial effects due to the coronavirus pandemic.
This investment option is not available from typical IRA custodians such as banks and investment brokers. You must use a self-directed IRA, which allows you to acquire alternative assets that don’t typically react when the stock market drops. If you have the funds in your account, loans from your IRA present a win-win scenario if you can lend a helping hand to someone who may be in dire economic straits right now.
How Private Lending from Your IRA Works
You dictate the terms of the loans. You set the interest rate, the length of the loan, and any other pertinent terms. For example, you can offer a lower interest rate for loans secured by collateral and a higher rate for unsecured notes.
Your IRA owns the asset. Even though you’re calling the shots as the account owner, your IRA owns the investment and all loans are titled in the name of your IRA.
Your IRA earns income on the interest of loans. And, this income grows tax-sheltered in your account depending on whether you have a self-directed traditional or Roth IRA. Traditional IRA owners pay tax on that income when you take distributions in retirement. But, if you own a Roth IRA, you’ll enjoy tax-free distributions when you retire.
Three Ways Your IRA Can Loan Funds
Private mortgages: If you know someone who is unable to obtain funding from a traditional mortgage institution, you can come to their rescue. The property is used as collateral. If the borrower defaults, your IRA can take possession of the house and sell it to regain the balance (or more) of the loan.
Mortgage down payments: Even those who qualify for mortgages at today’s low interest rates may need help with funding for the down payment. These transactions work the same way in your IRA. If the property is used to secure the loan, your IRA is in line right behind the mortgage company if the loan defaults.
Loans to other investors: This is a common practice between friends and members of investment clubs. Often, real estate investors use other people’s money for investments they make. The same rules apply—you set the terms of loans your IRA extends to people and entities seeking investment capital.
Private lending offers a unique way to protect and grow wealth for retirement. But, there many other alternative investments besides private lending you can use to build that wealth. There are also other types of accounts you can self-direct besides traditional and Roth IRAs.
Contact Advanta IRA today to find out how self-directed plans can maximize the earning potential of your portfolio. We can explain more about how private loans work in IRAs, and our role as a self-directed IRA administrator in facilitating your plan.