When it comes to IRAs, self directed IRAs definitely offer more flexibility than most other IRA options. Self directed IRAs allow you to invest in a wide variety of different options which provide much more diversity than any other type of IRA. One such example is a private lending IRA.
A private lending IRA is a type of self directed iRA that makes it possible for you to use the funds in your IRA to make loans to eligible borrowers to help finance their endeavors. Because you control who you lend to as well as the terms of the loans you make, there is a huge potential for you to grow your retirement savings much faster than through any other investment vehicle. How is this possible? The interest you charge on the loans you make out of your private lending IRA are generally more than the rate of return you would receive from your other investment activities, especially in the face of a sluggish economy. This interest, plus principle payments, are directly deposited into your IRA, where it can then be used to make more loans and create more wealth.
Seem too good to be true? The good news is that it is not. However, there are a few rules that govern this type of retirement account. Here are a few private lending IRA rules that you should be aware of.
Loan to Value Ratio
When making loans to individuals, the loan amount cannot exceed 75% of the value of the asset being purchased. For example, let’s say you are loaning $100,000 to someone who is looking to purchase a house. The value of the house must be equal to or greater than $135,000 in order for it to be eligible for the loan.
Titling
The title of the asset won’t go into your name. It will be titled to the IRA and held by the custodian. This is because the asset belongs to the IRA, at least until you begin taking distributions from the account.
Eligible Borrowers
While borrowers don’t have to qualify for a loan like they do with traditional lenders and you have final say in who you loan your money to, the IRS has created some rules around who is an eligible borrower and who is not. For example, you cannot loan money to yourself or any of your family members.
Taxes
You are free to loan your money and grow your balance via interest and principle repayments tax free so long as you aren’t taking distributions from your IRA. However, once you begin taking distributions, you will pay income taxes on your earnings. This is a lower rate than gains taxes, however, so you’ll still save money. And, you can postpone taking distributions from your account and leave the proceeds to your heirs, if you so choose. They will have to pay an inheritance tax on the proceeds, but it’s a great way to leave your loved ones a nice nest egg for their future.