Private Lending with a Self-Directed IRA

For many, saving for retirement isn’t just about investing in traditional assets like stocks and bonds, it’s about creating a personalized strategy that works for their unique needs. Private lending through a self-directed IRA (SDIRA) offers a way to diversify your portfolio, potentially earn passive income, and take more control over where your money goes. This alternative investment option is becoming increasingly popular as people look for flexible ways to fund their retirement while supporting individuals, businesses, and real estate projects they believe in.

What Is Private Lending with a Self-Directed IRA?

Lending through your self-directed IRA enables you to lend money to individuals or businesses through your retirement account. Think of it as taking on the role of the bank — you benefit from earning interest on the loan, without the need to get overly involved in the management of the loan. There are risks associated with this type of investment, including the loan payments not being paid on time to the complete loss of your investment.

As a private lender, you can typically charge higher interest rates and set your own unique loan terms and requirements. The borrower’s payments on the loan, including interest, flow directly into your IRA account, and the interest may accumulate tax-deferred or tax-free, depending on whether your self-directed retirement account is a traditional IRA or a Roth IRA.

Types of Loans Offered

Your SDIRA can act as a lender to a variety of loans, including:

• Personal loans: These loans are highly flexible and can be used by your borrower for everything from paying off medical bills and tuition to funding a wedding or vacation.
• Business loans: These can be used by your borrower to cover operating costs, purchase equipment, or expand their business.
• Mortgage notes: You can also fund property purchases or construction for residential or commercial real estate through secured mortgage notes backed by real estate.
• Car, equipment, or livestock loans: Your SDIRA can invest in a loan that provides financing for goods like automobiles, manufacturing equipment, livestock, and more.

How Private Lending Works

To get started lending through your self-directed IRA, take the following steps:

1. Conduct due diligence: Whatever type of loan your SDIRA will provide, make sure to understand the opportunity, verify the borrower or real estate project’s credibility, and assess its risk against your retirement portfolio. You may want to consult a financial professional for help in this assessment.
2. Define loan terms: Create a written contract (a promissory note) between your SDIRA as the lender and the loan recipient (Borrower) outlining the terms of the loan, including the amount, duration, interest rate, repayment schedule, and whether it will be collateralized. Be sure to spell out what happens if the loan is not repaid.
3. Initiate the investment: Contact your SDIRA custodian to request an alternative asset investment form for any private lending notes, or a real estate note investment form for a mortgage note.
4. Have your IRA custodian send funds to the borrower: Upon confirming your loan documentation is complete, your custodian will disburse the funds to the borrower. Remember, you will not send the funds directly because your SDIRA is the lender, not you personally.

Benefits and Risks of Private Lending

Like other alternative investments, using your SDIRA to act as a private lender comes with its own set of benefits and risks. Be sure to consider your risk appetite carefully and to measure against the rest of your retirement portfolio.

Pros:

• Flexibility: Invest in smaller businesses or projects that align with your goals.
• Passive income: Earn interest on the money you lend without managing real estate or business operations directly.
• Potential for returns: As a private lender, you can typically charge higher interest rates due to shorter loan terms and the higher risk nature of this type of lending.
• Support for local impact: You can invest in projects or businesses that positively impact your community, as long as they are not related to you directly, providing opportunities for individuals or businesses that may not otherwise qualify.

Cons:

• Risk of default: If your borrower fails to repay the loan, you may lose your investment, especially if no collateral is involved.
• Limited recourse: Recovering funds in case of default can be time-consuming and costly, especially if you need to take legal action.
• Higher risk borrowers: As an alternative lender, you may be doing business with higher risk borrowers who may not have a chance of getting approved by a bank.
• Economic uncertainty: Market conditions beyond your control may affect your borrower’s ability to repay the loan.

Rules and Restrictions

All IRAs must not violate IRS Rules Prohibited Transaction rules, which includes lending to “disqualified persons.” This includes but is not limited to yourself, immediate family members, friends, business associates, and so on. You also cannot act as a lender to issue a loan that benefits one of these disqualified people in any way. For example, your SDIRA cannot loan your daughter $100,000 toward a down payment on a home. You can, however, lend $100,000 from your account to an unrelated third-party to fund a real estate renovation project, as long as all returns (the interest and the principal amount) are paid directly back into your self-directed IRA.

Interested in how you can allocate a portion of your retirement dollars for private lending? Open a self-directed IRA through Forge Trust today.