Using Leverage Within Self-Directed IRAs
Many people are under the impression that it’s illegal to borrow money to invest in Self-Directed IRAs. That’s unfortunate, because that’s just not true. Indeed, many people have borrowed within their IRA to terrific effect: Research shows that because stocks tend to outperform bonds over very long periods of time, using leverage within a retirement portfolio – that is, borrowing money and investing it in assets with a return greater than the costs of carrying that loan – can actually reduce retirement risk.
Indeed, that’s the specific conclusion of this study by two Yale professors, Ian Ayres and Barry Nalebuff.
From the abstract:
By employing leverage to gain more exposure to stocks when young, individuals can achieve better diversification across time. Using stock data going back to 1871, we show that buying stock on margin when young combined with more conservative investments when older stochastically dominates standard investment strategies—both traditional life-cycle investments and 100%-stock investments. The expected retirement wealth is 90% higher compared to life-cycle funds and 19% higher compared to 100% stock investments. The expected gain would allow workers to retire almost six years earlier or extend their standard of living during retirement by 27 years.
The keys to success here: Ramp up the leverage when you’re young, and then dial it back as you get older. The idea is that you will benefit from early gains magnified by leverage not just early on, but for many years afterwards, because once you pay off the loan, the increased gains from your leveraged investment continue to compound as long as you live.
This is exactly the strategy proposed by some newsletter companies such as the Oxford Group – and it does work, potentially, though it’s certainly not for everyone!
The problem: Few garden-variety mutual fund companies will tell you how to do this. If you have a brokerage company handling your retirement account, they might approach you about taking out a margin loan – but they have a built-in conflict of interest, too: They only want you investing in their products… the stocks and bonds and mutual funds in their inventory that their managers want their brokers to push.
Furthermore, some of them may not do margin lending within an IRA or 401(k). They just aren’t set up to account for the rules specific to these kinds of accounts.
Even if they do allow margin lending within Self-Directed IRAs, that might be ok if all you knew about were stocks and funds. But most of our clients have much broader perspectives. What’s more, Federal requirements limit what they can lend to a 50 percent margin.
Always remember that while leverage may amplify returns, it also amplifies the risk of loss. Don’t take on leverage within your IRA unless you have some tolerance for substantial variations in your account balances.
Borrowing Within Self-Directed IRAs and other Retirement Accounts
You don’t have to limit yourself in this way. For example, if you are comfortable with real estate investing, and you want direct exposure to real estate in your portfolio, you can frequently borrow up to about 65 percent of the purchase price of a residential property within your IRA, Roth IRA, solo 401(k), SEP or SIMPLE plan, provided you set up the account with a firm like ours, American IRA, LLC, which is very easy to do.
You can engage any lender you like, though in practice there are a few lenders that specialize in self-directed retirement account investing and are already familiar with the rules.
Loans must be non-recourse. That is, you may not pledge anything outside the IRA asset or the underlying real estate asset within the IRA as collateral. You also cannot use your IRA to lend to or borrow from yourself, your spouse, your descendants and antecedents or any entity they control.
This actually grants you a great deal of flexibility: If you can find a suitable lender, you can leverage your exposure to nearly anything you can think of:
- Real estate,
- House flipping
- Precious metals
- Tax liens and certificates
- Private lending
- Venture capital
- Private equity
And much more.
Self-Directed IRAs: restrictions and prohibited investments
The only things you can’t invest in using Self-Directed IRAs are alcoholic beverages, life insurance certain kinds of precious metals of insufficient or uncertain purity, gems, jewelry and collectibles.
Note that while the IRA provides certain tax advantages like deferral or, in the case of Roth accounts, tax-free growth, you may be liable for tax on any growth attributable to money you borrowed. Speak to your tax advisor about any concerns arising from unrelated debt-financed income tax, which is the name for the tax that applies to income attributable to borrowed money in retirement accounts.
For further information, contact American IRA, LLC at 866-7500-472(IRA) or visit us online at www.americanira.com.