When most people enter the workforce, they set up an employer-sponsored 401(k) plan to save for retirement. They may also set up an individual retirement account (IRA). These types of tax-advantaged accounts are managed by a brokerage firm and allow individuals to invest in a straightforward mix of stocks, bonds, mutual funds, and exchange-traded funds (ETFs). In recent years, individual investors have become increasingly interested in the private markets. Historically, these alternative investments were only accessible by institutions like pension funds or high-net-worth individuals. They can offer higher return potential, greater diversification, and less volatility. Common alternative investments can include private equity, venture capital, cryptocurrencies, and real estate. A Self-Directed IRA (SDIRA) is one tax-advantaged tool individual investors can use to access alternative investments, such as private placement real estate funds.

What is a Self-Directed IRA?

A self-directed IRA (SDIRA) is a type of IRA that can be used to invest in alternatives such as real estate and private equity and can be structured as either a traditional or Roth IRA. In a traditional SDIRA, contributions are made with pre-tax dollars, and you pay income tax on withdrawals in retirement. In a Roth SDIRA, contributions are made with after-tax dollars and qualified withdrawals in retirement are tax-free. A SDIRA is considered “self-directed” because individuals are responsible for researching and managing investments. For an investor with expertise in a specific industry, using a SDIRA could allow them to capture potential returns that are not possible in conventional retirement accounts.

To establish an SDIRA, investors must establish an account with a qualified custodian, a third party who will administer the account. The custodian processes investments, holds assets, and ensures compliance with IRS reporting requirements. The custodian will not provide investment or tax advice or evaluate the quality of an investment. When selecting an SDIRA custodian, investors should research the fee structures, specific expertise, customer service, technology, and reputation of the company. Individuals must typically look beyond their trusted relationships with bankers, brokers, and financial planners to establish a self-directed IRA. Setting up and managing this type of IRA is complex and will require more energy than other types of retirement accounts. Once an account has been established, investors can fund a SDIRA by contributing cash directly, transferring funds from another traditional or Roth IRA, or rolling over funds from an employer plan such as a 401(k). After selecting a private fund investment, investors can work with their custodian to submit subscription agreements and authorize the custodian to fund the investment. It’s important to consult legal or financial experts for additional guidance on complex investment scenarios.

Self-Directed IRA Limitations

While self-directed IRAs allow access to a wider investable universe, they are subject to risk and limitations in the form of prohibited transactions by the IRS. Many of the prohibited transactions are related to self-dealing or a disqualified person engaging in transactions or receiving personal benefit from SDIRA investments. Disqualified people are defined by the IRS to include the SDIRA account holder, spouse, ascendents, descendants, fiduciaries, and any entity in which a disqualified person owns 50% or more of the voting stock. Violating these rules can result in heavy tax penalties or full account disqualification. Common prohibited transactions include:

• The account holder cannot sell, buy, or lease property between their SDIRA and a disqualified person.
• The account holder cannot lend money to a disqualified person or borrow money from them.
• The account holder cannot use SDIRA assets for personal benefit or transfer them to a disqualified person.
• The account holder cannot live in or perform work (“sweat equity”) on real estate purchased in their SDIRA.
• The account holder or disqualified persons cannot receive compensation for managing its assets.

Next Steps

If you are an accredited investor looking to access the benefits of private real estate within your retirement savings accounts, a self-directed IRA may be the right choice for you. To learn more about the investment opportunities available to you through Timberland Partners, we invite you to connect with our investor relations team.