Avoiding the Conflicts of Interest of 401(k)s with a Self-Directed IRA

401(k)s with a Self-Directed IRAIn recent weeks there has been new talk about introducing stronger investor protections and providing increased opportunities within the area of retirement savings. One of the biggest areas of concern has been a new focus on how individual investors fare in their employer-sponsored 401(k) plans.

Surprisingly, under current law there is no legal obligation for a 401(k) plan provider to put the interests of plan participants before their own. This type of duty is known as a “fiduciary” duty, and without this protection retirement savers may be fighting an uphill battle in trying to build their nest eggs.

Perhaps the biggest conflict is the limited choices that you are provided with a 401(k). For example, you might assume that the 401(k) provider selects the available investments based on their quality or suitability for the 401(k) plan participants. But in fact, in most cases, the fund company provides a fee to the 401(k) provider in order to be listed. And in many cases, the fund company can charge additional fees to the plan participants (often in the form of so-called “12b‑1” fees).

These types of fees, which relate to marketing and preferential treatment within the fund, do not benefit the 401(k) plan participants in any way, and essentially represent an extra charge that lowers their overall return. This is permitted under current law because 401(k) plan providers do not owe a legal “fiduciary” duty to the plan participants.

In contrast, a self-directed IRA custodian such as Quest Trust Company cannot market any specific investment funds or opportunities to the account holders. Self-directed IRA account owners make all the investment choices, and have the widest possible range of investment opportunities available to them. Rather than being limited to a handful of mutual fund choices (with the potentially inflated fees we discussed above), a self-directed IRA account holder can choose whatever fund or other investment asset is legally permitted under the IRS regulations.

You’re only given one choice when it comes to 401(k) plans – the one that your employer offers, or none at all.

Within the plan that your employer chooses to provide, you’re likely to note a significant limitation in your investment choices. For example, you may only have a single choice when it comes to a particular type of neutral fund or investment philosophy. And forget about being able to select individual stocks yourself; that won’t be available in an employer-provided 401(k).

A self-directed IRA is better because you have the maximum freedom in choosing where you want your retirement funds to be invested.

Finally, with a 401(k) plan, you are essentially locked into the choices and account custodian that your employer provides. There’s no incentive for your plan provider to offer the best service or even to offer a range of fee options, because they know you can’t take your 401(k) business elsewhere. The plan they provide is your only 401(k) option, and you generally can’t move your funds to a different retirement investment vehicle.

But when you do change jobs, you’ll certainly want to use that as an opportunity to roll any 401(k) account you have into a new self-directed IRA.

Using A Self-Directed IRA To Move Beyond Stocks And Mutual Funds

Setting up a new self-directed IRA with a custodian such as Quest Trust Company can be one of the best ways to retirement planning efforts to a host of new investing options. With a self-directed IRA you be able to move beyond investments in stocks and mutual funds, and explore asset classes that might be a much better fit to your investing personality and needs.

First things first – there’s not necessarily anything wrong with incorporating stocks and mutual funds into your retirement portfolio. These types of investments can be a great cornerstone for many individuals’ retirement portfolios.

The potential issues arise in that there are other individuals who want additional options – options to target other investing markets and potentially secure a much higher level of return for themselves. Let’s take a closer look at the self-directed IRA.

Real Estate. There are a variety of methods through which you can invest in real estate with your self-directed IRA. The most accessible type of real estate investment is probably the single family home. These may be the easiest real estate investments to manage yourself (assuming that you don’t want to incur the expenses of an outside professional).

But you can also use your self-directed IRA to invest in multifamily properties, farmland, commercial real estate, undeveloped land, or any other type of real estate interests that a non-retirement account investor has available to them.

Private Investments. The IRS rules governing IRAs also authorize account holders to invest in non-public assets such as private equity and private debt instruments. Depending on the nature of the investment, you may need to meet the definition of a “qualified investor”, but even non-qualified individuals can still make other types of nonpublic investments, including loans and mortgages.

One of the biggest challenges may simply be acquainting yourself with being able to find these types of opportunities. This is one area of investing in which the Internet can provide you with a great deal of useful information. A number of different private investment exchanges and clearing houses have come online in the past few years, and these can help you find suitable private investment opportunities for your self-directed IRA.

Precious Metals. In seeking to diversify beyond stocks and mutual funds, retirement savers often seek out investment asset classes that have a low correlation to the stock market – meaning that their prices do not frequently move in the same direction or to the same extent as publicly traded stocks. Precious metals can be a great way to gain this type of investment exposure.

Direct physical investments in precious metals are authorized with a self-directed IRA, provided that you have a third-party custodian actually hold the physical metals on your behalf. Among those who use their self-directed IRAs to invest in precious metals, the most common types of metals are gold, silver, platinum and palladium.

These types of non-stock investments are sometimes unfamiliar to retirement savers, so always be sure to do your research and understand the risks of any investment fully before committing any funds.

Steps For Rolling Over Existing Accounts Into A Self-Directed IRA

As people work their way through one or more careers, and have several (if not dozens) of jobs, they can easily accumulate multiple retirement accounts. They generally come in the form of 401(k) accounts at past employers, traditional IRAs, Roth IRAs, and perhaps even employer pension plans (although this last type of benefit is becoming increasingly rare).

Unfortunately, it can often become quite an administrative burden to manage so many different accounts. For some individuals it can be challenging enough trying to come up with the time to review the monthly or quarterly statements from a single retirement account. Trying to do so for a half-dozen or more accounts can quickly become nearly impossible.

The best way to clear up this administrative nightmare is to roll over all of your existing accounts, including accounts from prior employers, into a single self-directed IRA. Here are the steps for doing so.

1. Identify Your Target Account.
If you don’t currently have a self-directed IRA, then you’ll need to set one up before you go any further. Requesting a rollover from a prior 401(k) or a current IRA, but not having a target account in place, can result in the other plan administrator sending you a check for your account balance. If you don’t deposit this check quickly enough, the IRS may consider it a taxable distribution, and the cost to you could be significant.

The better path forward is to have your self-directed IRA already in place, and request that your current custodian or plan administrator send your rollover proceeds directly to the new account.

2. Contact Your Prior and Current Account Administrators. Once you have a self-directed IRA set up, it’s time to contact each of your current and prior account custodians and administrators. When attempting a rollover of a 401(k) from a prior employer, you may need to begin the process by contacting the employer first; and if you don’t know where to begin, start with the HR or benefits department.

Have all the information regarding your new account ready to give the prior administrators, and be prepared to follow-up if the rollover doesn’t occur within the timeframe they specify. Some plans will give you the choice of liquidating your account and doing a rollover of the proceeds, or rolling over the investment positions themselves, while other plans will automatically liquidate your investments and do a rollover of cash. If you have the choice, make sure to do your research on what’s best for you.

3. Consider Your Next Investment Steps. As you may already know, self-directed IRAs provide significantly more investment options than traditional IRAs or 401(k)s, so it might seem a little overwhelming. You can use a self-directed IRA to invest in real estate, certain types of precious metals, private companies, private mortgages, and many other investment classes that almost certainly weren’t available with your prior retirement plans.

Exploring investment possibilities while the rollovers are occurring will give you the confidence to proceed with your retirement investing plan once the rollover funds are in your new account.

Types of alternative investments to consider for your self-directed IRA

Having the flexibility to consider alternative types of investments is one of a self-directed IRA’s most attractive features. IRA custodians such as Quest Trust Company allow individual savers to invest in the full range of investments that are legally permitted, rather than just the publically traded stocks and bonds that other IRA custodians limit their customers to.
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But even within the range of permissible investments, some types of alternative investments aren’t quite as widely known as the others.

Other types of real estate. When you think of using your self-directed IRA to invest in real estate, you may generally think of investing in residential and commercial properties. But you can also use your self-directed IRA to invest in farmland, industrial properties and even undeveloped pieces of land.

Tax liens. Another type of alternative investment relating to real estate is tax liens. A tax lien is a lien (a secured debt that’s similar to a mortgage) that a local government entity places on a piece of residential or commercial real estate when the owner does not pay his or her taxes. The local governments often sell these liens to investors who earn above-market interest rates until the property owner pays his or her taxes.

Mortgage loans. You can participate in the real estate market without ever buying a piece of property. The IRA rules permit you to make private mortgage loans, which means that you can take the role in a real estate transaction that a bank or finance company would normally fill. If you decide to pursue this investment opportunity, you’ll want to make sure that you have adequate legal advisers to assist you. These types of transactions are highly technical and you’ll want to be comfortable that your funds are adequately secured by the underlying property.

Precious metals. Self-directed IRAs can be used to purchase investment-grade precious metals. This can be an attractive option if you are looking for a reliable inflation hedge in your portfolio. But hobbyists take note: The authorization to use IRA funds to invest in precious metals does not include investments in collectible coins.

Franchises. One reason that franchises are a particularly suitable investment for self-directed IRAs is that the total investment amount is relatively clear at the outset (unlike investing in some other types of businesses, where there can be unexpected needs for additional capital).

Whenever you’re considering investing in some of these lesser known assets, there are a few basic caveats to keep in mind. First, make sure that you understand and plan for any illiquidity that’s inherent with the investment. Second, be sure to understand the prohibitions on self-dealing and follow them. Finally — and this guidance should apply to any investment you make, whether in your self-directed IRA or otherwise — make sure to conduct an appropriate level of due diligence before committing any of your funds. If you don’t understand the investment you’re considering, then you probably shouldn’t be investing in it.

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Quest Trust Company helps change people’s lives and financial future through self-directed IRA investment education. Quest Trust Company helps people invest in what they know best and build their financial future on their own terms.

 

Procedure for Purchasing/Selling Real Estate in your IRA

Procedure for Real Estate Transactions in your self-directed Individual Retirement AccountOne of the most popular alternative investments for your IRA would be purchasing real estate as an investment. Due to the potential safety, security and predictability of the asset, many Americans are making the decision to diversify their retirement account into a tangible asset class like real estate. With self-directed IRAs you are now able to invest in real estate assets like Land, Single Family, Multifamily, Commercial, Mobile Homes, etc…

Please use this guide when investing in real estate through your IRA. Should you have any further questions please don’t hesitate to contact one of our experienced Transaction Managers at 800.320.5950 or visit our website www.QuestIRA.com.

 

Completing Purchase Offer/Contract for IRA Real Estate Purchase:

Once you have completed your due diligence on your investment and have selected the property you would like to purchase within your IRA you MUST draw up the offer/ contract in the name of the IRA. The proper vesting of the offer/contract will read:

Quest Trust Company Inc., FBO (your full name) IRA # (account number)

which is the legal name of your IRA. REMEMBER: Your IRA should be treated as an investor separate from you, and its name, not yours, MUST be used on the offer/contract.

Quest Trust Company, Inc. is the legal entity in administration of the IRA and thus must sign as the buyer on the purchase offer/contract, however we CANNOT sign anything without the client’s written approval. To approve the offer/contract for Quest Trust Company to sign the client simply writes “Read & Approved”, and then signs, on each page that requires a signature or initial from Quest. Without the “Read & Approved” signature from the client Quest Trust Company, Inc. will not legally be able to sign any document. NOTE: It does not matter where the “Read & Approved” signature from the client is located on the page.

Sending Earnest Money Deposit for IRA Real Estate Purchase:

PLEASE NOTE: Earnest money MUST come from your IRA!

Once the client is ready to send the earnest money deposit to the title company or attorney’s office the client will need to fill out the Direction of Investment for Real Estate form. This form is located on our website or any Transaction Manager can send it directly to the client as well. This form can be faxed or emailed to the Transactions Department as originals are not required. Please accompany the Direction of Investment form with a copy of the purchase offer/contract that has the client’s “Read & Approved” signature. NOTE: This process does not generate any Quest Trust Company Fee’s except for the cost of the check ($5) or wire ($30). Your IRA has not purchased any asset yet. It has merely made an offer.  In the event you do not close on the investment your IRA will not be charged any annual asset fees.

As long as Quest Trust Company has the proper vesting on the offer/contract, the Direction of Investment of Real Estate, and the “Read & Approved” signature by the client we will be able to fund your earnest money deposit request within 24-48 hours. If you require a special request please contact one of the Transaction Managers immediately and they will see if Quest is able to make your request. We at Quest Trust Company understand that many real estate transactions may hinge on the timeliness of our process and we are dedicated to doing what we can to ensure you do not lose out on any investment(s).

Handling Closing of IRA Real Estate Purchase:

Should the title company or attorney that is involved in the closing have any questions about the transaction in your IRA please have them contact any Transaction Manager. Our staff is very experienced in educating and working with 3rd party closing agents who have no experience with closing real estate in the name of an IRA. So, please don’t ever hesitate to have them contact Quest with any questions.

 

Good news! Since Quest Trust Company, Inc. is the legal entity in administration of your IRA, the client will not have to attend any closings. However, just like the offer/contract, we CANNOT sign any of the closing documents from the 3rd party closing agent without the client completing their “Read & Approved” signature. Once all the proper documents are signed Quest will work with the 3rd party closing agent to close your real estate purchase.

NOTE: The closing package along with the warranty deed will be sent directly to Quest Trust Company, Inc. corporate office in Houston, TX and will be kept in a fire proof safe before being shipped for final safe keeping to our custodian, Mainstar Trust, located in Kansas.

Payment of Taxes, Insurance & Other Ongoing Maintenance Bills after closing:

All expenses associated with the property owned by your IRA MUST come from your IRA. These types of expenses could include, but not limited to: repairs, contractors, HOA, property taxes & insurance. In order to pay expenses from your IRA Quest requires a copy of the invoice/purchase order to be paid along with the Payment Authorization Form (One Time). The Payment Authorization Form can be faxed or emailed along with the invoice/purchase order to be paid. Should there be recurring payments the client can complete a Payment Authorization Form (Recurring) and then only need to submit the invoice that needs to be paid. All forms can be found on the website or from any Transactions Manager. REMEMBER: All expenses MUST be paid from cash funds in your IRA account and never be paid directly by the account holder. Also, the client can never be reimbursed from their own IRA.

Handling a Real Estate IRA Purchase with Financing/Debt Leveraging:

The client may finance or leverage any real estate purchase within the IRA should they be able to find a willing lender. As the property is owned by the IRA, repayment of the underlying debt must come from the IRA. The IRA will be the name of the borrower and all mortgage payments will be made by your IRA. The loan obtained by your IRA must be “non-recourse” and your IRA will be subject to Unrelated Debt Financed Income (UDFI) tax. For more information on UDFI contact a Territory Director. The major difference in this closing process is that the client will have to attend the closing or submit original signatures for the closing documents from the lender. There will be certain forms that the client will personally have to sign for the lender.

 

Handling Sale of IRA Owned Real Estate:

Before sending the contract to the 3rd party closing agent, should there be one involved, the client will need to submit the contract to Quest for signature. Just as before Quest Trust Company CANNOT sign any documents unless the client add their “Read & Approved” signature. Along with the contract the client will also need to submit a Direction of Sale Form. This form is located on our website or from any Transaction Manager. Quest will work with 3rd party closing agent, should there be one, to ensure they have all of the proper legal documents and they are using Quest Trust Company, Inc. TAX ID- 61-1435085

Valuation Process for IRA Owned Real Estate:

Private investments, like real estate, need to have valuations performed annually. The reason is that, unlike exchange-traded investments (like stocks and bonds), which are priced daily through the public exchanges or markets, an alternative asset’s value has to be derived through other means.

With real estate, the valuation is done through an opinion of a value from a licensed independent realtor or broker to get the fair or current market value of the investment. Quest Trust Company can accept recent appraisals, as well as, we accept tax assessments for valuation purposes, which is the most commonly used form of valuation for our client’s.

Should the client want to take a distribution as the real estate property, you’ll need to have the investment appraised and valued by a licensed real estate appraiser prior to being distributed. As always, please feel free to contact Quest Trust Company, Inc. with any questions.

Procedures For Purchasing Promissory Notes In IRA

Procedure for Promissory Notes in your self directed IRAPlease use this as a guide when investing in a promissory note through your self-directed IRA with Quest.

The exciting part of a self-directed promissory note investment is that you get to negotiate all loan terms including, but not limited to: loan amount, initial payment date, maturity date, interest rate and payment or amortization schedule. Once you have the terms set, you will want to use the following guidelines to ensure timely funding of your promissory note.

General Information:

The first step in funding this transaction is to make sure you have the vesting for the lender correct on the documents. NOTE: Remember, it is not you personally loaning the money and since it’s your IRA that is loaning the money it will need to be vested in the name of the IRA to hold the asset. Thus, all documents must be registered as:

Quest Trust Company Inc., FBO (Your Name) IRA (Your Account Number)

You will also need to submit Quest Trust Company’s internal form (Direction of Investment), along with the promissory note, before we can generate a check or wire for the funding of the promissory note. Please make sure all the necessary fields are completed on the Direction of Investment form for timely funding.

When the lenders tax ID or physical address is required on lending documents, please make sure that you use Quest Trust Company’s information:

Tax ID: 61-1435085

Address: 17171 Park Row Ste 100 Houston TX 77077

It is up to the client to determine if the interest rate on your promissory note complies with the applicable state laws, such as usury laws in Texas.

Quest Trust Company does not provide tax, legal or investment advice and thus we cannot provide any legal documents for the creations and/or funding of your promissory note. This will be the responsibility of the client to ensure the correct corresponding states legal documents are used in creation of the promissory note.

How to service the promissory note? Quest Trust Company is not a loan servicer. Clients do have a few options for ensuring payments get deposited into your IRA account. NOTE: Quest Trust Company does accept cash.  Payments or deposits must be made by check, money order or ACH Funds. Payments can be sent directly to Quest Trust Company from the borrower and once deposited the client can monitor those payments with online access to their IRA account. The client may also have the borrower make check payments out to Quest Trust Company FBO your account and hand those to you but, this will make you responsible for forwarding any payments to Quest Trust Company – NOTE: Please keep in mind NO PAYMENTS can ever hit your personal checking account. All payments must be forwarded to be deposited. Lastly, the client can also elect to get a third party servicing agent. They will then have the responsibility to collect the payments checks for your IRA and forward all payments to Quest Trust Company.

Items Needed for Funding Unsecured Notes:

1-    Direction of investment for notes
2-    Original signed promissory Note ( the original does have to be in the office before funding can take place)

Items Needed for Funding Secured Notes:

1-    Direction of Investment for notes
2-    Promissory Notes
3-    Security agreement ( IE Deed of Trust)

** If the transaction is closing at a third party agent like a title company or attorney office Quest Trust Company can accept unsigned copies of the note and deed of trust for funding. If there is not a third party involved then Quest Trust Company would need the original note and a copy of the signed deed of trust before funding. Quest Trust Company will also need to know who will be responsible for recording of the deed of trust.

Items Needed for Funding Existing Note:

1-    Direction of Investment for notes
2-    Original deed of trust and Promissory note
3-     Copy of the allonge and transfer of lien. Both of these items will put the note and deed of trust into the name of your IRA.

What to know after funding of your promissory note with Quest:

All original legal documents, the promissory note and recorded deed of trust, need to be mailed to Quest Trust Company, Inc. at the following location:

17171 Park Row, Suite 100 Park Row – Houston TX 77077

 

The documents will be kept in a fire proof safe in Houston before being shipped for final safe keeping to our custodian which is Mainstar Trust located in Kansas.

Fair Market Value of your investment will be requested for every calendar year you are a client. Clients will be sent the FMV form to complete and then should return the form by fax, email and/or mail.

Maturity dates must to be kept current on all promissory notes. If your promissory note has expired, and Quest Trust Company has not received notification and/or documentation that you are going to modify or extend the promissory note with your borrower, Quest Trust Company will be forced to distribute the asset to you. The distribution may cause a penalty and/or tax burden that must be paid by the client.

Payoffs – When the borrower is ready to payoff the promissory note the client will need to fill out a sell direction and/or payoff letter for Quest Trust Company’s records. If is the responsibility of the client to calculate the payoff and interest due for the borrower, as Quest Trust Company, who acts as the third party administrator of the IRA account,  does not calculate the payoff amount. If the promissory note is payoff is processed at a title company they will most likely request a payoff letter and/or verification of mortgage (VOM). The client will need to complete the title company forms and then send Quest Trust Company to us for final signature.