How Much Retirement Income Can You Generate With Real Estate Investments?

Why do you save for retirement? At the most basic level, you probably save so that you’ll be able to pay for your living expenses once you reach your desired retirement age (whatever that age may be). One of the best ways to plan for your retirement finances is to have the goal of putting together a nest egg that generates enough income every year to cover some or all of those living expenses. This will often be preferable to having to liquidate your investments in order to pay your living expenses, and be at risk of depleting your account too quickly, and effectively outliving the usefulness and value of your retirement savings.

Unfortunately, individuals who aren’t familiar with self-directed IRAs, and the additional investment opportunities that those accounts can provide as compared to IRAs with traditional custodians, might take an overly narrow view of the types of investments that can generate meaningful income.

More specifically, many would consider an “income investment” to be something like a municipal bond or U.S. government bond, or a corporate debenture, or perhaps even publicly traded stocks that pay quarterly dividends. While these are certainly income generating investments, they only scratch the surface of what’s available to a retirement saver who has a self-directed IRA.

Private Debt Investments. Self-directed IRAs are authorized to invest in private debt instruments. This can include not only personally guaranteed notes (lending money directly to an individual), but also borrowings from businesses, and even private mortgages. That’s right, with a self-directed IRA you can make loans to people who are looking to buy a home, and use the home as your security for repayment — just like a traditional mortgage lender would do.

These types of investments have the potential to generate a significant income stream, and the more risk you’re willing to take with respect to repayment, the greater that income can be.

Real Estate. Speaking of home buyers, you can use a self-directed IRA to invest in real estate directly, and generate income from renting the properties you buy. In the residential marketplace, stagnant incomes have combined with increasing real estate prices and tighter lending standards to create a huge demand for rentals. In some areas the growth in prevailing rents has actually exceeded the rate of growth for home prices.

And you’re not limited to residential properties when you invest with a self-directed IRA. You can use your account to purchase commercial properties, including office, retail, and industrial properties. These types of investments can provide exposure to a different type of risk if you’re looking to diversify your retirement investment portfolio, but they can still generate a healthy level of periodic income.

Obviously, making these types of investments is a significantly more complicated process than simply buying a corporate bond. When considering these types of investments with your self-directed IRA, be sure to seek out qualified professional assistance to help you as necessary.

Getting Started with a Self-Directed IRA When Your Nest Egg is Small

While you might have been initially drawn to a self-directed IRA because of the investment flexibility that this account type offers when compared to IRAs with traditional custodians (e.g., being able to invest in precious metals, and real estate, and private companies), it’s true in all areas of investing that not every investment option is suitable for every investor.

Precious Metals. One way that this quickly becomes apparent is with respect to investing in precious metals. Investing in bullion or investment grade coins can be a great way to diversify and hedge your other investments, but it’s significantly more expensive than more straightforward investments like publically traded stocks. And some of these expenses are baseline fees to get started, regardless of the size of your investment.

Make the Maximum Contributions Every Year. When your self-directed IRA balance is relatively small, it’s vital that you make the maximum contributions to your account each and every year. If you fail to make the maximum contribution in any given tax year (the contribution limit for the 2015 filing period is $5,500, with an additional $1,000 allowed for taxpayers age 50 and over), you won’t be able to make up for that lost opportunity in later years. Once the chance to make the maximum deposit has passed, it’s gone forever.

Consider Maintaining Two Accounts. It’s a common misconception, but taxpayers are not limited to having a single IRA. In fact, it can be good practice to maintain both a traditional self-directed IRA as well as a Roth self-directed IRA, and then decide where to make your deposits each year based on the tax deduction advantages you might be able to get from contributing to the traditional account. The key is to deposit the maximum each year, regardless of the self-directed IRA you choose. And remember that it’s always possible to convert a traditional self-directed IRA to a Roth account whenever you decide that you only want or need a single account.

Does Small Mean Little Investment Experience? If your nest egg is relatively small because you’re just starting out with your retirement savings and don’t have a lot of investing experience, then don’t feel pressured to start investing in the most complicated and advanced investment types right away. Even though the self-directed IRA structure permits investments in a wide range of investments, you’re still free to choose investments that you have more experience and familiarity with.

Use 401(k) Rollovers. Finally, another way to grow your self-directed IRA is through the use of rollovers. Whenever you leave an employer, you’re permitted to roll over the funds you’ve accumulated in your 401(k) to an IRA. Because many individuals are permitted to contribute to both 401(k)s and IRAs, this can be a great technique for building as large of a nest egg as possible.

The Biggest Secret to Retirement Saving Success With a Self-Directed IRA

There are certainly a lot of different retirement strategies out there. Regardless of your age, income level, or current level of savings, you’re likely to have access to multiple strategies to try to help you reach your goals.

And there’s no shortage of investment advice on what types of investments are best for you. Just pick up a copy of virtually any personal finance magazine and you’ll read about a wide range of options, some of which may even appear to be in direct conflict with one another.

But perhaps the biggest factor that will contribute to you reaching your retirement goals is common across all of these options. And it remains something of a secret even though it’s so easy to do. The secret?

Be consistent with your retirement savings.

By that we mean that if you save as much as you can each year, and you do so year in and year out, then you stand a very good chance of reaching your goals. When you are more consistent with your retirement savings, your choice of investments becomes less important. You won’t have to chase high yielding investments in an effort to boost the value of your nest egg because your account balance will grow over time merely by choosing investments

When you invest consistently, then over long periods of time your investment choices become less of a factor in determining how much you’ll accumulate. This isn’t to say that you should disregard the process of trying to choose your investments wisely, and select assets that meet your risk tolerance and other financial circumstances. Rather, it simply means that your research and analysis of your various investment possibilities shouldn’t overshadow the priority to put money aside in the first place.

In other words, your primary goal should be to contribute the maximum amount to your self-directed IRA every year, and your efforts should be focused on that first and foremost. After you’ve done the work to save as much as the IRS allows, then you can put the time and effort into figuring out how best to put that money to work.

You’ve probably seen the examples before. Looking at several different case studies of hypothetical investors — one who invests each year at the market low, one who invests at the beginning of the year, and one who is unlucky enough to invest at the top of the market — the results are surprising.

Over a period of several decades, the individual who is unfortunate enough to make their investments at the market peak each year has a smaller nest egg than the other two investors, but not by as great of a margin as you might think. And, more importantly, that bad market timer still has accumulated significantly more than an individual who didn’t save as much, or who simply contributed the same amounts to a bank account or other cash equivalent savings vehicle.

 

The Basic Relationship Between Social Security Benefits And Your Self-Directed IRA

Regardless of whether you envision Social Security to be a significant component of your retirement income, or simply a helpful supplement to your self-directed IRA, it’s important to understand how the two are related. The timing and nature of distributions you take from a self-directed IRA can impact the size of your Social Security benefits, as well as the income taxes you may have to pay on those benefits.

First things first. Under current law, your eligibility to receive Social Security retirement benefits, and the amount of those benefits, is a function of your prior work experience and earnings, not how much you have saved. In other words, having a large self-directed IRA or taking significant distributions from your account during retirement won’t make you ineligible for Social Security benefits.

However, those distributions may impact the taxability of the Social Security benefits you receive. Finally, it’s important to keep in mind when you’re planning your retirement income strategy that you control when you begin receiving Social Security retirement benefits (anywhere between age 62 and age 70), and you control when you begin taking distributions from your self-directed IRA – with no limit for Roth account, and required minimum withdrawals from a traditional account kicking in at age 70½.

Early Retirement Scenarios.

Individuals who choose to retire early and begin taking their Social Security retirement benefits before their full retirement age can see those benefits reduced if their earned income exceeds a certain amount. (For 2015, this amount is $15,720.) In short, the Social Security Administration withholds one dollar in benefits for every two dollars and earnings above the this amount, and even more for earnings that are significantly higher. Distributions you take from your self-directed IRA are not considered “earned income,” and therefore do not count against this limitation.

However, when the IRS determines whether your Social Security benefits are subject to income tax, they look to your “combined income,” which will include distributions you take from any IRA that’s set up as a traditional account.

Roth Self-Directed IRA Benefits.

Significantly, distributions from your Roth IRA will not affect your Social Security benefits in any way. Just as is the case with traditional IRAs, they are not considered earned income by the Social Security administration for purposes of calculating your benefits in an early retirement scenario. In addition, they are excluded from the definition of “combined income” when considering the taxability of those Social Security benefits.

Distribution Strategies.

Given that your Social Security benefits will be increased the longer you wait to take them (with the deferred retirement credits increasing up to age 70), some individuals can maximize their total retirement income by waiting as long as possible to take Social Security, and taking distributions from their self-directed IRA in order to fund retirement living expenses. The analysis is highly individualized, and you’ll have even more options to consider if you are married and your spouse is also eligible for Social Security benefits.

But remember that you’ll only put yourself in a stronger financial position by maxing out your self-directed IRA contributions each and every year, and trying to build the largest account possible.