Unlocking Wealth: How to Use Self-Directed Retirement Accounts for Real Estate Investing | Ep 49

James: Welcome to the Furlo Capital Real Estate Podcast, where we dive into the intricacies of passive real estate investing. And our mission is to equip people to invest wisely in both property and people so that together we can build wealth while improving housing. I'm James, and this is my wife, Jessi.

Jessi: Hi! And it's my birthday! Oh man, that's awesome! I know, I love fall because it's where my birthday is, and My favorite holiday, Thanksgiving, because you get to eat amazing food. Yeah, that's right. Which happens tomorrow. Yeah, I often growing up, I, I remember having a lot of pumpkin pies as birthday cakes.

James: Yeah, that makes sense. So, I've

Jessi: just kind of adopted that, because it's my favorite anyway, so. Yeah, yeah, yeah. That's

James: fair. That's fair. I

Jessi: once ate an entire pumpkin pie, not in a day, I think it was over the course of like three days.

James: Okay.

Jessi: But.

James: Wow.

Jessi: I, yeah.

James: Okay.

Jessi: I love pumpkin pie.

James: Man, and you're the, and what do you get the big four, one,

Jessi: four, one, you're

James: solidly in your forties now.

Oh man. How's that feel? Just normal. Yeah. So what I want to talk about is things that happen when you get older.

Jessi: Yeah. I mean, that's the way to look at them. One more. One year closer to retirement.

James: Exactly. So I want to talk about retirement accounts. And I do got to add a disclaimer here. Just because we're talking about financial products, I guess.

And I should probably be in every episode, but whatever. I am not an accountant and even if I was an accountant, I'm not your accountant. And so the things that we're talking about, there's nuances and every single individual situation is different. And so. Treat this as good information to know. And what you should do is go talk to either your tax or financial advisor for your specific situation.

Cool. Do

Jessi: that. Good advice.

James: But yeah, so I saw that. Let's talk about something. Not kidding. No, what I want to talk about are self directed retirement accounts. And they're, do you know what those are? Let's start with that. I'm just curious if you know, I mean,

Jessi: I can guess

James: a

Jessi: retirement account. It's like you put money away for when you retire.

I

James: know

Jessi: that

James: in an account and there's

Jessi: like different options of where you put that and how it's invested. What are

James: those options?

Jessi: I, I, there's like a money market account, and like stocks, and there's a 401k, I don't

James: know. I really, I have no idea. Like, I

Jessi: know there's just, there's different ones that you can do and certain of them yield more or not.

So I'm guessing that a self directed one is you get to decide what to do with the money.

James: Yeah. Or like

Jessi: when to take it out, I guess. Yeah.

James: So let's talk about a traditional retirement account to start with. Right? So there's your classic. You got your 401k. Yes. Or when you were a teacher, remember what you had?

Jessi: 453B.

James: Yep. That's right. Or 456, 403.

Jessi: There you go. 403B. Yeah. Yeah.

James: There's the 457, which is if you're a government employee, but yeah, no, not that. 403B. So when you have those retirement accounts, oftentimes you, You have it with some sort of custodian investment account, right? And, and then what you do is you put money into the account and they then invest it typically in some set of stocks or bonds or that's it.

And, and then because it's a retirement account, as long as you keep it in that account until, well, you retire, which has a very defined, very specific definition of what equals retirement in the U S

Jessi: who sets it up. I think so. I think it's the federal government. I

James: think it's the federal government.

Yeah.

Jessi: Which is like, or just around 65.

James: So, yeah, 59 I mean, that's

Jessi: a magical number. Wait, 69 and a

James: half? 59.

Jessi: 59 and a half.

James: Not

Jessi: 65.

James: Official retirement.

Jessi: Correct. Oh, I didn't realize that.

James: Yeah. Does it

Jessi: change?

James: What do you mean?

Jessi: Does that number shift?

James: No.

Jessi: I always thought it was 65.

James: No, I think you're thinking about social security.

Jessi: Oh.

James: I think that's when that becomes a thing, which is different when you get full social security. But yeah, so you have a retirement account and so essentially it's as if you were investing in the stock market or in an index fund, but it's this specific account. And the cool part about it is if you were able to wait until you hit that 59 and a half, there's either taxes are deferred or there are none on the gains, which is super convenient.

So if you have a traditional that's usually it's tax deferred. So then you only pay taxes when you withdraw the funds. Okay. The theory being, I don't know how much I agree with this, but your taxes in the future will be less than they are today because you'll be, quote, earning less.

Jessi: Interesting.

James: So your tax bracket changes.

So if you think about the logic of, Yeah. Like right now you get taxed on your income, which makes sense, but in theory you're not spending all of your income. You're saving some of it. So let's say that you are saving 20 percent of your income. Ooh, awesome. When you retire, you don't need to withdraw that savings part anymore.

So your income is technically saved. 20 percent less. So therefore your taxes will be 20 percent less.

Jessi: Interesting.

James: It's kind of the, it kind of

Jessi: makes sense.

James: Yeah. They don't have this for 401ks, but there are Roth options. We're going to talk about that. Those ones are tax free. Your gains have no, now you put after tax dollars in.

And so, cause that's the thing that I, that's the thing about like a 401k is All that money is before you pay your, your income tax, your gross income. Yep. Yep. Yep. Whereas on a Roth it's based on your after tax you put that in. Yeah. And then it grows and does whatever, but you have already paid tax on it.

So you don't have to a second time. So that's like your traditional retirement account. Now the issue with that is you are. Stuck investing in either stocks or bonds paper assets. That's

Jessi: all those official Retirement companies do

James: yes. Huh.

Jessi: So there's not a particular

James: Vanguard for example, right? You could open up an IRA an individual retirement account with them.

Jessi: Yeah,

James: they're like sweet choose all the stocks You want choose all the bonds you want? That's it. So

Jessi: sometimes you you can choose but if you Go a more traditional route. It's gonna be stocks and bonds,

James: correct? You

Jessi: They don't have like, here's an investment firm and we're going to buy businesses or whatever.

No, no, no, no, no, no,

James: no, no, no. Now that's like, and Vanguard is probably if you're going for like traditional custodians, they're awesome. They're they're actually a nonprofit technically. And so their fees are typically less, but there are some custodians that allow you to do what are called self directed investments.

Retirement accounts.

Jessi: Okay.

James: Okay. So it

Jessi: doesn't have to be stocks and bonds, I'm guessing. Correct.

James: You can do all sorts of stuff, and honestly, the list of what you cannot do is shorter than what you can do. Interesting. Yeah. So you can still do stocks, bonds, CDs, all that stuff, but you can also buy commodities like precious metals, like gold, silver, oil, gas, lumber, minerals.

You can buy real estate. Okay. So you know, and all this stuff, commercial shopping center, single family homes, apartments, raw land, duplexes, all this stuff. You can do promissory notes via private lending. So you can give mortgages or unsecured loans if you wanted to, or options. You can invest in private placements.

This is the thing you were talking about. You can invest in an LLC or a limited partnership. You can invest in a startup or in a small business. This That kind of stuff. But you can invest in crypto if you wanted to. It's an option and

Jessi: doge coin. Yeah,

James: exactly. Exactly. One of

Jessi: the, is that what you mean by crypto?

James: That, yeah, yeah. I'm thinking more Bitcoin, but yes, there are, but whatever. Right. Yeah. The, there really are not a lot of limits to the things. Now there are some, you cannot do collectibles. You can't do art, antiques, beanie babies, gems or stamps, probably not beanie babies. I know, right? You can't invest in life insurance.

You can't do S corporations for some reason, and you cannot invest in illegal activities. Well,

Jessi: that makes sense.

James: Well,

Jessi: collectibles, I mean, come on.

James: I know, right? Treasure trove. I think I have a hunch that's because there's a high degree of fraud potential there and there's no quote value being created.

Interesting. Maybe. I don't know. Precious metals are cool. Collectibles not crypto. It's more of a, I, Hey, I'm just is the rules. I don't know. And so, but so the idea is you have a lot more flexibility over what you can invest in. And like I said, you could still invest in stocks and bonds. You can have a self directed retirement account and it could look exactly the same.

Jessi: Why, what

James: would be the benefit of that? You have flexibility cause setting up the account and doing all the transactions takes time. Like you might say, like, for example, I would like to invest in a property a year from now, but you're not ready yet. Cause you're saying a year from now. So what you do is you say, but I want to get everything set up.

Jessi: Oh. And in the

James: interim, I'm still going to have it sitting in this Vanguard index fund. And it's going to be there doing its thing. And then when I'm ready, boom, I can pull the money out real fast, get into this other deal, and go.

Jessi: So with a self directed retirement account, you can move the money around, like, multiple times?

You don't have to like commit to like one. Oh yeah,

James: correct. It's just like like currently investing in the stock market, right? You can, again, you can open up a retirement account and as long as you don't withdraw it, that's like, that's the no, no, but yeah, you can move it around. I mean, there's some people do day trading, not with retirement accounts, but like, yeah, you could.

Jessi: Right. But you, I mean, like you were just talking about, you could put it in stocks and bonds and just, it's a little, you I don't know, less risky, I guess, or more stable or something. Yeah. And then you're like, okay,

James: it's more liquid when

Jessi: I'm doing whatever I need to do. In this year while I'm waiting, getting educated, finding a sponsor, whatever I'm doing.

Well, maybe

James: you're like, I don't quite have enough funds yet to do the thing I want to invest in. So while I'm growing it, letting it grow, saving

Jessi: it and then I can, yeah.

James: Or maybe you're like, I'm not going to put my entire portfolio into real estate or into crypto. I'm just going to do 20 percent of it or something like that.

Those are also options. Yeah. So that's fundamentally what it means to be self directed. Now there are, caveats all over the place. Why would you

Jessi: not just create a self directed retirement account in the first place to give yourself flexibility? If you could have it act like a regular one.

James: Mm. Sometimes the fees can be a little bit higher, so all you're planning on doing is investing in stocks or bonds.

You should just go the traditional route. Yep. Yeah. And there's a little bit more paperwork and stuff like that. Interesting. But that's, that's the really only reason why. So there are a whole bunch of types of plans that you can do. We've already talked about it for individuals. You've got your IRA, you've got the traditional, and the Roth.

And there's some interesting things about each of them. Again, the cool part about the Roth is that A, it's totally tax free after 59 and a half. And here's another big one. There's no mandatory distribution requirement. So after I think it's, I'm going to get this wrong, I think it's after 73, you're required to take out a percentage of your portfolio in a traditional version of it.

And cause they want you to draw it down, like to actually use it for retirement.

Jessi: Why?

James: I don't know. Cause they want their tax money, I guess. I don't know why. I Interesting. Yeah. And so it makes it a lot less appealing for like family planning down in the future, right? So the, the advice that I read about that I thought made sense to me was if you are, have a traditional account converted over to a Roth, pay your taxes today and then let it grow.

Because A, that assumption that your taxes will be lower in the future is probably not a great assumption. And the whole, like, you don't have to do a minimum distribution is kind of a big deal. And so that's the big difference there.

Jessi: And so, when you're talking about the IRA and the Roth IRA, are those both, like, Self-directed

James: They can be.

Yes.

Jessi: So, so they can be traditional. Yeah. Everything I'm about to talk about. And they can be self-directed.

James: Yep. Mm-Hmm. Either. Mm-Hmm. . Mm-Hmm. . Okay. If you own a small business, you can do a self-directed solo 4 0 1 KA sep IRA or a simple IRA. The simple stands for saving incentive match program for employees.

Well, the cool part about the solo and the sep. Is that the contribution limits are much higher. So for the individual one, your contribution limits, these numbers are always, they're actually in the middle of being changed right now, thinking ahead for 2025, but they're currently at 6, 500 a year per person.

Okay. If you have again, or a solo or a SEP, it's 66,

Jessi: 000. Whoa.

James: Yeah. Or 25 percent of your revenue, whichever one's smaller.

Jessi: That's a lot higher.

James: Yeah.

Jessi: Why does the, why does the IRA and Roth Roth IRA have such a small limit?

James: I don't know. Well, because they, cause they're assuming you could also have a 401k.

Jessi: Oh,

James: and this is, this is in. So it's almost treated like a

Jessi: supplemental account or something.

James: The IRA is, yep. So

Jessi: if, so they're assuming if you, if you're a business owner, You don't have a job with 401k and the supplemental one. Like that's it.

James: Yeah. Cause that's the other thing is if you're a business owner, not only could you have like a SEP IRA, you could still have an individual, yeah, you can have both.

Yeah. It really is. It's, it's in lieu of doing the, the company 401k. Sure. It's what it is. You can have other ones saving plans, like a health savings account. You can turn that into, yeah, you can turn that into a self directed one. cool about that one is it's kind of a hybrid. If you use the money for medical expenses, it's tax free.

And then if you use it for just like, but you can still use it for regular retirement stuff and then it's just tax deferred. So it's a cool, cool option. And then you can also do an education savings account and ESA, not to be confused with an emotional support animal in the real estate world. And so that's one again, for like for your kids or whoever you can In theory, we could start up an ESA for our kids, buy a couple rentals, put it in there for them, and then use the rental income, or just sell the rental when the time comes, to then fund their education.

Okay, now all I

Jessi: can think is emotional support animals. Yeah,

James: sorry.

Jessi: What is it called?

James: Education Savings Account.

Jessi: Education Savings Account. Yes. Does it have to be used towards schooling? Yes. Okay.

James: Yes, or school related things.

Jessi: Can it be used?

James: Technically, like, you can pay for, like, dorm or rent with that fund, because it's towards schooling.

Jessi: And I was going to ask, like could it count as, like, towards a trade type degree? Yes. Huh.

James: Huh. Yep. Yep. It could. And then you have former employee plans, and this is a huge deal, okay? So if you had a 401k Or a 4 0 3 B or a 4 57 and you used to work at that company. Mm-Hmm. . Once you leave that company, you can then convert those into self-directed individual retirement accounts and roll that entire amount over.

Mm-Hmm. . So that's super big. And and yeah, anyone that you have that was a previous employer, you can now turn self-directed while you're still working there. And it's a 401k. Sorry, you're stuck with the employer plan, that's the name of the game, but then afterwards it technically converts into an IRA anyways, and so now you're just rolling that IRA into a self directed one from whatever custodian your company was with.

Does that make sense? Yeah, I think so. Yeah, super, super powerful. And yeah, so pretty neat. Now there are some restrictions to this, okay? And it is, the big one is A disqualified person cannot invest or benefit from the retirement account.

Jessi: What's a disqualified person? Ah, great question.

James: A disqualified person is you or any Direct Line family member or any entity that is owned by 50 percent or more by one of those, either yourself or a Direct Line family member.

Okay. So, let's do an example. So, let's say that Let's say that I've got a retirement account and I want to invest it in a deal. I cannot, say, like, go buy a deal and then manage it myself because I am now benefiting by providing free labor, essentially, to my retirement account. Hmm. Furthermore, let's say that I, my parents had a deal and they were like, hey, do you want to invest in this deal?

I'm like, sorry, I can't do it because you are part of my direct line. Now let's say that my brother was buying a property and he was like, hey James, do you want to invest in it? Yes, absolutely, I can, no problem, because he's not in direct line.

Jessi: That's weird.

James: He's not in direct line.

Jessi: So, not your parents, or your grandparents, or your kids.

Correct, or my kids spouses. Cousins and brothers.

James: Yep, all good. That's weird. Oh, it's just the rules.

Jessi: Whatever.

James: And well, it's to prevent that kind of stuff. And so the big thing is, you personally cannot. Benefit from it and the retirement account cannot benefit from one of those disqualified people. Like this is, this is a huge, like a huge thing.

So like for example like, you know, let's say you got your parents, my parents, they've got some money that's saved up and they're like, yeah, let's put this into a self directed retirement account because we're investing in deals and we're looking for investors. Yeah. No, they can't participate. They can't invest through their retirement accounts.

Correct.

Jessi: They can. , well, they can invest with somebody else. Correct. Just they can't invest with you. Correct. That's what you're saying?

James: Yep. Mm-Hmm. . Mm-Hmm. . Yeah. And again, the, like, the big thing is what people want to do is they go, huh, I've got this pot of money. Lemme go buy a rental. Mm-Hmm. . And then I'll manage it and it's Mm-Hmm.

And so, like for example, when we bought our second duplex, right? Mm-Hmm. , we had funds sitting in a retirement account and now granted it was a Roth IRA and it was we were able to pull out the principal pay no taxes on it, but we could have kept that duplex. I could have turned that Roth IRA into a self directed one and then use the funds to buy that duplex.

But then we would have had to hire a property manager to do everything. We would have had to hire contractors to do all the work. We would not have been able to help it out in any way. The the way that I've been trying to think about it is you got to pretend that your self directed retirement account is your enemy.

Okay, you wouldn't do anything or it wouldn't do anything to help you out, right? It's not going to give you any money, any income. It's not going to give you any benefits and you wouldn't do anything to help it. You're not going to give it any free labor, supplies, money, or co invest. It's kind of the, the idea behind it.

So if you think of it that way, but

Jessi: you're getting benefit. If you in,

James: if you

Jessi: invested the money in that property, you're getting income from it.

James: No, not how am I getting income from it?

Jessi: Don't you get a return on your investment? The

James: retirement account invests in that property. Yes. And the property pays the retirement account.

And then, unrelatedly, I will withdraw money. So you are getting

Jessi: a benefit.

James: Right, but you can't directly benefit.

Jessi: Okay.

James: That's the important, like, it's really, like, it's really important. Weird. That's I mean, what's weird about it?

Jessi: Maybe it's just the terminology.

James: Okay, what do you mean? About

Jessi: directly or indirectly.

It's like, that's the whole point. You're using this retirement account so you can get more money. You're investing it.

James: But see, they don't want you, they want you to benefit from it in retirement when you withdraw it after you're 59 and a half. Whereas what some people do is again, they try to manage it or pay themselves out ahead of time and they're trying to benefit today before they're retired.

And that's a no, no. And if you do it, it's not just that little bit that you did. Your entire account could be considered. No longer retirement, in which case taxes are due today. Interesting. And penalties and all that fun stuff. Okay.

Jessi: That makes more sense. Describing it. Because the

James: whole point of a retirement account is to say, This is money you're saving aside for the future.

So it's got to stay there. So money I make today, or money that the retirement account makes today, I don't touch. Yeah.

Jessi: It's savings.

James: Yeah. That makes sense. That's the entire idea. Okay. Cool. Yeah, that's a huge, that's a huge piece of it. There are some other Things that go into it depending on what you decide to invest in.

If you do decide to invest in like a syndication there is something that is, it's an unrelated business income tax. And more specifically, it's an unrelated debt finance income. There are potentially some fees or some taxes that you do have to pay. It's not all 100 percent deferred. But And it depends on whether or not you have loans and stuff like that, which is why like syndications really matter.

So like the syndication that we invested in, had we invested with our IRA then whatever income we earned from that, that would be subject to this UDI, UDFI. But that's it. Hey, we haven't got any payout yet, so, so, not a problem. But you can also offset other stuff with depreciation and expenses and stuff like that.

So, that's just one of those weird, like, if you get into a deal and you decide it's a syndication specifically, or like a start up company or something like that even short term rentals kind of fall into this category, because they're more regular income. That you just really want to talk to your tax advisor to be like, alright, here's my situation.

How much do I need to be setting aside for taxes? I'm gonna help you do that math. If you're given interest on loans or you're like going off and buying a single family home somewhere and it's all passive income, it's all pretty straightforward, that's all exempt. That would just be my one word of advice on that.

So, let's say you're interested. Next steps, right? First thing you gotta do is you gotta identify a custodian.

Jessi: So I'm interested in creating a self directed retirement.

James: Correct. Yeah, yeah, yeah. Let's say you've got some money sitting in Vanguard. You're like, it's great. I'd like to roll us over a new self directed one or just open a self directed one from scratch.

There are a couple of ones that, that that I like, but do your own due diligence. You direct IRA services is one American estate and trust checkbook, IRA, and then safeguard advisors are four of them. And and I wrote down five questions. Asking. The first one is like, what type of accounts do they offer?

Cause not almost all of them will offer the self directed IRAs, but they may not offer SEPs or simples. Like you just got to

Jessi: ask

James: you want to know what they charge to get it set up, to do the maintenance things, to do transactions. Cause those do cost money. Cause you're kind of directing it where to go, which is something that's different from others.

You gotta ask what type of investments you can make. I know I said like the list is very long, but not all of them are necessarily set up to, to do all the different types of transactions. And so, you just gotta, just gotta ask. So if

Jessi: you're looking at particularly investing in real estate, you should make sure that the one you open can invest in real estate.

James: And that's where I rattled off can all do it. Shocker. You want to just also just get a good idea for like, what's that process for handling investments and distributions. So you just want to say, Hey, let's say I find a property. What do I do? And they're like, yep, here's the form. Here's the process.

Here's many days, whatever. Like they'll describe it all to you. And they're all slightly different. Yeah. And then and then the other one is, what processes do you have in place to ensure compliance with IRS rules and regulations? And so that really is like, there's some reporting requirements that have to happen.

And again, it's the whole like, you or drug client family member can't benefit and they will help you make sure that happens. There's more to it. We'll, we might talk about some of those subtleties in future episodes, but I think if you're getting started and like, ah, this sounds interesting to me, like I've got a retirement account.

And, I'm really interested in investing in some of it in real estate, like, yeah, here's what you do. Yeah, like, self directed, find a custodian, roll some funds over, get it started, and while you're waiting, sure, have it in the stock market, go look for deals, and once you find one, boom. Talk to your custodian, be like, send that money!

And they will. It's pretty easy. So there you go. Kind of cool. Kind of a neat way to build your wealth that yeah, that just helps you diversify. Yeah. out of the stock market a little bit, which is always good. And get some consistent returns, which is super cool. So there you go. Things

Jessi: to think about now that I'm older.

James: There you go. Exactly. Nice. That's awesome. And well, if you enjoyed this episode we. Hopefully you do. We would love it if you left us a quick rating. And if you are interested in investing with us, you can check us out at furlo.com and just learn a whole lot more about our investing thesis and ways to go.

And if you are interested in setting up a retirement account to do this, would love to chat with you as well about that. Thanks for listening and have a great day.