Case Study: Investing in a Promissory Note with IRA Funds

Estimated reading time: 3 minutes, 12 seconds

Remember Paula? Paula purchased real estate with IRA funds and plans to hold it for several years. After age 50, she can anticipate tax- and penalty-free withdrawals from her Roth IRA while feeling more protected against stock market volatility.

We didn’t think Paula would stop at the one alternative asset investment, though. And after further pullbacks in the stock market, Paula seeks to add another non-traditional asset to her investment portfolio.

One morning, Paula and her husband, Tim, meet his college roommate for breakfast at a local café. His friend, Jayson, just moved back to town and found a starter home for him and his fiancée. Unfortunately, they do not have the money to fund the purchase of $68,000. Tim has met with several bankers about taking out a loan, but they need to have 15-20% down. While Jayson has a great job with steady income, the down payment is a sticking point. Plus, he doesn’t want to pay down a loan for 30 years.

Later that evening, Paula and Tim discuss the possibility of loaning Jayson money from one of their retirement accounts. Tim’s retirement savings are tied up in an employer plan in which the investments are determined by the plan administrator. But with rental income, uninvested cash and rollover funds from a dormant 401(k), Paula has more than enough in her Roth IRA to make the loan.

Paula would love the opportunity to hold a promissory note in her IRA for additional investment diversification.

Following discussions with her investment advisor and tax professional, Paula is ready to make an unexpected offer to Jayson. A week later, Paula and Tim invite Jayson and his fiancée, Kori, over for dinner. They ask Jayson if he’s considered a private loan for the home purchase. Paula tells him she would offer the following from her IRA:

Loan amount: $68,000

Length of note: nine years (108 months)

Interest rate: 9%

Monthly payment: $920.92

The loan would be secured by Jayson’s property. But unlike a normal private loan, the monthly payment would go to the IRA, not to Paula herself.

Jayson and Kori—while very surprised and appreciative—obviously need time to consider the offer and review the numbers.

Weeks later, after reviewing the information and consulting their own financial advisor, Jayson and Kori decide to counter Paula’s offer. After crunching the numbers, Jayson would prefer an 8-year loan at 9.5% interest. They would rather pay the loan off sooner—well worth the monthly increase of $93.02.

Not satisfied with a $2,120.85 reduction in interest income, Paula counters with an 8-year loan at 10% interest. This reduces her total interest paid by only $402.18 from the original offer.

Jayson and Kori agree to these terms. Once the note contract is created and signed by both parties, the note is executed in the name of Paula’s IRA and the funds wired from Kingdom Trust to Jayson’s bank account. Jayson and Kori purchase their starter home and will begin monthly payments to Paula’s account the following month.

Once recorded, the deed of trust and original promissory note are provided to Kingdom Trust for safekeeping.

Paula looks forward to earning tax-free interest income from the promissory note investment.

Paula will accumulate $31,056 in interest income over eight years—an annual return of 5.7%. With these returns and rental income from her IRA-owned property, Tim decides to move his Traditional IRA to Kingdom Trust so he might invest in alternatives as well.

Tim’s strongly considering digital currency and private equity as potential investments in 2019. Maybe Paula will find a third alternative asset type to invest in down the road. After all, the possibilities are nearly endless!

If you’re considering self-direction and/or investing in alternative assets, consider opening a Kingdom Trust account today. Simply chat in, email or call us to get started, or proceed right to the online account application. There’s no time like now to join savvy investors like Paula who choose self-direction as the path to true investment diversity.

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