Socially Responsible Self-Directed Retirement Accounts

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The best mechanisms people wanting to invest with their values on the path to financial independence (FI) in the U.S. have available may well be self-directed IRAs (SDIRA) and Solo 401ks. Not only do these little known self-directed retirement accounts allow one to make a wide range of alternative investments, they offer a tax-advantaged way for investors to truly diversify their retirement investments and increase their financial resilience. These accounts generally require much more active participation on the part of the account holder than their mainstream cousins. And there is a good bit to learn to successfully navigate these waters amidst the IRS rules pertaining to them. However, that shouldn’t deter those of us who want to make investments that are more aligned with our values from considering socially responsible self-directed retirement accounts because they unlock opportunities to truly make meaningful and impactful investments.

Before we delve any deeper into this topic I want to insert an appropriate disclaimer – I am not a certified financial planner and I’m definitely NOT your certified financial planner. All information presented here is for educational purposes only. Do your own due diligence prior to opening any self directed retirement account. And before deciding if one of these accounts is right for you, consider consulting a tax advisor first.

Overview of Self Directed Retirement Accounts

Like traditional retirement accounts SDIRAs and Solo 401ks also provide a tax advantaged means to save and invest retirement funds. Participants are required to adhere to the same eligibility requirements and contribution limits as traditional IRAs. The major difference is that these accounts offer a much higher level of freedom and flexibility. Most retirement accounts, which are generally provided through employers, banks, or held with broker-dealers such as Vanguard, Etrade, or Morgan Stanley, restrict clients to a limited menu of assets – primarily, stocks, bonds, and mutual funds. Self directed accounts allow account holders to invest in a much wider array of assets; essentially everything except S corporation stock, collectibles (such as stamps, art, or wine), and in the case of SDIRAs – life insurance.

One of the most commonly held non-traditional investments in these accounts is real estate, which can include things such as rental properties, rehabs, mobile home parks, tax lien certificates, vacant land, private mortgages, notes, and more. Precious metals and crypto-currencies are also often found in these accounts. Other alternative investments frequently encountered in these accounts are private placements, peer-to-peer lending, and investments in start-up companies.

The complexities with these accounts stem in part from what the IRS refers to as disqualified persons and prohibited transactions. As certified financial planner Michael Kitces explains on his website,

“..because an IRA is intended to be treated as a separate tax-preferenced retirement account from the other assets of the IRA owner, the Internal Revenue Code also contains a series of “prohibited transaction” rules intended to prevent the IRA owner from using the account to enrich themselves or their family members (without actually taking a taxable withdrawal). The prohibited transaction rules cause adverse tax consequences for the IRA if it engages in such prohibited transactions with any “disqualified person”, which includes the IRA owner themselves and his/her immediate family members (as well as certain related trusts and business entities).”

For most readers of this blog, who are interested in making more local and regenerative investments, this won’t be an issue as long as we don’t invest in businesses owned by family members or buy a house for ourselves or one of our family members to live in.

Self-Directed IRAs

Anyone eligible for a Traditional, Roth, SEP, SIMPLE or Inherited IRA is eligible to open a Self-Directed IRA. People have also begun establishing self-directed HSAs as well as Coverdell or College IRAs. These accounts can be funded by personal contributions as well as transfers or rollovers from previously existing retirement accounts. You cannot however, rollover a company plan with a current employer.

SDIRA accounts must be administered by a qualified custodian company. As the number of people opening SDIRAs grows so does the number of companies handling these accounts. Not all custodians handle all types of investments so think about what types of investments you’ll want to make and be sure to find a suitable custodian company. Innovative Advisory Groups’ list of SDIRA custodian companies is a good starting point, but with more custodian companies popping up all the time it’s by no means comprehensive. These custodians aren’t allowed to give financial advice (that’s why the accounts are called self-directed).

Typical SDIRA custodian company charges include a one-time fee to open the account, an annual renewal fee, and fees for investment bill paying. I took the additional step of establishing a checkbook LLC that is owned by my IRA. This gives me the ability to write the checks myself for the investments I want to make without needing to wait for my custodian company to process my request or pay their transaction fee each time. I still pay the custodial company’s annual fee as well as an annual business registration fee for the LLC itself.

While I didn’t do it because I didn’t know about these companies when moving forward with the creation of my checkbook LLC, it could be worth it for some people to pay the higher fees to work with a full service advisory company with legal and accounting advisors on staff to help answer the questions that may arise as you start making these alternative investments from your SDIRA. A few of the companies I have since learned about are Safeguard Advisors, KKOS Lawyers, and Innovative Advisory Group. You could also work with individual accounting and legal advisors well-versed on SDIRAs on an ad hoc or as needed basis. A good starting place to find them is this other helpful list on the Innovative Advisory Group’s site. Custodian companies can usually recommend local professionals well versed in these accounts as well.

Solo 401ks

It wasn’t until after I opened my SDIRA that I learned about Solo 401ks, which are a great option for entrepreneurs with no employees. Solo 401k history begins back in 2001 when the US Congress passed EGTRRA (Economic Growth and Tax Relief Reconciliation Act) allowing the self-employed to utilize the 401k. Solo 401ks, referred to as one participant 401k plans by the IRS, are likely the most popular retirement plan option for the self-employed.

One reason these accounts enjoy such popularity is because the contribution limits are higher. Contribution limits for a Solo 401k are about ten times more than an IRA. For 2019, the Solo 401k contribution limit for participants under age 50 is $56,000. For an IRA, that limit is $6,000. Participants over age 50 can contribute an extra $6,000 to a solo 401k bringing that total up to $62,000, but only $7,000 to an IRA.

Those higher contribution limits are also part of why solo 401ks are usually regarded as a better option than a SDIRA for those who qualify to open one. Also, these accounts are less expensive, allow for loans, and have significant tax advantages. Plus, while SDIRAs must be held by a custodian company, that is not the case with a Solo 401k. This means Solo 401k participants can bypass the middleman and control their retirement assets directly. Solo 401k account holders are able to access their funds without needing to submit paperwork or payment to a custodian company requesting to do so. This also eliminates the added hassle and expense of establishing a LLC to have this checkbook control.

Additional features that make the Solo 401k such an appealing option as outlined on Discount Solo 401k include:

*Just as with a regular 401k, a Solo 401k participant can borrow up to either $50,000 or 50% of their account value (whichever is less). (This is not the case with self-directed IRAs.) The loan is not considered to be a distribution so no taxes or penalties are due on the amount borrowed.

*If your spouse works in your business as well, you can both participate in the same Solo 401k plan, effectively doubling the amount that can be added to the plan each year.

*The penalties for prohibited transactions are generally less severe with a Solo 401k.

Others Pursuing Financial Independence through Self-Directed Retirement Accounts

Traditional IRAs populated with Vanguard and other index funds may be the norm in the FIosphere, but self directed retirement accounts have even made it into this realm. Assets held in SDIRAs represent only about 4% of total assets held in IRAs. To the extent that we hear about SDIRAs and even Solo 401ks in the Financial Independence/Retire Early (FIRE) community the tendency to populate them with real estate investments remains consistent.

The first FIosphere reference I encountered by another self-directed retirement account holder was by Carl at 1500 Days, who has been making real estate related investments for a number of years this way – of note: this write up of a mobile home park he bought with Solo 401k funds. Other FIRE bloggers who have chronicled their self-directed retirement account real estate adventures are:

FI Tax Guy

Costa Rica Fire

Coach Carson

Physician on FIRE

A few others in the FIosphere have created online content outlining self directed retirement account investing pursuits beyond real estate. Financial Panther sings the praises of these accounts for side hustlers like himself and describes how he treads a more mainstream investing path with his Fidelity Solo 401k. Self-directed IRAs and alternative investments get some coverage on the 2 Frugal Dudes podcast when hosts Sean and Kevin interviewed Kirk Chisolm from Innovative Advisory Group.

Investing in the World we Want to Live in through Self Directed Retirement Accounts

There are so many options beyond purchasing rental property and precious metals though, that exist for self-directed retirement account holders. We can use the accounts to direct our retirement funds, which are the greatest source of wealth to which many middle-class Americans have access, away from the extractive practices of major corporations towards our communities and innovative companies that are developing sustainable solutions to help regenerate our planet.

I first learned about self directed retirement accounts while attending a Slow Money Northern California meeting. Members of this group use SDIRAs as a vehicle to invest in small local food businesses and agree to a (s)lower rate of return on their investment knowing instead that they are strengthening their local food system and economy. Not long after that I read Locavesting by Amy Cortese and Local Dollars, Local Sense by Michael Shuman both of which encourage readers to open these types of accounts and use their retirement funds to keep their money closer to Main Street than Wall Street by lending to and investing in businesses and people in their communities.

I’ve written before about how the SRI (socially responsible investing) and ESG (environmental, social, governance) mutual funds and ETFs that are becoming more and more popular still limit us to “less bad” shareholder-driven companies pushing products and services in ways that don’t sync with the vision of the world in which many of us want to live. As Next Generation Trust CEO Jamie Raskulinecz highlights in Forbes, “…traditional investments, such as stocks, bonds and mutual funds, offer a limited and indirect way… to support social causes.” She also notes that self directed retirement accounts enable investors “.… to put their money where their interests lie, by investing in alternative assets that align with their values.”

Previously, many innovative impact investment opportunities were typically only available to wealthy investors, but with the passing of the JOBS Act in 2012 more and more of these investment opportunities are being made available to less affluent retail investors like myself. Crowdfunding sites like Wefunder and SeedInvest make it possible to search out and invest in startups that tackle social and environmental issues. Through websites like Worthy and Streetshares we can earn 5% interest while helping small businesses access much needed capital. And if you do want to invest your self-directed account funds to real estate consider investing in Small Change, which offers non-accredited investors a way to invest in real estate projects that change cities and neighborhoods for the better. Or how about Iroquois Valley’s organic farmland REIT? These self-directed accounts also make it possible for retail investors to more easily invest their retirement funds in the burgeoning cannabis industry in a tax-advantaged account. (You can find even more ideas on the 3pfi investing resources page of this blog.)

Educate Yourself Before Diving into a Self Directed Retirement Account

SDIRA custodian companies can’t give financial or investment advice so the burden of research and due diligence rests entirely with the account holder. A similar onus exists for solo 401k participants. If you want help picking or managing your investments, you can always work with a financial advisor, one of the full service advisory companies I listed earlier, or another advisor well versed in self-directed retirement accounts.

It is essential that anyone considering opening one of these accounts spend a significant amount of time learning more about them prior to opening one. Look for a company that is reliable, reputable, and experienced. Many of the companies offering these accounts provide educational resources on their websites or YouTube, through webinars, and with in-person classes. Tapping these free resources can be a good way to screen potential companies prior to opening an account. It is also helpful to talk to people, who have been using these accounts for a number of years already.

Search at your library to see if there are any books on self-directed retirement accounts you can check out. One well-known book is Mat Sorensen’s The Self-Directed IRA Handbook. He has also created many informational videos about SDIRAs. Adam Bergman, president of IRA Financial Trust Company, wrote Solo 401(k) In a Nutshell and delves into the intricacies of both types of accounts on his podcast Adam Bergman Talks.

The Sustainable Economies Law Center (SELC) in partnership with LIFT Economy and author Michael Shuman (referenced above) recently launched the NextEgg initiative. It’s a subscription based online community of people “learning to self-direct their retirement savings into investments that repair injustices, sequester carbon, nurture local enterprises, and create a world that will sustain us into retirement and for generations to come.” This write up prepared by one of the founding team members further explains the intent of this initiative. And this NextEgg write up provides some additional helpful information on solo 401ks and SDIRAs. The monthly fee is currently $9.99, although it may be possible to waive the fee in certain situations. If interested, you can use this link to subscribe.

Final Thoughts

I’ve only scratched the surface in this post. It is not my intention to deter people from opening these accounts, quite the opposite, but I also want to be honest about the fact that these accounts can often involve a significant learning curve and require more of your time as you seek out investments, fill out forms for each investment, and manage the paperwork. The reward is that you can divert your retirement savings from consumer products, sugar filled soft-drinks, big banks, pharmaceuticals, and so many other extractive harmful products and services and still have a tax-advantaged way to invest in sustainable and meaningful opportunities in your community and globally.

In the second post in this series I will go into a good bit more detail about the specifics of checkbook LLC self-directed IRAs (which is the account I currently use) and share observations from my two years of experience with a SDIRA. I will also discuss the investments I’ve made to date with this account.

Do you have a SDIRA or Solo 401k? If so, what alternative or sustainable investments have you made?

If you don’t have a SDIRA or Solo 401k are you thinking about opening one? What’s preventing you from doing so?

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