A harmonization of innovation is offering individual investors and, eventually, advisors the ability to invest as if they were institutions.
Advances in financial products, regulation and technology are allowing investors to more easily open, fund and invest within self-directed retirement accounts, said James Jones, Senior Vice President of Investor Relations at CalTier, a digital alternative investment provider.
Typically, taxes are a major obstacle for investors (negatively affecting overall returns and performance) in certain alternative asset classes, said Jones.
“Very simply, under crowdfunding regulations like Regulation A+ and Regulation CF, a large proportion of the moneys invested are in taxable accounts,” said Jones. “Every time there is an exit, dividend, interest payment, or some type of capital appreciation delivered to the investor, they’re taxed.”
Why Use Retirement Accounts for Alts?
Retirement accounts give investors the ability to defer taxes, or in the case of Roth accounts, avoid taxes on growth and income altogether, permitting greater compounding growth over time, said Jones.
The ability to defer or avoid taxes allows passive real estate investors in funds like those offered by CalTier to enjoy the full return on their investments within those accounts, said Jones. However, if someone is investing in real estate as a direct investor, it may make more sense to invest via a taxable account to enable the use of various tax write-offs and 1031 exchanges.
If one of CalTier’s funds targets an 8% annual return, held outside of a retirement account, the net return enjoyed by the investor would likely be closer to 5% due to taxes. Similarly, a fund that targets 8% after taxes could potentially deliver 11% in a retirement account. Similarly, a fund that targets 8% after taxes would offer an estimated 11% tax-deferred or tax-free equivalent. Over time, compounding amplifies the difference between taxable assets and non-taxable assets.
“It also makes sense for investment sponsors because that’s where the money is,” said Jones. “At any given time, there’s $1 trillion in checking and savings accounts. That’s how people are paying for their mortgages, car bills and groceries—how much do they have laying around to make an investment in alternatives? But there’s 35-times that, a whole $35 trillion, sitting in retirement accounts, overallocated to stocks, bonds and mutual funds, and ETFs.”
Another benefit to sponsors and asset managers is that retirement assets are long-term assets invested over a person’s accumulation period. Over time, distributions and dividends are more likely to be directly reinvested in retirement accounts than in taxable accounts, said Jones. That stability benefits investors as well, as long-term portfolio success often depends on time in the market.
The technological and pricing efficiencies of self-directed IRA, or SDIRA, should pave the way for more alternatives to be offered within tax-deferred and tax-exempt accounts, enabling true diversification of retirement assets, much more in line with institutional and endowment portfolio allocations, said Jones.
Why SDIRAs Are Underutilized
“Most people don’t know what a self-directed IRA is,” said Jones. “They don’t know that you can use a retirement account for other things besides traditional stocks and bonds.”
While regulations have long permitted SDIRAs, they’re required to be held by a qualified custodian. In the past, these were specialist custodians operating independently from the Schwabs, Pershings and FIdelitys of the world.
Until recently, opening a SDIRA was an antiquated, paper-driven process. Some larger custodians allow investors to use an API to open an account.
“From investor to deal sponsor, opening up a self-directed IRA to hold alternative assets is a cumbersome, painful process,” said Jones. “One company, AltoIRA, has built a new self-directed IRA custodial platform. Most of the rest of the industry all runs on the same administrative and accounting software, and at the end of the day it becomes a manual, paper-based process that can take weeks. I, personally, have spent three months trying to complete transactions with a self-directed IRA.”
The costs are painful as well, said Jones. Typically, an investor could pay as much as $300 per asset per year based on industry averages. If their assets were spread across a few different investing platforms, they might incur (as much as) $3,000 in fees. These costs are prohibitive for investors who might want to allocate $20,000 or less per year to alternatives.
Technology presents another obstacle.
“Most deal sponsors aren’t integrated – there’s no technology integration,” said Jones. “So you would go to an issuer like CalTier, and you’d have to leave that platform, open a new second account with a custodian, and then try to get those two entities to speak back and forth on your behalf. Until the SDIRA industry can learn how to better integrate and automate with deal sponsors, it’s a conversation piece at best. Over the last few years, the industry has done little to gain any meaningful new client acquisition. Most Investment Sponsors and Deal Platforms have 1-2% of their client base in retirement accounts.”
Enter AltoIRA and CalTier’s Partnership
That is why CallTier has partnered with digital IRA custodian AltoIRA, which specializes in self-directed IRAs that can hold alternatives, including cryptocurrencies.
“AltoIRA has a streamlined, integrated platform, and they’re planning to eventually launch IRA-as-a-service, third-party account opening that the advisor can get in on,” said Jones.
CalTier offers access to the AltoIRA to its investors, absorbing the price of opening the account. If an investor makes a $5,000 investment, CalTier will absorb AltoIRA’s annual account fees. Today, that’s accomplished by reimbursing investors, but in the future it should be a truly free IRA, said Jones.
“We have absorbed the price of opening an account,” said Jones. “Right now we’re reimbursing the investor, who is typically using a card up-front.”
The Case for Alternatives in Retirement Accounts
This all comes at a fortuitous time for investors. With equity valuations near or at historical highs and interest rates rising, many market analysts believe that long-term goals like funding a retirement will be difficult to accomplish with a portfolio allocated to traditional asset classes.
Typical institutional portfolios and college and university endowment funds follow the Yale Portfolio Model, where real estate can comprise as much as 40% of the portfolio; private equity, private debt, venture capital and hedge funds as much as 30%; stocks, bonds, mutual funds and ETFs as much as 20%; and the remainder in gold and cryptocurrencies—meaning the new self-directed IRAs allow “for true diversification across all asset classes,” said Jones.
*CalTier does not provide tax, financial or investing advice. Please consult your tax, financial or investment expert for assistance.
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