Promissory Notes With Your Self Directed IRA: Investor Guide

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Investors and advisers considering some promissory note investments at a conference table

One option investors often choose in self-directed IRAs is investing in promissory notes. A promissory note is a signed agreement promising to pay a person or business a certain amount, with interest and a maturity date. There are so many strategies used by investors, from buying and selling notes to acting as the lender on real estate deals (often known as mortgage notes).   

Today, we'll be covering promissory notes (but not those secured by real estate)— here's the process to get started:

 

What Is A Promissory Note?

promissory note is a signed agreement, where one party (the borrower) is promising to pay a specific person or business a certain amount (the lender) with interest and a maturity date. You may hear them called: promise to pay, personal notes, loan agreements, or secured/unsecured notes, to name a few.

In the case of investing in notes with your self-directed IRA, the IRA would be the lender, essentially acting as the bank. You can do these types of alternative investments in a Traditional IRA, Roth IRA or any other type of IRA account as long as these investments are allowed by the IRA custodian or trust company. Depending on the type of IRA, the income generated from the investment grows tax-free or tax-deferred. Promissory notes have many names, depending on the situation.

 

What Are The Different Types of Promissory Notes?

The two main types of notes are secured and unsecured:

Secured Promissory Notes

A secured note is a note that guarantees collateral in case of default, meaning the lender can make attempts to recoup their investment in the event the borrower cannot pay back the loan. This is especially common with real estate investments, where the note is secured by the property itself. 

Be aware of the terms of your note and see that your borrower understands their portion of the agreement. If your note is secured, make sure the borrower is clear on what happens in the event of default, along with their obligation to maintain the property held as collateral.

Unsecured Promissory Notes

An unsecured note is a promissory note where nothing is held as collateral, meaning you won’t have much recourse if the borrower defaults on the loan. These loans typically have higher interest rates and higher monthly payments, along with a lengthier pre-loan vetting process, to try to make up for this risk— but they do come with risks.

 

Who Can I Loan Money To?

As always when investing with your self-directed IRA, using your own due diligence is required.  You need to be aware of IRS rules on prohibited transactions and disqualified persons. Your IRA cannot loan, borrow money from, or engage in any transaction with a disqualified person, or your IRA could lose its tax-advantaged status, which could lead to forcing distribution of—and taxing—the asset.

 

How Do I Do It? Step-By-Step Process

Open & Fund Your Account

To open your account with IRAR Trust Company, you'll need to complete and submit our Account Application and General Fee Disclosure, along with a clear copy of a government-issued ID or passport. 

Once open, most clients transfer IRA funds to IRAR Trust. To do this, you'll submit our Transfer Form along with an account statement from within the past six months. If your funds are coming from retirement savings in an employer sponsored plan or 401(k), you'll need to rollover your funds. This must be initiated by you, by submitting a request to your current custodian. You will also need to complete an IRAR Rollover Form so that we can allocate the funds/assets to your account when they arrive.  If you have any questions over which method is right for moving your retirement account, an IRAR representative would be happy to help. 

Relevant: Transfers vs Rollovers: What’s the Difference?

 

The Investment Process

Once your account is open and funded, the next steps are to fill out our paperwork and submit your promissory note. 

To fund your investment, we need:

  • An IRAR Promissory Note BDL (this is for non-real estate assets)
  • The Original Promissory Note or agreement with a physical/wet signature and a list of collateral (if the note is secured)
  • It's important that both documents are complete and accurate, otherwise this can hold up your transaction or cause trouble down the line. 
  • IRAR Trust does not provide or assist in drafting promissory notes. We cannot legally do this for you. If you need assistance, there are plenty of resources you can find online with a quick search. 
  • Your note agreement should at least include: the amount of the loan, the maturity date, interest rate, when and how payments are made (e.g. monthly, quarterly, or lump sum), what happens if a note is late (are there late fees?) or isn’t paid back, if it can be transferred to another person, and if any collateral is being offered.

When reviewing your investment paperwork, we're looking for a few things:

  • We need all the information on the Buy Direction Letter and in your promissory note to match. This is the most common issue that slows down transactions.
  • Verify that the dollar amount and borrower's name are correct
  • Make sure you have physically signed the promissory note “Read & Approved” wherever a signature is required.
  • Clarify you are not investing with a disqualified person or engaging in a prohibited transaction.
  • Check that the lender is correctly listed as your IRA (IRAR FBO John Doe 35-XXXXX) in all official documents.
  • If any issues come up along the way, an IRAR representative will reach out to you to clarify the details and what is needed. Please note, there is a 2 - 3 day processing timeline, so take this into account when submitting your paperwork.
  • Once your account has been opened, your funds have arrived, and your paperwork has been reviewed, we'll go ahead and send the funds to the borrower (as instructed on your forms).

That's it, you've invested in a promissory note with your self-directed IRA!

 

Anticipated Fees

At IRAR Trust, you'll pay a $50 transaction fee, plus a charge depending on how you want the funds delivered to the borrower ($7 for a check, $30 for a wire, no fee for an ACH). There may be additional fees if you are using a loan processor or another service to draft your note paperwork, but (if written into your agreement) you can pass these along to the borrower. If you’d like more information, our fee schedule has a more comprehensive breakdown of how we charge.

 

After Investment

There are a few things to keep in mind after you've invested, to make sure all goes smoothly with your self-directed retirement account. Make sure your borrowers have the right address to send payments and be sure to monitor these payments for accuracy. IRAR Trust is not a loan servicer. It is up to you to ensure complete payments are being made in a timely manner and that the value of the loan is accurately reflected on your account. 

 

Ready To Get Started?

Now you know how to expand your retirement strategy by investing in promissory notes (secured or unsecured) with your self-directed IRA! The process isn't complicated, you just need to make sure you've covered all your bases. 

With self-directed IRAs, you have freedom to invest that’s rarely found in other retirement investment options.  Now take that freedom and use it to build your dream retirement. If you have any questions or want to talk strategy, an IRAR representative would be happy to help.

 

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