Investing in Promissory Notes With a Self-Directed IRA

Investing in Promissory Notes

Lending with Promissory Notes and Your Self-Directed IRA

A promissory note is a type of private lending that stands as a written agreement and legal contract accompanying a loan. On this agreement, you can find the sum borrowed, due date of the loan, interest rates, a repayment schedule, collateral, and any other terms relevant to the arrangement.

Promissory note investments hold particular allure to IRA investors, as they could yield relatively steady returns. Note that terms are outlined in advance and are available to investors before a transaction takes place. This is quite different than investing in a publicly traded asset where the profits tend to be speculative. When you include this type of investment in a Self-Directed IRA, a promissory note typically offers investors peace of mind, as they can account for the return on their investment and likely balance their portfolios accordingly.

Self-Directed IRAs allow investors to invest in promissory notes by loaning money to emerging companies and small businesses. In these cases, investors perform their own due diligence to determine the creditworthiness of prospective borrowers.

The Varieties of Loans

There are three ways to invest in a promissory note with your Self-Directed IRA:

Notes Secured by Real Property

Secured notes, such as mortgage notes and trust deeds, are promissory notes that are backed by the borrower's collateral. In this case, the collateral would be the real property in question. In the event of default, the lender is entitled to the underlying collateral. Repayment of the loan follows the terms that are outlined within the promissory note itself. Examples of repayment options include fixed principal and interest payments amortized over a specified time period, a balloon payment of interest and principal, or interest-only payments for a set period of time with a final balloon principal payment.

Notes Secured by Non-Real Estate

These are secured promissory notes where the borrower pledges non-real estate items to the lender. Examples in this category include factory or farm equipment, company stocks, or even manufactured homes.

Unsecured Notes

Unsecured notes are promissory notes where the borrower does not pledge any collateral to the lender. The loan is made to the borrower based solely on the merit of the borrower's ability to repay. These types of notes are typically seen as a generally riskier type of promissory note investment.

Benefits of Investing in Promissory Notes

Promissory notes provide a multitude of benefits. Because you get to set the loan term, including the repayment schedule and the interest rates, you’ll receive a relatively predictable return. This will all accrue in a tax-advantaged vehicle with your gains developing tax-deferred (Self-Directed Traditional IRA) or tax-free (Self-Directed Roth IRA). In conjunction, you’ll be curating retirement portfolio diversification as promissory notes are generally not tied to the stock market’s performance. If you have other investments in Wall Street products, this may further balance your investment portfolio and potentially hedge against inflation. This type of investing may also prove to be impactful – you get the opportunity to help a struggling business, fund a startup that you believe in, or even aid in redeveloping a community.

Navigating Promissory Notes with a Self-Directed IRA: What You Need to Know

Watch as Dana Udumulla, Investments Manager, and Ian Robertson, Senior Account Executive at Madison Trust, discuss investing in promissory notes with a Self-Directed IRA.

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Issuing a Loan From Your Self-Directed IRA

When issuing a loan from your Self-Directed IRA to a third party, title must be held in the name of your IRA and not in your personal name. The exact titling is as follows: "Madison Trust Company Custodian FBO [First Name] [Last Name] [Madison Trust Account Number]." Upon your instruction, Madison Trust Company will send the requested loan amount to the borrower, and the borrower will repay the loan by making payments directly to your IRA.

As the Self-Directed IRA holder, you get to decide what individuals or businesses you can lend money to. Ensure that the recipient of your loan cannot be considered a disqualified person, as this may result in you performing a prohibited transaction. This primarily concerns lineal descendants and entities that are either owned by you or a disqualified person, with an ownership of 50% or more.

Below are the documents you will provide to Madison Trust Company when placing the investment:

Investment
Authorization Form

Promissory Note

Security Document such as Deed of Trust, Mortgage, or Personal Guarantee (if applicable)

The Note will outline the terms of the loan, including:

・Amount of loan

・

Interest compounding period (annual, quarterly, monthly, daily, none)

・

Date of issuance

・

Repayment terms

・

Interest rate

・

Due date

If the Borrower is a business entity, you will also need to submit:

・

Documents certifying formation of the entity (e.g., Articles of Organization or Articles of Incorporation)

・

Certificate of Good Standing
(only required if the entity has been in existence for more than 12 months)

Loan Satisfaction

When the loan has been repaid in full, you will supply Madison Trust with a Satisfaction of Note and we will retire the asset from your Self-Directed IRA. A promissory note that's secured may require additional documents.

Madison Trust has streamlined the promissory note investment process to make it easier than ever to issue a loan with retirement funds. Whether you want to issue a secured loan from your IRA or add an unsecured loan to your portfolio, we can help you do it. When you're ready to get started investing with a Self-Directed IRA, contact Madison Trust and let our Self-Directed IRA Specialists assist you.

HOW TO ISSUE A SECURED LOAN FROM YOUR IRA

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