June 10, 2024

Building Wealth Beyond Limits: Exploring Private Credit in Self-Directed IRAs

Written By: Daniel Gleich

Key Points 

  • A Self-Directed IRA (SDIRA) allows you to invest in private credit, expanding your investment options beyond those typically offered in standard IRAs.
  • Private credit investing with an SDIRA has the potential for steady returns, diversification, tax advantages, and the ability to help an individual or private entity raise capital.
  • Speaking with a knowledgeable SDIRA Specialist at Madison Trust and a financial advisor can help equip you with the information you need to know when investing in private credit with a Self-Directed IRA.
Self-Directed IRA investor shaking hands with smiling individuals she is investing in with her Self-Directed IRA.

As the market is generally volatile, many investors seek to diversify their retirement portfolios. One such way to diversify is by investing in alternative assets, such as gold or real estate, through a Self-Directed IRA (SDIRA). An asset gaining popularity is private credit. Let’s explore what private credit is and the benefits and potential risks of investing in private credit with a Self-Directed IRA.

What Is Private Credit?

Self-Directed IRA investors high fiving to show that they agreed on the loan terms for the private credit investment with a SDIRA.

Private credit refers to loans or debt investments made from non-bank lenders to companies that are not publicly traded. Private credit investments are negotiated directly between the lender (in this case, the Self-Directed IRA account holder) and the borrower (an individual or entity).

It is an exciting investment opportunity for self-directed investors seeking to diversify their portfolio, receive steady returns, and receive tax-advantaged income.

Can a Self-Directed IRA Loan Money?

Yes! Through investing in private credit, a Self-Directed IRA serves as the lender. Typically, a bank would lend money to borrowers through loans, such as mortgage loans or personal loans. In a private credit investment, your Self-Directed IRA acts as the bank and can loan money to suitable borrowers.

Balance board with a bag of money with “Loan” written on it on one side and a car, house, and family on the other.
Self-Directed IRA investor smiling as he sets up the loan terms and lending process with his borrower.

The setup is generally favorable, as you are in control of the loan terms and lending process. You get to select the loan amount, interest rate, collateral (if applicable), maturity date, and repayment terms. You also get to choose who you loan money to, whether that be an individual, small business, startup, or another entity.  

For even greater control, self-directed investors may consider a Checkbook IRA. With this account, a Self-Directed IRA LLC or trust and dedicated checking account are established to give you the ability to simply write checks or send a wire to make your investment.  

It is important to keep in mind that all lending activity comes to/from the Self-Directed IRA. The money lent must come from your SDIRA. All profits, like interest earned, must be returned to the SDIRA. The borrower should make payments in the name of the SDIRA, not your name.

What Are the Types of Private Credit You Can Invest in with a Self-Directed IRA?

There are many types of loans that you can invest in with your SDIRA, including:

  • Secured Loans
  • Unsecured Loans 
  • Direct Lending 
  • Real Estate Debt 
  • Venture Debt 

Other popular types of private credit include promissory notes and private equity.

Benefits of Lending From an SDIRA

Hand holding a bag of money to show the benefit of investment control when you invest in private credit with a Self-Directed IRA.

Investment Control

When you invest in private credit with your SDIRA, you get to choose the terms of the loan.

Scissors cutting a sign that says “tax” to show the benefit of receiving tax advantages when you invest in private credit with a Self-Directed IRA.

Tax Advantages

When you invest with an SDIRA, the funds earned are tax-deferred (Self-Directed Traditional IRA) or tax-free (Self-Directed Roth IRA).

Graph of real estate, dollar bill, and precious metals as part of a pie chart to show the benefit of portfolio diversification when you invest in private credit with a Self-Directed IRA.

Portfolio Diversification

Investing with an SDIRA allows you to invest beyond Wall Street. Unlike standard products, private credit is typically uncorrelated with the stock market’s performance, potentially leading you to have portfolio resilience, particularly during market downturns.

Coin being inserted into a piggy bank to show the benefit of the potential for steady returns when you invest in private credit with a Self-Directed IRA.

Potential for Steady Returns

Depending on how you set up the loan terms and fee payment structure, you can receive relatively predictable returns.

Dollar bills in an envelope to show the benefit of generally easy to manage when you invest in private credit with a Self-Directed IRA.

Generally Easy to Manage

Once the loan is set up, minimal management is typically required.

Handshake to show the benefit of impactful investing when you invest in private credit with a Self-Directed IRA.

Impactful Investing

You can lend your retirement funds to help a local business, aid in the redevelopment of a neighborhood, fund a healthcare startup, and other philanthropic opportunities.

Access to Capital

Private credit provides an alternative source of financing, particularly for those that may not meet the criteria for traditional bank loans or face challenges accessing capital markets. Typically, private companies or individuals can gain capital faster since requirements are generally less strict than bank or mortgage companies.

Dollar bills stacked up to show the benefit of access to capital for borrowers when investing in private credit with a Self-Directed IRA.

An Increased Source of Funds

There is over $3.8 trillion in U.S. retirement funds that can be invested in these private credit opportunities.

Check being signed to show the benefit of an increased source of funds to borrowers when investing in private credit with a Self-Directed IRA.

Flexible Terms

The borrower and lender can work together to form a repayment schedule, interest rate, and other terms they are both financially comfortable with.

Coin with arrows pointing around it to show the benefit of flexible terms to borrowers when investing in private credit with a Self-Directed IRA.

Potential Investor Expertise

Self-Directed investors are encouraged to invest in what they know and believe in, so they may be more interested in these industries than the average investor. SDIRA investors are also investing for the long term, as they are saving for retirement.

Lightbulb and person icon to show the benefit or potential expertise or interest of investors in your fund when investing in private credit with a Self-Directed IRA.

Potential Risks of Lending From Your Retirement Account

Piggy bank with a note that reads “IOU” sticking out of it to indicate the risk of not getting your return on investment if the borrower does not pay back the loan.

Like any investment, private credit has potential risks. There is the potential that borrower does not pay back the loan.

To potentially reduce risk, perform due diligence before extending a loan from your SDIRA. Consider asking for an application and checking the borrower’s credit.

It is also important to understand the SDIRA lending rules and regulations set by the IRS, including prohibited transactions and disqualified persons.

It is considered best practice to speak with a tax professional, financial advisor, or Self-Directed IRA custodian. This can help you stay compliant with IRS rules.

Can an SDIRA Borrow Money?

The short answer is yes, your Self-Directed IRA can borrow money. The IRS has regulations in place that state that the debt must be “non-recourse.” This means that the IRA owner does not have a personal guarantee on it.

You can apply for a non-recourse loan in the name of your SDIRA. When utilizing a non-recourse loan, the investment property is collateral on the loan. If a default occurs, the lender can only foreclose on the collateral to satisfy the loan. There is no additional recourse against the SDIRA owner or other assets.  

Notepad with “Non-Recourse Loan” written on it in red ink on a table with investment graphs behind it and a highlighter to show that your SDIRA can borrow money through a non-recourse loan.
Borrowers signing the loan terms put forth from a Self-Directed IRA investor who is investing in their fund.

Investing in private credit with a Self-Directed IRA can be intriguing for investors seeking to diversify their retirement portfolios and potentially enhance returns. It is essential to conduct due diligence, understand the associated risks, and stay compliant with IRS regulations. By leveraging the flexibility of a SDIRA and investing in private lending, investors can potentially build a robust and resilient retirement portfolio.

Have Questions? We Have Answers!

Speak with a Self-Directed IRA Specialist to learn more about this exciting opportunity.


Disclaimer: All of the information contained on our website is a general discussion for informational purposes only. Madison Trust Company does not provide legal, tax or investment advice. Nothing of the foregoing, or of any other written, electronic, or oral statement or communication by Madison Trust Company or its representatives, is intended to be, or may be relayed as, legal, tax, investment advice, statements, opinions, or predictions. Prior to making any investment decisions, please consult with the appropriate legal, tax, and investment professionals for advice.

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