April 24, 2020

Investing in Distressed Debt with a Self-Directed IRA

By: Christopher Orr, CISP®, SDIP

Tags: distressed debt ira private debt self-directed ira

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Investing in Distressed Debt with a Self-Directed IRA

With the world potentially facing its worst downturn since the Great Depression, businesses are buckling under pressure, and the amount of distressed debt in the US has surged to levels not seen since 2008.

Distressed debt refers to securities issued by companies that are in financial distress and are typically near or going through bankruptcy. This debt carries a high risk of default. With shelter-in-place orders forcing many businesses to curtail or close operations, US distressed debt surged to nearly $1 trillion by the end of March*.

According to Bloomberg, the largest chunk of distressed debt outstanding belongs to US energy companies, which are being battered by plunging travel demand and an oil price war. But, as the chart below illustrates, energy is far from the only sector contending with a surge in troubled debt.

As Distressed Debt Rises, so Does Investor Demand

Soaring inventory is creating a buying opportunity for bargain-hunting investors, hedge funds, and private equity firms focused on highly risky distressed debt. Investment firm Oaktree Capital Group LLC is seeking $15 billion to start the largest-ever distressed-debt fund, according to Bloomberg News.

Even before pandemic hit, investors demonstrated heightened interest in debt opportunities. The Chartered Alternative Investment Analyst (CAIA) Association recently surveyed its members, and nearly 40% of respondents indicated they were likely to raise their allocation to private debt by 2025.

One unexpected place where investors can own this debt is within self-directed IRAs. Americans hold roughly $291 billion** in self-directed IRAs, which enable account owners—not a plan administrator—to make active investment decisions. As a result, the vast majority of self-directed IRA owners use their tax-advantaged dollars to invest in alternative assets, including private and distressed debt.

Investing in Distressed Debt with a Self-Directed IRA

At Pacific Premier Trust, where we custody assets for our clients’ self-directed IRAs, we are seeing an uptick in client interest in debt investing. Debt has the potential to provide yield, to act as an income source, and to diversify a portfolio, according to responses from the CAIA’s member survey.

For IRA owners who fully understand the risks associated with investing in distressed, investing in this asset class using retirement funds provides the benefit of making an investment with tax-advantaged dollars. Investors who own a traditional IRA can defer taxes on their retirement investments until it is time to take distributions. In a Roth account, holders may not have to pay taxes on qualified distributions. At Pacific Premier Trust we always recommend investors work with a tax or legal advisor to determine if an investment is the right fit and to weigh tax implications.

For asset sponsors/fundraisers, IRAs provide an often-overlooked source of capital that may be well suited for holding debt investments. Some debt investments require long holding periods, which make them a good match for retirement funds that inherently require extended time horizons. And investors who may have already invested capital with an asset sponsor using taxable dollars can also do so with their retirement funds.

Asset sponsors seeking to raise capital from IRA owners should work with an alternative IRA asset custodian that can quickly review offerings to let you know if the asset meets an administrative review for a retirement account. At Pacific Premier Trust, we’ve helped clients use IRA funds to invest in private and distressed debt since 1989. We understand the specific IRS rules and regulations—such as what may be considered a prohibited transaction and who is a disqualified person—that you and your investors need to follow. Working with experts will make the process of raising IRA capital smoother.

To learn more about working with Pacific Premier Trust to invest in distressed debt, please download our guide, Expanding Your Capital Raising Through Self-Directed IRAs. You can also reach us by phone at 855.453.4960.

*Bloomberg.com, “Distressed Debt Balloons to Almost $1 Trillion, Nears 2008 Peak,” March 25, 2020

**Retirement Industry Trust Association estimates 3-5% of IRAs are self-directed. This data reflects 3%.

This Blog does not provide investment, tax, or legal advice nor does it evaluate, recommend or endorse any advisory firm or investment vehicle. Investments are not FDIC insured and are subject to risk, including the loss of principal.

Pacific Premier Trust (formerly PENSCO Trust Company) performs the duties of an independent custodian of assets for self-directed individual and business retirement accounts and does not provide investment advice, sell investments or offer any tax or legal advice. Clients or potential clients are advised to perform their own due diligence in choosing any investment opportunity as well as selecting any professional to assist them with an investment opportunity. Alternative investments are not FDIC insured and are subject to risk, including loss of principal. Pacific Premier Trust is not affiliated with any financial professional, investment, investment sponsor, or investment, tax or legal advisor.


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