On September 18, 2004, the Federal Reserve slashed its benchmark interest rate by half a percentage point, the first and the biggest cut since March 2020. The Fed has also signaled that it could cut the rate by another half a percentage point this year and expects four more cuts in 2025 and two in 2026.
Lower Interest Rates
So, what does lower interest rates mean for Self-Directed IRA investors? Lower interest rates can significantly benefit investors who focus on non-traditional investments (such as real estate, private equity, or precious metals) for several key reasons.
Increased Asset Values
Low interest rates tend to boost the value of non-traditional investments. When borrowing is cheaper, more investors stream into these markets, increasing demand and pushing up prices. Self-Directed IRA investors holding these assets can benefit from this appreciation over time.
Greater Access to Diversified Assets
Lower interest rates can reduce returns on traditional investments, like bonds and savings accounts, making non-traditional investments more attractive. Lower interest rates allow IRA investors to diversify into alternative assets to seek higher returns when traditional fixed-income products offer lower yields.
Greater Compounding Growth
With lower interest rates, alternative assets will benefit from higher cash flow and asset appreciation allowing investors to experience more significant compounding growth. Since returns within IRAs grow tax-deferred (traditional IRA) or tax free (Roth IRA), investors can capitalize on the long-term benefits of compounding in a low-interest environment without losing gains to taxes in the short term.
Better Financing Options
Lower interest rates reduce the cost of borrowing. If the IRA uses leverage (via a non-recourse loan) to purchase assets like a real estate property, lower interest rates mean smaller loan payments. However, if one does use leverage to acquire real estate, UBTI tax could apply. The maximum tax rate is 37%, which could impact the overall investment return for the IRA.
However, for the self-employed, a Solo 401(k) plan can be established which would allow the retirement account owner to use a non-recourse loan to acquire real estate without triggering the UBTI tax. This exception only applies to 401(k) plans.
Conclusion
With lower interest rates, returns on traditional savings and bonds tend to decrease, pushing investors to seek higher returns from alternative assets like real estate. This increased demand for non-traditional investments can further drive up their value, which is why Self-Directed IRA investors are flocking to alternatives in a period of falling interest rates.
