Part 1: Opening a No Fee Lending Club Roth IRA

Lending_Club_No_fee_roth_iraI’ve been investing with Lending Club for three years now and my returns are still over 10%.  I’ve developed a specific set of filters that I feel give me a distinct advantage over the average LC investor yet it’s nothing ground breaking.  The average investor is doing pretty well according to Lending Club, but I want to do better.  My filters have produced just one default out of 50 loans(37 still issued and current) in my after-tax account and although my initial investment was only $500 3 years ago, I’ve been continuously re-investing interest payments and my account value is now over $700.  That is a pretty amazing return considering the low interest rate environment we’re in.

I wouldn’t dare compare Lending Club to fixed investments like CD’s or even bonds in terms of risk but I’d say there is a very favorable risk-reward trade-off when it comes to peer to peer lending.  Since it’s such a relatively young business, the market has not caught up to it yet and individual investors like you and I can take advantage of that fact.  I’d say the risk is somewhere in-between stocks and bonds but the returns are more closely aligned with stocks.

Most people invest in stocks because they want the high returns that bonds/fixed investments don’t offer.  But with higher returns, there is almost always higher risk.  Stocks are no exception as anyone investing in the past 10 years has seen just how volatile the market can be.  Even though Lending Club has some obvious risks, I don’t see nearly the same volatility that stocks have even though they both produce similar returns.  The lack of volatility coupled with higher returns is what makes Lending Club such a great investment.

Why Roth IRA?

I’m not going to get into a whole Roth IRA debate here but the benefits are pretty obvious in my opinion.  You don’t know how much money you’ll make in the future and you don’t know what the tax rates will be like.  If you diversify your investments between stocks, bonds and real estate then you should diversify your retirement accounts from a tax perspective.  Pay taxes on some of your money now and pay taxes on some of it later.

I decided to contribute $5,000 to my Lending Club Roth IRA for 2013 and I will contribute $5,000 more in 2014.  This represents about 5% of my overall retirement portfolio and even though I’m a huge Lending Club fan, I don’t think it would be prudent for this number to ever go above 15%(for now).

Re-invest the Interest?

Here’s where things get fun since Lending Club pays out monthly cash payments of interest and principal.  Investors can either re-invest that money in new loans or withdraw it to their bank account.  Personally, I plan on re-investing the dividends to start, but eventually I think it could be a great source of passive income.  And the best part would be the fact that the income would be tax-free.  Here’s how:

From 2008-2012, I contributed $5,000 a year to my Roth IRA for a contributions total of $25,000.  Obviously the market has done well over that period so my Roth IRA has gone up.  But I don’t ever plan on touching this money(principal and gains) until I retire.

Since I’ve already contributed $5,000 in 2013 to my Lending Club IRA, I’ll contribute another $5,000 in 2014 for a total of $10,000.   Let’s assume that my $10,000 balance is fully invested at the start of 2015 and I earn a 10% return for the year.

At the end of 2015, I would withdraw $1,000 from my Lending Club Roth IRA.  Up to this future point in my future life, I’ve contributed a total of $35,000 to all of my combined Roth IRA’s.  Since I’m allowed to withdraw contributions at any time tax free, all I’m doing is withdrawing a contribution, my first $1,000.  I can do this for the next 35 years!

So technically, even though I’m taking out the money I made from Lending Club, the government sees it as me taking out the first $1,000 I ever contributed to a Roth IRA.  This is what’s known in the finance world as ‘the fungibility of money.’

Even if I never contributed the first $25,000 to my Vanguard Roth IRA, I would still be able to use this strategy for 10 years and take out $1,000 a year.  After that though, I would have to pay taxes on any withdrawals or leave the money in the account and take it out tax free when I retire(still not a bad deal).

The Fees Associated with a Lending Club IRA

This all sounds too good to be true right?  Kind of, although there are fees associated with a Lending Club IRA, they can be negated by depositing 5k within the first year and 10k by your 2 year anniversary.  Lending Club is actually pretty good about disclosing their fees and the only fee they charge is the servicing charge on each loan.  You will clearly see this fee when you go to place an order and it calculates your expected return(rate – default percentage – fee).

Lending Club doesn’t actually offer retirement accounts so you’ll have to open one through their custodian SDIRA Services as an administrator.  Now these guys know how to charge some fees.  Just take a look at their fee sheet!  There are all sorts of fees for wire transfers and things of that nature but fortunately there is no charge for ACH transfer, so getting your money in and out should be free(I haven’t tried this yet).  And as long as you meet the 5k/10k requirements, Lending Club will cover all the other applicable fees.

The only thing that worried me was the $150 account termination fee, so if you ever decide to close your account you might be hit with this fee.  With certain companies, you can try to transfer out all your money instead of closing the account.  They might require that you leave a certain amount of money in the account, but if that amount is less than the account closure fee it might save you some money to transfer instead of close the account.

Editor’s Note:  This article turned into kind of a monster at over 2,000+ words so I decided to break it up into two parts.  The second part of this article will cover how I invest in Lending Club: what filters I use and why.  I’ll also talk about the best sign-up bonuses currently going on at Lending Club so check back on Thursday.

You can read part 2 here: Investing in a No Fee Lending Club Roth IRA

Readers, what do you think about my new Lending Club strategy?  Do you like the idea of opening an IRA or rolling over your 401(k) to Lending Club?

-Harry @ PF Pro

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Hi, I'm Harry, the owner and head writer for Your PF Pro. I started this site back in 2011 in order to create a place where young professionals could come and get all of their financial questions answered. On the site, you'll find articles on everything from asset allocation for retirement to saving money at Chipotle! So enjoy..

Comments

    • says

      Like I said, ultimately I want to use LC as a source of passive income and if I can do that in a Roth IRA, then it’s tax free income! I’d like to take out 50% of earnings every month and re-invest the other 50%, but probably not for a few years. Gotta build the active income first.

  1. says

    Great post, Harry. I also started out with Lending Club tentatively at first; but now, I’m pretty confident with it. I was one of the lucky few who withdrew my money from the stock market as it was going down WAY before it hit rock bottom and rebounded incredibly. (I do sometimes want to kick myself for withdrawing). Nonetheless, I have been very happy with the seemingly lower risk Lending Club compared to the 90-10 balance I had before.

    Although Lending Club may not be for everyone, I am attracted to it because I am an active investor. I understand that depositing monthly while sitting back and letting it grow is prudent — but it’s boring! So with Lending Club I can let my money sit there and grow, but I can also reinvest the interest and feel like I’m really doing something every month.

    At first I opened a “test” account in 2011 with $850 I just had laying around. About a year later it had grown to an astonishing $975 (+14.7%)! It convinced me to open a Roth IRA and transfer from my previous provider.

    By the way, I copied your investment filters and my defaults have dramatically decreased! Thank you.

    • says

      That’s an interesting take Roberto. I guess if you’re the ‘active’ type LC is great since you do have to constantly check on the status of loans and re-invest. Personally, I hope they come out with some type of automation feature soon so I don’t have to constantly check for notes.

      I’m glad to hear your returns have improved with my filter, that’s awesome! Stay tuned for Thursday’s article, I’ve tweaked a couple filters and I also talk about the best times to find notes.

  2. Jim Burke says

    Harry, One unhappy feature of the IRA option (whether on Lending Club or Prosper) is that you are not allowed to sell your loans on FOLIOfn (like you can if you have a regular account). You have to hold everything to maturity, which means that you can’t dump some of your IRA assets if you either need cash or want to use periodic resale as part of your investment strategy. To me this is a big drawback; and for now I have elected not to open a P2P platform IRA account for this reason. I understand from the reps at both Prosper and Lending Club that they are working on alleviating this problem, but so far no joy.

    • says

      Aha! Thanks for mentioning that, I have never actually sold a note on FOLIO so I completely forgot about that caveat. Personally though, I kind of like investments that don’t allow you to withdraw your money. Retirement savings are supposed to be for retirement. If it were up to me I would make the rules so that once the money goes into a retirement account it can’t come back for any reason.

      Do you plan on needing the money in the future or do you just like the flexibility? Alternatively, I’m sure you have other assets(Roth? – penalty free) you could sell off in a crunch.

  3. ajhmom says

    WARNING!! I invested in a Lending Club IRA and did not read the fee schedule carefully for their intermediary, “Self-Directed IRA Services” until after I’d sent the $; now I discover that, when I want to withdraw all the funds (in a few years when I retire, or to roll them over to another IRA account), I have to pay $150 for the privilege of closing the account! That’s a very big bite of the return for a small investor, and I was pretty shocked and very annoyed. Complained to Lending Club but they had no solution to offer. Beware.

    • says

      Yea that is a pretty hefty fee but honestly doesn’t surprise me. Most companies make it very easy to get money in but a lot more difficult to get it out. $150 is a pretty big bite if you only have 5-10k but I would recommend leaving the money in there and using the dividends to fund whatever you need.

      Do you have to have that money or can you make do with the dividends?

      • ajhmom says

        No, this is a a bit of a spin-off from an IRA account, I can leave it in there, but the point was that
        a) the fee is egregious
        b) the advertising is very deceptive–they make it sound like they are paying the fees so long as you invest the minimum required. Well, they’re paying A fee, but not ALL the fees.

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