Peer to peer (P2P) lending through organizations such as Prosper.com and LendingClub.com is in general a high-risk, high-return, highly-tax-inefficient investment. Since the entire return is fully taxable at your marginal tax rate, it makes sense to have any significant investment in P2P Lending inside of a tax-protected account, such as a traditional or Roth IRA.
Regular readers know I've been tinkering with investments through both of these organizations, but only in small amounts in a taxable account. As I become more comfortable with the concept, I am considering allocating up to 5% of my portfolio to these consumer loans. But I don't want to do that in a taxable account. So I was pleased to see that both Lending Club and Prosper have made it possible to invest with them through IRAs. As you might expect, there's a few catches, and these are predominantly high fees. There's no Vanguard or TSP in this realm.
Neither Prosper, nor Lending Club, offers IRAs directly. They offer them through IRA custodians, Sterling Trust in the case of Prosper, and SDIRA Services for Lending Club. These are custodians that you might use if you wanted to hold physical gold or other less traditional assets in an IRA. You can't currently hold P2P loans in an IRA at a mutual fund company like Fidelity or a brokerage account like eTrade. These custodians, just like Lending Club and Prosper, want to make a profit, and they do this through fees. Those, unfortunately, come directly out of your return. So you have to assess the cost of these fees against the tax savings you get by holding the loans in a tax-protected account. They advertise these IRAs as “No-fee IRAs” but as you can see, that's not completely true.
IRA Fees at Prosper
Your fees at Prosper are exactly the same as they would be in a taxable account, 1% of all the payments made by the borrower, plus fees associated with collection efforts. Sterling Trust, however, has a whole new set of fees you need to be aware of.
- Annual Fee (includes first year) : $200 (increases if > $250K invested)
- Termination Fee: $200 (You pay this when you move assets away from Sterling Trust)
- Wire Fee: $30
- Withdrawal Fee: None
Prosper will cover that $200 annual fee IF you put a full $5K into the account when you open it, and one year later have at least $10K in the account (and keep at least $10K in there.) You're on your own for the termination fee.
IRA Fees at Lending Club
Fees at Lending Club are similar, 1% of all payments made plus collection fees. SDIRA Services has a different fee schedule:
- Annual Fee: $100 according to Lending Club, $300 after the first year according to SDIRA
- Paper Statements Fee: $20
- Termination Fee: $150
- Withdrawal Fees: $25 (wire) $5 (check) $0 (regularly scheduled ACH transfer)
Lending Club, like Prosper, will waive (pay?) the annual fee if you fund the account with $5K, then have $10K in there within a year and keep it in there.
Beware of fees in Peer to Peer Lending
What kind of impact can these fees have on your return if you're not careful? Consider an investor who opens a $5000 IRA at SDIRA in order to invest at Lending Club. Let's say he keeps his money there for two years, earning a 10% return, and then decides to roll it over elsewhere to invest in something else. His annual fee is waived the first year but is $300 the second year. Then he pays a $150 termination fee. He also paid a $20 paper statement fee each year. He earned about $1000, then paid about $490 in fees. Instead of the 10% annualized return he earned, he now ends up with close to a 5% annualized return. That sucks.
How can you minimize these fees? The main way is by starting big. Make sure you get $10K in there within a year. The easiest way is to just roll over part of your IRA or Roth IRA from another custodian. While these guys can probably do a backdoor Roth IRA, I think I'd rather trust Vanguard with that, then just do a rollover. I saw a per-asset fee for Roth conversion at one of the companies, but it's unclear how they would treat cash in a conversion process. You should also make sure you select electronic statements when you open an account at Lending Club/SDIRA. You can minimize the termination fee by investing more money (so it is a relatively smaller percentage of assets) and by leaving the money there for a long time. It's pretty obvious that an IRA isn't the place to experiment with Peer to Peer Lending. You should do that in a taxable account first. When (and if) you're convinced you want to make it a significant part of your portfolio long-term, then you can look into an IRA.
What about the bonuses?
Lending Club advertises that you get a cash bonus for opening/rolling over an IRA. Don't get too excited. You have to rollover at least $25K to get any bonus at all (0.5%, or $125) and $250K to get the maximum 2% ($5K bonus). It will take much time (and much hassle) to get that much money invested at Lending Club within 90 days. Trust me when I say you'll earn your $125. You can automate the process somewhat, but I'd still recommend you forget the bonus and move over a smaller amount at a time. $5K is doable. $250K would make you a giant on the P2P scene. According to Lendstats, there are only 25 investors at Prosper with more than $250K invested.
What about defaults?
Defaults are common with peer to peer lending. That's why the rates on these loans are generally over 10% and often exceed 20%. A loss due to default can normally be claimed on your Schedule D. Not so when you invest in an IRA. However, that shouldn't matter. In a taxable account, you offset your losses with your gains and only pay taxes on the gains minus the losses. In the IRA, you still only earn the gains minus the losses. You'll still come out ahead in the IRA, as long as you watch those fees. In fact, now that you can eliminate the hassle of having to fill out Schedule D for all those defaulted loans, you'll be much better off.
Would you like to get started?
One of the ways this website makes money is through advertising and affiliate sponsorships. Both Prosper and Lending Club pay me a small commission if you open an account through links on the site. If you think you'd like to get into P2P Lending, via a regular account or an IRA, please use the links below: