Or, how to use a Private Placement in Your Self Directed IRA to fund your business with retirement savings and pay no tax!
You’ve worked at a job for the past 15 years and want more from your career. Starting your own business is typically the next step. How would you fund this? By using a self-directed IRA and a Private Placement.
Saving for retirement is something we all think about on some level. I felt time was on my side when I was young. Now that I’m in my 60’s, I realize how misguided (politically correct phrase for stupid) I was in my thinking.
Another benefit of saving for retirement is
So what’s the deal with Self-Directed IRA Plans?
I. What’s a Self-Directed IRAs and Why Do I Care?:
The primary difference between a Traditional IRA and a Self-Directed IRA is the custodian of your account.
The “Big Guys” like JP Morgan, Schwab or Smith Barney can all house Traditional IRA’s for you but you are only allowed to buy the investments they offer. The IRS has a short list of the type of investment you can hold in your IRA.
The IRS must approve your financial institution to act as a custodian for self-directed IRA’s.
The list of investment options is much larger with a self directed IRA. It can also be a source of funding to invest in or start a business (this is considered for private placement since the investment is offered privately and not through a public offering)..
II. What Really is a Private Placement Investment:
Generally, private placement is a sale of securities to a preselected set of individuals (or institutions, but that doesn’t matter for the purpose of this article).
Private placements generally have much less government oversight or regulation to be concerned with.
I perform due diligence when I’m in a private placement not of my own doing (i.e. starting my own business or investing in one I have knowledge of). This is really important at this level since you can’t rely on the custodian of your IRA to do ANY due diligence for you.
Private placements have recently taken the place of IPO’s due to all the hoops the issuing company needs to hop through. These startups look at private placements as an IPO lite, or pre-IPO. A great way to get funding without dealing with all of the red herring laws associated with even a small IPO or offering to accredited investors.
III. What are the Nuts and Bolts of this Craziness!?:
Not every brokerage firm can offer you custodianship of a self-directed IRA or allow private placements. Investment firms which offer Self-Directed IRA tend to be more of a niche firm. They may offer other services, but they’d be more of the niche variety as well. Think precious metals or commodities.
A custodian of a Self-Directed IRA must be approved by the IRS and follow the same rules as other brokerage firms, plus additional regulations related to the types of trusts needed to hold your investments.
The custodian has a lot less liability exposure compared to custodians of traditional IRA’s. Self-Directed IRA custodians are only responsible for the administration and holding of the assets. They don’t have any responsibility as to the virtue of the investment. You will solely be responsible for any due diligence relating to the investments.
IV. This Is Where I Usually Tell You About Doing Your Due Diligence:
But not today. You don’t need due diligence if you’re trying to find financing to expand your own business, or buy a business. A Private Placement can be your business’ financing arm.
The simple explanation to using your IRA to finance your business is as follows:
Create a new corporation for the business. There will be special tax considerations if you’re moving assets from one corporation to another. This is done to maintain an arms length. Self dealing is prohibited.
Create a Self-Directed 401k plan for the business (I’d advise using a different custodian for the self-directed IRA). You will be an employee.
Initiate a rollover from your current IRA account(s) to your Self-Directed 401k account. Your self directed 401k account now has cash that you as the trustee can invest how you wish.
As trustee, you would have the ability to purchase stock in your new corporation. You would initiate a transfer from your self directed IRA account to the corporation checking account to purchase stock of the corporation. The corporation will then issue you stock shares which you will give turn over to your self directed 401k custodian.
V. If You Also Want To Invest in Private Placement Investments:
Since you are acting as trustee for your self directed IRA/401k, you have the option of making other private placement investments than your business. Other allowable investments are:
Real Estate (no mortgage)
Cryptocurrency
Private Investment (non listed)
REIT’s
Convertible Notes
Hedge Funds
Again, do your due diligence. Your custodian will have the paperwork and a checklist of items needed.
Holding private placements in a self directed IRA are like the wild west of investing. Treat this as such. I don’t think you’ll get scammed. But I do want you to understand that these are going to be much riskier investments with much less oversight than a publicly listed investment.
VI. Potential Tax Implications and Considerations:
Since you are administering your IRA, you are also responsible for observing and obeying all tax laws and FINRA/SEC regulations.
Since Private Placement investments are different beasts and run in different crowds, they are also less regulated. You need to be aware of things like Unrelated Business Tax Income, Unrelated Debt Financed Income, Required Minimum Distributions, and avoiding prohibited transactions.
Self-dealing is prohibited. You can’t rent “office space” that you own in a Self-Directed IRA to your business. You can’t enter into financial deals with disqualified people such as beneficiaries or the IRA, family members or yourself
VII. Conclusion:
Using a self directed IRA for private placement opens up a lot more available options regarding the types of investments you can hold in your IRA.
Since you will be self-directing your investments you need to be aware that the company acting as your custodian will not be giving you investment advice.
You must take care not to trigger a distribution by making a prohibited transaction or dealing with a prohibited person. If this happens, the IRS goes back to the year of the improper transaction and deems the entire balance of the account as a distribution.
A self-Directed IRA can be a source of funding for you to start or invest in a business. Since there are rules against self-dealing in the IRS code, a C Corporation is formed and a 401k plan started for the corporation.
A self-Directed IRA can also be used to hold real estate, precious metals, closely held corporations and other non standard investments.