How You Can Raise Capital for Your Business Through Self-Directed IRA Investors

June 26, 2019
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We’ve been talking about retirement plans for investors all month long on the Illumination Wealth Blog. We’ve looked at SIMPLE IRAs and Cash Balance Plans as alternatives to traditional 401(k) plans. In this article, we’d like to talk more about what is known as a Self-Directed IRA and how it can help you raise more capital for your business if you are an entrepreneur and looking to grow and scale.

What is a Self-Directed IRA?

The concept behind a Self-Directed IRA is simple and makes a lot of sense for investors. All retirement plans use investments to help you build your retirement savings beyond what you contribute year after year. Regular IRAs typically house only stocks, bonds, mutual funds, and other relatively common investments. These accounts are what you would find at TD Ameritrade, Charles Schwab or Fidelity, amongst others. A Self-Directed IRA offers many more investment possibilities. For example, you could invest in a private loan, a rental property or a privately held company.

People who are forming startup companies, trying to grow a business or possibly looking to buy an existing business can attract and utilize investment capital within a Self-Directed IRA. This can open up the investment possibility to many different potential investors with these types of IRAs because they allow people to invest their retirement funds into a privately held business. This can help your business grow and become more profitable, which feeds back into the investment gains for your investors on a tax-protected basis. Many investors consider the IRA money long-term which can help create a more “patient” investor base since your timeframes are aligned. It can be a win-win scenario, attracting growth capital to your company and the potential to provide investments returns to the investors in your company through their Self-Directed IRA.

What You Need to Know

Before accepting Self-Directed IRA investment into your enterprise, it is very important to do your research and consult with a financial advisor and tax advisor familiar with these plans. The tax implications are especially important to navigate because you don’t want to do anything that will get the IRS on your case. Here are some tax rules you should know:

  • The Legal Business Structure Makes a Difference – You do not want to invest in an S-corporation or a general partnership. The tax definitions of these business structures don’t allow for Self-Directed IRA investment.
  • Understand the “Prohibited Transactions” – Certain people are unable to invest in your business through a Self-Directed IRA. You, your friends, your business associates, and siblings are allowed. Your spouse, parents, and children are not.
  • You Can’t Own More than 50% of the Business – This is where it gets a little tricky. You cannot own more than 50% of the business in which you are investing, and you can’t have a controlling interest in the company. This would be considered “self-dealing” by the IRS and that’s bad news.

Purchasing a Business with a Self-Directed IRA

Another thing to note is that you can also purchase a business with your self-directed IRA. The business is then subject to a tax called the unrelated business income tax (UBTI), since IRAs are otherwise tax-free. However, your equity position in the company can still grow tax-protected inside your IRA. There are fairly complex tax and securities law involved with effecting a transaction like this. Please consult with your financial advisor and other trusted advisors with experience in these matters and talk with Illumination Wealth.

As you can see, there are a lot of potential benefits raising capital thru Self-Directed IRAs, but there are also plenty of pitfalls. If you want to go down this path, it’s imperative you do things right.

Achieve Your Financial Independence!

For help with all your personal or business retirement planning, wealth management and tax planning needs, contact Illumination Wealth to arrange an initial consultation with one of our top financial advisors. Get started down the road to financial independence and a fruitful retirement.