One strategy investors can use to diversify their investment portfolios is adding private placement investments to their investment mix. Through the MicroVentures platform, investors can access a variety of early- and late-stage private investment opportunities with relatively low minimums. While many investors are already using private equity to diversify their investment portfolio, many may not realize that they can also use their individual retirement account to make such investments.
What is an IRA?
An Individual Retirement Account, or IRA, is an account that allows an individual to save for retirement with certain tax advantages. There are a few different types of IRAs, and they have varied tax advantage characteristics, contribution limits, and eligibility:
- Traditional – contributions are often tax-deductible; taxes on earnings are not paid until retirement, upon which withdrawals are then taxed as income
- Roth – contributions are not tax-deductible, but earnings and withdrawals are tax-free
- SEP – enables an employer (often a small business or self-employed individual) to make contributions to a traditional IRA established in the employee’s name
- Simple – enables employer and employee contributions like a 401k plan but with simpler, cheaper administration costs and lower contribution limits
- Self–directed – may be opened as a traditional or Roth IRA with the same contribution rules, but allows for investments that often cannot be held by conventional IRA custodians
What is a self-directed IRA?
A self-directed IRA is an individual retirement account opened with a custodian that will permit investment in assets beyond the traditional asset classes, such as stocks, bonds, and mutual funds. With a self-directed IRA, investments in alternative assets such as real estate, private placement securities, certain bullion, and digital assets may be possible – dependent, of course, on the custodian with whom the account is held.
To use a self-directed IRA, you will need a custodian that can house alternative investment assets and provide the necessary record-keeping services for these assets. These custodians are generally considered “passive” in that they do not offer investment advice but rather provide oversight services.
Benefits of investing with your IRA
There’s no denying that investing in private placements is risky. However, if you’re already making private placement investments, it’s worth exploring the potential tax benefits of using an IRA to invest. Potential returns on your investment could be tax-free or deferred, depending on the type of IRA you hold.
In addition to the potential tax benefits of investing in private placements via IRA, the investment timeline lends itself to investing this way, as they are typically long-term investments. Of course, that potential benefit is synonymous with a lack of liquidity should you unexpectedly need to access retirement funds.
Using the MicroVentures Profile feature
With our Investment Profiles feature, we offer a simple way for investors to invest using your self-directed IRA. To get started, you need to create an investment profile for your IRA. We will then provide a brief financial questionnaire to confirm that you fully understand the risks involved and that private placement investing aligns with your overall investment objectives. Your IRA must be self-directed, which will require you to have, or to open, an account through a custodian or trustee who is authorized to serve as a third-party administrator for alternative investment asset classes.
Limitations of investing via self-directed IRA
The Internal Revenue Service prohibits certain transactions with respect to IRA investments. In general, if you use your self-directed IRA to invest in assets or non-public companies controlled by you, you risk disqualifying your account as an IRA, losing any tax advantages, and subjecting gains to taxation and possible penalty.
Note this is not a comprehensive discussion of prohibited IRA transactions. It’s important to discuss any concerns or questions with a qualified tax advisor before investing.
Risks of investing via self-directed IRA
Of course, all investments carry risk. You are responsible for conducting your own due diligence on first a reputable self-directed IRA custodian and then any potential private placement investments, evaluating the potential benefits of investing versus risks that include illiquidity, limited disclosure, volatile performance, and a higher risk of loss than is associated with investment in traditional asset classes. Self-directed IRA custodians also typically charge higher fees than traditional IRA custodians.
In addition to the inherent risk of investing in private placements, there is also risk around following the investment limitations previously mentioned. Using an IRA to engage in a prohibited transaction disqualifies the account as an IRA as of the first day of the year in which the transaction occurred. For taxation purposes, this means that the IRA distributed all assets to the account owner on that day; any gains are subject to applicable taxation and penalties.
It’s also important to note that you typically must begin taking an annual required minimum distribution (RMD) at age 70 ½ (unless you have a Roth IRA or turn 70 after June 30, 2019). Failing to take these distributions could result in a penalty that is equal to 50% of the required amount not distributed.
The information presented here is for general informational purposes only and is not intended to be, nor should it be construed or used as, comprehensive offering documentation for any security, investment, tax or legal advice, a recommendation, or an offer to sell, or a solicitation of an offer to buy, an interest, directly or indirectly, in any company. Investing in both early-stage and later-stage companies carries a high degree of risk. A loss of an investor’s entire investment is possible, and no profit may be realized. Investors should be aware that these types of investments are illiquid and should anticipate holding until an exit occurs.