Raising capital for your business is always a challenge. The eligibility criteria in the business lending space are stringent, and investors are quite picky too. The lack of funding options may, at times, frustrate you. But there is a way. You can use your investment IRA assets to raise money for your business.
Your self-directed IRA is a viable and potentially wise alternative. The best part is your friends, siblings, and business associates can also invest their IRA money into your business. Along with capital gain, they can enjoy favorable tax treatment.
Funding Your Business from a Self-Directed IRA
A non-self-directed IRA may allow you to invest in stocks, bonds, mutual funds, etc., but not in your business. On the other hand, a self-directed IRA lets you invest in your business.
But the IRS is vigilant. So, take note of these important rules. Otherwise, you could have the IRS pouncing on you, and the consequences could be expensive in terms of penalties and taxes.
- Don’t Invest in General Partnership/S Corporations: These legal structures are governed by specific taxation rules.
- Respect and Follow the List of Prohibited Transactions: Only your friends, business associates, and siblings can invest in your business with self-directed IRAs. Your parents, spouse, and children cannot.
- Don’t Invest if You are a Key Investor in Your Business: If you own more than 50 percent of your business, then it makes you a key investor or a key employee. If that’s the case, you cannot use self-directed IRA funds to invest in your business.
Setting Up a Self-Directed IRA for Entrepreneurs
If you structure your investment in the ways mentioned below, you will be able to use the money in your IRA to fund your business.
- Work with an experienced custodian or administrator to set up a self-directed IRA. Make sure that it adheres to all the necessary requirements.
- Initiate and execute a rollover from the existing accounts such as IRA, 403(b) 401(k), or Keogh to the self-directed IRA.
- Establish a Limited Liability Company (LLC). This is the legal entity for your business.
- Use the funds in the self-directed IRA to execute the purchase of the membership units in the LLC by the self-directed IRA.
Benefits of a Self-Directed IRA
Here’s why a self-directed IRA to potentially a wise investment idea for your business:
1. It offers tax-advantaged growth.
A self-directed IRA provides tax-free or tax-deferred growth.
2. It gives you more options and control.
With self-directed IRAs, you are not limited to make investments in stocks, mutual funds, and bonds only. You are allowed to go beyond and invest in certain business types, real estate, tax lien certificates, and precious metals.
3. It allows your friends, siblings, and business associates to invest with their IRAs.
But, once again, your spouse, parents, and children cannot invest using their self-directed IRA savings.
Your self-directed IRA can be a huge source of investment to fund your business or start-up. However, make sure that you comply with the prohibited transaction rules.
About the author: Rick Pendykoski is the owner of Self Directed Retirement Plans LLC, a retirement planning firm based in Goodyear, AZ. He has over three decades of experience working with investments and retirement planning, and over the last 10 years has turned his focus to self-directed accounts and alternative investments. Rick regularly posts helpful tips and articles on his blog at SD Retirement as well as Business.com, SAP, MoneyForLunch, Biggerpocket, SocialMediaToday, and NuWireInvestor. If you need help and guidance with traditional or alternative investments, email him at firstname.lastname@example.org.
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