It’s obvious to state that self-directed IRAs are different traditional IRAs. because that’s the entire point of a self-directed IRA. The individual investing in this type of IRA directs the investment choices that impact their retirement, as opposed to being stuck in stocks and bonds. This type of IRA is for people who want to invest in assets they can’t invest in using a traditional IRA and are willing and ready to steer their lives in their own direction. These investments can include real estate, precious metals, farms, and startups. So what are the pros and cons?
Finding a Custodian
A requirement for someone to open a self-directed IRA is to first have a custodian that offers alternative retirement plans, like self-directed IRAs. Not all custodians offer much outside of the traditional, so choose wisely. The role of the custodian is considered to be passive, as they do not give the holder of the self-directed IRA any investment advice. Their main job is to provide oversight for the IRA and proper record keeping for the assets.
It starts when a person with a self-directed IRA wants to invest in a startup, the main reason is to diversify their retirement portfolio. Any growth or earnings that result from this type of investment accumulates tax-free. This also includes any possible interest or capital gains. As well as dividend income and more that result from the initial investment. All of this income can all be tax-deferred. Even an experienced investor considering the use their self-directed IRA funds to invest in a startup business should contact a financial professional because this is the type of investment that comes with a high level of risk, and possible financial loss.
When an investor does not plan to take any funds out of their self-directed IRA for a number of years, putting the IRA funds into a startup company might be a good investment. This could be part of an investor’s long-term strategy. It has the potential for providing a high level of growth and income.
There are legal limitations when it comes to investing funds in a self-directed IRA. The main limitation is what’s known as “self-dealing“. This rule states that a person providing funds from a self-directed IRA, to be a key investor in the company, cannot be the owner of the company, or own more than 50 percent of the company. This means they can’t be the main decision-maker for the startup. Nor more ideally, involved with the business in any way, other than being the investor. This type of investor is also not able to hold a position within the company that prevents them from being fired. It’s also not permitted for this person to invest in a business that is owned by one of their immediate family members (child or spouse). It is, however, acceptable for them to invest in a startup that’s owned by their sibling, friend or business partner.
Should a person with a self-directed IRA invest in a startup and not follow the rules or obey the limitations, it could cause them serious problems, to say the least. In the worst case, the investor’s entire IRA could be immediately subjected to taxation.
Investing in a startup should never keep the investor from taking their required minimum distribution (RMD), starting when they turn 70 1/2. Not taking this distribution could lead to a fine of up to 50 percent of the required payout.
While there are risks involved, as any investment has, many investors would say that the risk is worth it.