When it comes to funding a startup, a cash infusion from an individual retirement account could provide just the solution needed. But special caution must be taken not to breach any tax codes by investing in such accounts and creating prohibited transactions.
Self-directed IRAs allow investors to purchase shares of startup companies and non-publicly traded assets privately, yet there can be numerous pitfalls when investing in startups.
Taxes
Individual Retirement Accounts provide tax advantages when saving and investing money, such as traditional IRAs, Roth IRAs and SEP IRAs. Traditional contributions are taxed at current rates; withdrawals in retirement typically remain tax-free; while a Roth IRA has its own set of rules to abide by.
SEP IRAs are specifically tailored for small business owners and self-employed individuals, offering higher contribution limits than traditional IRAs. There may also be restrictions on who may contribute, with contributions generally coming directly from employers themselves.
Apart from calculating how much to contribute, it is also important to take into account taxes and any other variables which might impede investment returns. One key consideration is asset allocation; another should be keeping beneficiary designations up-to-date as life events transpire and people pass away; you should also review retirement account policies so they reflect any new laws or regulations that might arise.
Investing
Investing involves placing money to work in order to generate returns that exceed those offered from savings accounts. While investing can take years to pay off, its potential returns could far surpass those available from bank accounts alone.
Startups are businesses in their early stages of business development that believe their products or services have market appeal and could disrupt or significantly affect an industry. To get their start-up going they may require funds from family or friends, venture capitalists or loans.
Congress intended for an Individual Retirement Account to be used exclusively for retirement savings, and any investment not in either traditional or Roth IRA is considered prohibited transactions and subject to harsh penalties, including an excise tax of 15% of any money involved and an unlimited penalty equaling 100% of its value; additionally, custodians such as banks, brokerage firms or mutual fund companies often won’t act as trustees when dealing with unorthodox investments such as real estate investments.
Rollovers
Utilizing retirement funds for startup investments has become more commonplace, and estimates suggest over one million self-directed IRA accounts dovetailing into private companies and start-ups. If this funding option interests you, make sure to do your research thoroughly and consult a tax professional prior to taking this route.
There are two options for funding a startup from an IRA: direct transfers and rollovers. Direct transfers involve contacting your plan administrator and asking them to transfer any distribution directly into another account with matching funds (i.e. an IRA).
Indirect rollovers involve receiving your distribution and then moving it yourself into a new IRA account – this process can be more involved and could expose you to taxes.
The IRS has a rule prohibiting your IRA from investing in startups owned by anyone disqualified, such as yourself or anyone disqualified person who owns more than 50%. However, this restriction doesn’t apply if the transaction is solely intended to benefit your IRA rather than for personal gain.
Custodians
Custodians provide safekeeping, asset management, record-keeping and financial transaction processing for investors. In addition, custodians act as brokers when trading securities. Usually they charge a fee for their services.
Startups are exciting but financially demanding undertakings. When searching for funds to start up their new businesses, many entrepreneurs turn to personal savings first; but if that is not an option for them, third-party loans or even IRA investments may become necessary.
Utilizing an IRA to finance a startup can pose risks, making it hard to avoid initiating prohibited transactions. That is why it is wise to consult a financial adviser prior to making this step – Advanced Capital Management provides free 15-minute consultations so they can assist with understanding all your options and provide advice when needed.
