Investing in Alternatives Through Your Self-Directed IRA

Nat Disston
Jan 28th, 2016

[Update] As of April 2016, EquityZen is excited to announce a partnership with Millennium Trust, providing their individual and advisor clients access to EquityZen and pre-IPO investments.

EquityZen has accepted investments through self-directed IRAs for some time, announcing our first partnership with Entrust in July 2014. The reason for accepting these types of investments and promoting them for our users is simple; IRAs are retirement accounts with tax incentives, and investors might as well benefit from those tax incentives for investment purposes. It is interesting to note that some of the world’s wealthiest have used IRAs to invest in all sorts of investments with major tax incentives. Mitt Romney at one point reportedly had $102,000,000 in his IRA account. Peter Thiel and Max Levchin, co-founders of PayPal, are reported to have used their Roth IRAs for many alternative investment purposes, shielding them from having to pay taxes on the profits of those investments as long as they stay in their IRAs until the age of 59 ½.

The major types of IRAs and their Tax incentives are:
  1. Traditional IRA (tax deduction received on your deposits, but you're taxed upon withdrawal)
  2. Roth IRA (no tax deduction on your deposits, but no tax upon withdrawal)
That said, many investors still aren’t aware they can invest in alternative investments, such as those offered by EquityZen, or they are unsure how to go about it through their IRA accounts. I caught up with Kirk Chisholm*, a Wealth Manager and Principal at Innovative Advisory Group, who provided some valuable insight and resources to help answer 1) how you should choose your IRA custodian for alternative investments and 2) common mistakes made using a self-directed IRA.

How to Choose your IRA Custodian

Given the intricacies of investing in alternatives as well as the IRS requirements involved, it is important that your IRA custodian is right for you. Kirk and his team at Innovative Wealth have reviewed more in depth what to consider here, but we’ll discuss the basics now. Firstly, it is important to note that a traditional IRA custodian for stock and bond investments does not have the same expertise in alternatives such as private company shares. Before considering various IRA custodians, you should have a clear idea the types of investments you will make, whether it be private companies, real estate, or gold. Secondly, you should consider your investment strategy and the number of investments you plan to make. This is important because IRA custodians will vary on how they charge fees, it may be transaction or asset-based. On that note, be sure to not overlook their fee policy in general. Many alternative investments require additional services (notarization, document storage) that can incur additional expenses. Finally, the level of service in general should not be forgotten. You should make sure they are timely in their response and detail-oriented to allow for an efficient investment process. Innovative Wealth has compiled a list of self directed IRA custodians an administrators here, but be sure to know your investment type and strategy ahead of time to find the fee and service model that best suit you.

Common mistakes using a self-directed IRA

The most common mistake of using a self-directed IRA is not knowing that you can invest in alternatives through it, which can include everything from private company shares to a horse (yes, an actual horse). The next biggest mistake is to not perform proper due diligence on the investment itself nor the IRA custodian for that investment, but you already know all that as discussed above. What we haven’t discussed yet is what is not allowed from your self-directed IRA. The main mistakes here include prohibited transactions and disqualified persons. A prohibited transaction is a transaction that causes your IRA to be disqualified, thus causing you to take an early distribution and then pay a tax penalty. Some common examples are:

  • You cannot provide sweat equity on an asset you own in your IRA
  • Your IRA cannot loan a disqualified person money (like a direct relative)
  • Real Estate in your IRA cannot be used by a disqualified person
  • Your IRA cannot purchase real estate from a disqualified person
  • Using an LLC is not a way to circumvent the rules

As mentioned above, a disqualified person can cause a prohibited transaction. An example of this is if you invest in a house and then rent it to your mother, who is a disqualified person since she is a direct relative.  For a more detailed read on the prohibited transactions and disqualified persons, check out Innovative Wealth’s article on these common mistakes here.

Diversification is a tenet of modern portfolio theory and one we discuss a lot here at EquityZen. One of our missions is to help shareholders diversify some of their net worth that is held in a particular private company’s illiquid stock. Another is to help investors diversify their portfolio into a previously difficult to access asset class. Knowing how to invest in alternatives through your IRA is one more way to help diversify your portfolio.

*Kirk Chisholm is a Wealth Manager and Principal at Innovative Advisory Group (IAG), an independent Registered Investment Advisor (RIA). He specializes in working with clients who want to invest outside the stock market with their retirement account. Kirk has an extensive understanding of the regulatory and financial considerations involved with investing alternative investments in self-directed IRAs and 401ks. His innovative approach to wealth management combines both traditional and alternative investments into well diversified portfolios. Fee-only advice, transparency and thorough due diligence are hallmarks of Kirk’s advisory style. He received a BA degree in Economics from Trinity College in Hartford, CT.

**Hyperlinks to sites outside of our domain do not constitute an approval or endorsement of content on the visited site.
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