How to Use Your IRA to Invest in a Business

Usually, you can only invest in the approved vehicles provided by your bank or firm when managing your IRA. That is, unless you have opted for the self-directed variety. In a self-directed IRA, your options are more open and flexible. This means that if you have business endeavors ahead of you, you might even be able to use your IRA to benefit those goals.

What is a Self-Directed IRA?

This classification of IRA is different from other types because you can individually decide where your investment will be applied. This IRA allows you to invest in assets not usually included within traditional IRA’s. Those are more often used in stocks, bonds and mutual funds. With a self-directed IRA, you can choose alternatives for your investments, such as real estate, coins and precious metals, and businesses and startups!

For the self-directed IRA you choose a custodian to manage your funds for you, rather than choosing a brokerage or bank to do so. The custodian houses your alternative investment assets and provides appropriate record keeping for these assets. This person is more passive than a traditional bank or brokerage firm.

Investing in a Startup with Your IRA

If your long-term goals include starting a business, you can set up your self-directed IRA so that you can start building equity for that business. You have to know ahead of time that you won’t be withdrawing from this account for a few years (at least). The average exit for a startup is seven years from inception, so your goal is already going to be long-term.

You can be on the board of your company or act as an advisor of your company, but your control is otherwise limited when you go about starting your business through your IRA. You can’t be the head employee or in possession of over 50 percent of the company – your restrictions for the self-directed IRA require that you cannot be the key investor in a business, so this is important. You also cannot invest in a business if it is owned by your parents, children or spouse.

The IRS keeps a sharp lookout for those who are trying to benefit currently off of funds there are supposed to be for retirement. This is the biggest reason why you cannot run the company yourself or be the key investor in your business. The best way to make the business investment work through your self-directed IRA is to move your funds into the self-directed IRA first (assuming you started with a more traditional IRA) and then direct that IRA to make an equity investment in your business.

The most advisable way to make this method work for you is to gather up fellow investors to go into the company with you and grow it together. Just be sure of what you are not supposed to do:

You cannot invest in S corporations or in a general partnership.
Abide by the list of “prohibited transactions” – remember the rule about parents, children and spouses.
You can’t be the key employee and/or the key investor. The IRS will keep an eye out to make sure you aren’t moving retirement funds illegally through a salary or other immediate payment.

Investing in other Types of Businesses through Your IRA

You can instruct your custodian to execute an investment directly out of the IRA so that the IRA account is considered the owner of the asset. This is different than having sole ownership of a startup, because you aren’t profiting immediately and directly from this venture. When it comes down to it, the IRS is concerned only with making sure you aren’t immediately profiting off of your retirement fund.

You can also invest all of your IRA’s assets into an LLC. If you choose to do this, you can make yourself the sole owner of the company and execute investments as that company’s manager. In this case, it’s all about the type of business for which management is “okay” and in what capacity. Either of these options are legally viable, but you must keep tax rules and guidelines in mind in order to not break any laws.

Be aware also that you can be held subject to the unrelated business taxable income that is imposed by the IRS in the case that your funds are being used to operate a company, rather than saving it for retirement. This is how you can legally be sure that you aren’t breaking any rules – taxes have to be paid somehow.

Joey Eplite