It is a natural tendency to keep savings, investments and business matters separate. To this end, the IRS has strict rules governing the use or withdrawal of investments for personal or business purposes, and financial planners will advise you not to dip you’re your 401(k) or a spouse’s retirement savings. The one exception to this rule is the use of funds in a Self-Directed IRA.
This is an as yet untapped sector for entrepreneurs and startups to secure suitable funding. By investing your own funds, and funds from your siblings and friends, via self-directed IRA’s, you not only secure funds but also provide tax benefits for capital gains. Think about it this way – You, your friends and siblings would be investing into your startup in any case, and expecting only capital gains from the investment. By routing the funds through self-directed IRA’s, all of you ensure significant tax benefits in addition to the capital gains.
Even for other investors, this additional benefit provides an incentive to stay put if and when you experience any growing up pangs. Startup investors are notoriously skittish, and likely to bolt at the first sign of trouble. By assuring tax breaks for the investment and earnings, you give yourself some additional slack to pull you through a rough patch.
What you do is pretty simple. Set up a self-directing IRA, and direct your IRA to make an equity investment in your company. You also suggest to all potential investors that they should follow the same procedure. It might help if you had some solid facts and comparative figures of how specific investments would fare over specific periods if made directly and if made through the IRA.
While it is simple, the primary purpose of an IRA is as a retirement savings vehicle. As previously stated, the IRS frowns on a diversion of retirement funds. To make sure you do not cross the line, you need to follow a few basic rules. Do not invest in S corporations or general partnerships. Your parents, children or spouse are prohibited from making investments into your company via a self-directed IRA. You cannot hold a controlling stake in any business into which you invest funds from a self-directed IRA. While these rules may seem restrictive, the concept behind it is prevent re-routing of IRA funds to the owner in the form of salaries, perks, family, etc. Any way you look at it, if you are planning to invest time and money into a business, it becomes inherently more profitable and the equity more valuable if you do it through the IRA.
You are advised to consult with your financial planner to make sure your self-directed IRA investments are in line with IRS guidelines, as also to understand the relative benefits of direct investments as opposed to investments through an IRA. While there are very few financial organizations handling self-directed IRA’s, you are still advised to research each company in detail and use your own judgment when it comes to making the investments.