Starting Your Own Business? Use Your Self-Directed IRA for Funding

Estimated reading time: 2 minutes(Last Updated On: October 30, 2012)

More and more individuals from all walks of life are becoming interested in starting their own businesses. Some of the interest stems from the decrease in the number of good paying “middle management” type jobs from the economy, and some comes from a desire to have more control over one’s career and financial future.

Unfortunately, many businesses require a large amount of funding before they can get off the ground. Most potential small business owners don’t have access to the amount of funds that are required — with one possible exception. Many potential entrepreneurs already have sizable retirement savings accounts.

If you have your IRA funds with a traditional custodian (such as a bank or investment brokerage), then the first step is to open a self-directed IRA. The legal structure of a self-directed IRA and an IRA with a traditional custodian is identical, but the self-directed IRA custodian will permit you to invest in the full range of investment types that are permitted under IRS regulations.

While the self-directed IRA provides you with a much higher degree of flexibility and investment types, including investments in small businesses, there are some very important rules that apply. Basically you can’t be the majority owner or otherwise outright control the small business you are looking to invest in. The IRS wants to make sure your eye are a funds are being “invested,” and not simply used to pay you a salary or otherwise engage in prohibited “self-dealing.”

Furthermore, certain legal structures for a small business will not permit this type of funding, including a general partnership structure. Fortunately, creating a business with a small number of other individuals could in some circumstances qualify you to use your self-directed IRA funds to invest in the business.

Because the rules and regulations governing this type of financing are not always intuitive or clear, it’s important to rely upon a self-directed IRA custodian, such as Quest Trust Company, that has significant experience in helping investors navigate all of the legal requirements.

Finally, you may hear discussion of another technique that small business owners have used to fund their businesses with IRA assets. This technique involves creating a new 401(k) plan for your business, rolling over your IRA assets into the new 401(k), then using the newly deposited 401(k) funds to invest in the company. Unfortunately, the risks and downsides to this technique can sometimes be quite significant. First, if your business has employees, the 401(k) plan would need to make company stock available to them as well. In addition, you wouldn’t be able to make any other investments beyond those that were permitted by the 401(k) custodians (company stock is authorized, but you wouldn’t be able to make nearly as many different types of investments as you could with a Quest Trust Company).