First Time Using Your Self-Directed IRA to Invest in Private Stock?

Estimated reading time: 3 minutes

As you look to use your self-directed IRA to broaden your investment holdings, you may come across opportunities to invest in private stock. Among many individuals, this type of investment is among the least familiar, and potentially most confusing. Let’s take a look at some of the basics about using your self-directed IRA to invest in private stock.

Let’s first make sure we understand what we’re talking about when we use the term “private stock.” In the broadest possible terms, shares of “stock” in a company represent ownership interests in that company. Depending on the type of stock the company chooses to issue, this ownership interest may include the right to receive dividends (should the company choose to pay them), to vote on certain matters relating to the company’s governance, and to receive money back in the event of a company liquidation (if there are funds available after repaying company debts and other obligations).

Most individuals who are saving for retirement are familiar with stocks in the context of “publicly traded” securities. Publicly traded stocks on those in which buyers and sellers conduct their transactions on a public stock exchange, subject to the rules and requirements of the exchange. In the United States, publicly traded stocks are also subject to a number of disclosure and informational requirements promulgated by the U.S. Securities and Exchange Commission (SEC).

The purpose of the SEC disclosure requirements is to make sure that the general public has enough information to make informed and reasoned decisions about whether or not to invest in a particular company’s stock.

But while most of the largest and well-known U.S. companies are publicly traded, other companies choose to forego access to public securities exchanges in order to avoid these disclosure obligations. In doing so, U.S. law provides that these private companies can only accept funds from investors if those investors are considered to be advanced and experienced enough that they do not need the protections afforded by the SEC disclosure rules.

The SEC uses the term “accredited investors” to refer to individuals who can invest in private company stock. Under current law, an accredited investor is an individual who either (i) has an income in excess of $200,000 for each of the last two years (and reasonably expects to have a similar income this year), or (ii) as a net worth in excess of $1 million, not including their primary residence.

If you meet the requirements for being an accredited investor, and wish to use your self directed IRA to invest in private companies stock, it’s absolutely essential that you do your research before committing any funds. This level of due diligence will be far in excess of anything you’ve done previously before making an investment in publicly traded securities.

You may also wish to consult with a self-directed IRA custodian such as Quest Trust Company in order to be sure you are following the proper steps for such a private company stock investment.

Best Practices for Maximizing Your Tax Benefits With a Self-Directed IRA

Estimated reading time: 3 minutes

Self-directed IRAs are a powerful tool to help individuals build the largest possible retirement nest eggs. Obviously there is great value to being able to choose from the widest possible range of investment options. But the greatest upside of having a self-directed IRA and making regular contributions to it is the fact that it provides you with long term tax-deferred (or, in the case of a Roth IRA, tax-free) growth.

Here are some of the best practices for maximizing all the available tax benefits you have with a self-directed IRA.

Current Year Tax Deductions for Contributions

If your self-directed IRA is structured as a traditional account, then you may be able to take a current year tax deduction for the value of your annual contributions, depending on your income and whether you are covered by a retirement plan at work. While you’ll be subject to taxation on withdrawals from your traditional self-directed IRA once you reach retirement (which wouldn’t be the case for withdrawals from a Roth account), you may decide that the current year tax advantage is worth it to you.

Hold Tax-Advantaged Investments in Your Taxable Accounts

Because all investment income and capital growth that happens within a self-directed IRA is tax-advantaged, holding investments that have built in tax-advantages is redundant and wasteful in terms of tax benefits. Therefore, if you invest in tax-free government bonds then those assets would be better held in a taxable account, and not your self-directed IRA.

Avoid UBTI

Also in the same category of avoiding mistakes is making sure used to your clear of unrelated business taxable income (UBTI). In the context of self-directed IRAs, UBTI most often becomes an issue when an account holder borrows money to make an investment – commonly by taking out a mortgage in order to buy real estate. Borrowing money to invest is outside of the statutory authorizations of any IRA, so it’s important to avoid any transactions that would lessen the tax benefits of your account.

Maximize Tax Free Growth

In order to maximize the benefits of tax-deferred or tax-free growth within your self-directed IRA, it’s important to let your account grow for as long as possible. One implication is that you should try to avoid taking any early withdrawals from your account. Even if you fall within one of the penalty-free exemptions for doing so, by reducing the amount you have invested you reduce the amount of tax benefit you’ll achieve in the years leading up to retirement.

Consider a Conversion to a Self-Directed Roth IRA

Finally, if you truly want to maximize your tax benefits, consider converting a traditional self-directed IRA into a self-directed Roth account. You’ll need to pay taxes on the conversion amount, but if you can afford that current year tax hit, and you have a number of years before retirement, it may be the best long-term decision.

Of course, tax laws evolve and change over time, so it’s also very important that you stay up-to-date on all the rules and regulations regarding self-directed IRAs.

Three Common IRA Myths to Guard Against

Estimated reading time: 3 minutes

There is a lot of good information out there about individual retirement accounts. Quest Trust Company, for example, has published a great deal of valuable information and guidance about the pros and cons of the various account types, including the self-directed IRA, how to get started, and pitfalls to avoid.

But there’s also no shortage of misunderstandings that people have, as well some common IRA myths have been around for decades, it seems. The biggest problem with this misinformation is that it can lead people to make sub-optimal decisions regarding their accounts, or perhaps even to not open an account in the first place.

Here are three of the most common myths that you need to guard against.

It’s Not Worth Making Non-Deductible Contributions to an IRA.

Many retirement savers are initially drawn to IRAs because their contributions may be tax-deductible in the year they are made. This can be an extremely strong incentive to contribute, as it effectively gives the account holder and immediate “rebate” or return on their investment equal to the amount of their deduction.

The downside of this valuable benefit is that it can sometimes lead people to focus too much on the possibility of a deduction and not enough on the long-term benefits of the IRA itself. For example, Roth IRAs don’t allow deductibility of contributions, but all investment earnings and income within the account can be withdrawn tax-free during retirement. (With a traditional IRA, those withdrawals during retirement would be taxable.)

Even if you are not eligible to make contributions to a Roth account, making nondeductible contributions to a traditional IRA still provide a significant tax savings because of the tax deferred nature of investment earnings. Just keep in mind that you may want to set up a separate account for those nondeductible contributions, just to ease your administrative burden.

You Can’t Make Contributions to an IRA and 401(k) in the Same Year.

Another common misconception is that an individual cannot contribute to both a 401(k) and an IRA in the same tax year. This is simply not the case.

Both IRAs and 401(k)s have annual contribution limits, and your decision to participate in an employer-sponsored 401(k) may impact the type of IRA contribution you can make (deductible versus nondeductible) but you certainly can – and should – seek to maximize your IRA contributions each year.

Self-Directed IRAs Have No Investment Limitations

This myth is really only applicable to self-directed IRAs, but it’s an important one to understand. Self-directed IRAs provide individual investors with far more options than the IRAs that are available from traditional custodians. But there are IRS restrictions that apply to all IRAs (even self-directed IRAs), including prohibitions on self-dealing. For example, you can’t use your self-directed IRA to invest in a business that you draw a salary from, or to purchase art or collectible coins (even if your intention is to make those purchases for investment purposes).

The best way to make sure you understand all the important factors surrounding IRAs is to do your research.