Maximizing Retirement Savings: Tax Benefits of Self-Directed IRA Investments in Private Companies

Investors Education

Traditional investments like stocks, bonds, and mutual funds have long been the mainstay of retirement portfolios. However, as investors become more sophisticated and seek to diversify their holdings, alternative investments like private company investments have gained popularity. These alternative assets can offer unique opportunities for outsized returns while complementing a broadly diversified portfolio1Now investors can access these investments within the framework of a self-directed Individual Retirement Account (IRA), maximizing tax benefits too. Please note that this should not be construed as tax, legal or investment advice.


What is a Self Directed IRA? 


When it comes to retirement savings, Individual Retirement Accounts (IRAs) are a well-known tool. Traditional IRAs and Roth IRAs are the usual suspects, offering tax-advantaged ways to save. For those looking to supercharge their retirement savings and diversify their investment portfolio, the lesser-known but powerful self-directed IRA (SDIRA) can enable alternative investing within a retirement account.  For this reason, they have grown in popularity in recent years.


A self-directed Individual Retirement Account (IRA) offers individuals more control and flexibility over their investment choices compared to traditional IRAs. With a self-directed IRA, the account holder has the authority to choose from a broader range of investment options, including traditional assets like stocks and bonds, as well as alternative investments such as real estate, private equity, and more.

Investing via a Self-Directed IRA can offer several benefits. With a self-directed IRA, investors have the freedom to invest in assets they understand and are passionate about. If you have expertise in a specific area, such as a particular industry, you can leverage your understanding to make informed decisions that may lead to better outcomes. This personalized approach allows you to take a more tailored approach to your retirement investments and align your portfolio with your strengths. There are also important tax advantages.


Tax Advantages of a Self-Directed IRA

Self-directed IRAs share the same tax advantages as traditional IRAs. Contributions may be tax-deductible (for traditional IRAs) or tax-free (for Roth IRAs), and the investments grow tax-deferred. This tax-advantaged structure extends to alternative assets like private company investments. 


Tax-Deductible Contributions for Traditional SDIRAs


If you have a traditional self-directed IRA, you can benefit from tax-deductible contributions. The money you contribute to your SDIRA is tax-deductible in the year of the contribution, which can lower your current taxable income. This tax advantage can free up more capital to invest, potentially boosting your long-term retirement savings.


Tax-Free Distributions (for Roth SDIRAs)

When your self-directed IRA generates returns, they accrue within the account without immediate tax consequences, allowing your investments to compound more effectively over time. As long as your investments remain within the SDIRA, you won't pay taxes on the gains generated from these alternative assets. 

For those with a Roth self-directed IRA, the tax advantages are slightly different. Roth IRAs allow you to make after-tax contributions, meaning you've already paid taxes on the money you invest. This means that when you eventually withdraw funds during retirement – it's all tax-free. That includes the original contributions and any gains you've accumulated over the years. Because of this, investing in alternative assets within a Roth SDIRA can result in substantial tax savings.

 

Why invest in private companies via a SDIRA

Private company investments can align with the goals for many investors’ retirement accounts, making them a good fit for a self-directed IRA. First, the timelines match. Given the long term expected holding period for private company investments (5-7 years) it makes sense to make these investments with funds meant for long-term holding. Retirement accounts are held with the expectation of liquidation often decades later. This duration alignment allows investors to reap the potential benefits that come with long-term investments, like private company investments. 

In addition, retirement portfolios tend to be optimized towards growth. After all, these funds are meant to sustain the cash needs of a retiree who no longer receives employment income. At EquityZen, we consider private company investments as a crucial part of an investor’s growth equity allocation. As companies stay private longer, investors are tapping the private markets to achieve the asymetrically skewed returns less frequently available in the public markets. For this reason private company investments can help fuel growth in your retirement account. While growth is the goal, investing in private companies may involve a high degree of risk. It is important that investors are able to afford the loss of their entire investment when considering a private company investment as part of a diversified retirement portfolio.

 

Know the rules & regulations

It's important to note that the IRS has specific rules and regulations governing these accounts. You must follow these guidelines to retain the tax-advantaged status of your self directed IRA and engaging in prohibited transactions can result in penalties. As with any investment, careful research, and professional advice can help you make informed decisions and navigate the world of alternative investments within the framework of your self-directed IRA. By doing so, you can take greater control of your retirement planning and shape your long-term financial goals.


Investing in alternative assets through a self-directed IRA  can unlock new opportunities for diversification and potentially higher returns, maximizing your retirement savings.  The tax advantages, including tax-deferred growth, tax-deductible contributions for traditional SDIRAs, and tax-free distributions for Roth SDIRAs, make SDIRAs an attractive option for investors.  It's important to note that the IRS has specific rules and regulations governing these accounts. You must follow these guidelines to retain the tax-advantaged status of your self directed IRA and engaging in prohibited transactions can result in penalties. As with any investment, careful research, and professional advice can help you make informed decisions and navigate the world of alternative investments within the framework of your self-directed IRA. By doing so, you can take greater control of your retirement planning and shape your long-term financial goals.


Interested in investing via a self directed IRA on EquityZen’s platform? EquityZen welcomes investments from self-directed IRAs and partners primarily with Alto IRA and RocketDollar. You can add your Alto IRA or Rocket Dollar account as an additional profile to your EquityZen account by clicking here or by navigating to Profile Management under Account Settings and clicking Add New Profile. For more information, check out our FAQ

 

  1. Diversification does not assure a profit or protect against market loss.

Investment opportunities posted on this website are "private placements" of securities that are not publicly traded, are subject to holding period requirements, and are intended for investors who do not need a liquid investment. Investing in private companies may be considered highly speculative and involves a high degree of risk, including the risk of substantial loss of investment. Investors must be able to afford the loss of their entire investment. See our Risk Factors for a more detailed explanation of the risks involved by investing through EquityZen’s platform.

 

 

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