If you were thinking of starting a business with money from your individual retirement account, you may want to put that idea on hold for a moment.
The same is true if you were considering using tax-deferred retirement accounts to invest in a startup run by a friend or family member.
the new tax bill on Capitol Hill plans to ban those moves. Worse, it will effectively act retroactively, so if you have made such investments before it becomes law, you will have two years to sell them or remove them from your IRA.
Selling could mean a loss. Taking them out of your IRA will affect you with taxes.
The bill is currently under review by the Senate. It is expected to become law, in some form, in a few weeks.
Under current proposals, no one will be allowed to invest their IRA money in any company in which they are an officer or own 10% or more of the shares, which would make it very difficult to invest in their own business, or one. being started by a friend or family member.
(The new law will also prohibit so-called “accredited investors” from using IRA money for investments in private placements and higher risk companies. Therefore, you will not be able to turn to third-party “angel” investors through private placements.)
Previously, these investments were possible as long as you managed a so-called “self-directed IRA,” which allows you to invest your retirement savings in assets other than stocks, bonds, and mutual funds.
The new proposals come after revelations earlier this summer that Peter Thiel, PayPal billionaire was able to amass a $ 5 billion IRA over nearly 25 years through some controversial tax maneuvering and a huge chunk of luck.
Steve Rosenthal, a tax expert at the liberal Urban Institute and one of the main proponents of change, explains the justification for the new proposals. “Too much tax expense [i.e. tax breaks] go to the richest and whitest homes, [and] reward those who don’t need a reward, ”he says.
But the law doesn’t just crack down on the super-rich, says Adam Bergman, CEO of the self-directed IRA provider. Financial IRA.
“I just spoke to someone earlier today,” he tells me. “He lives in Connecticut, he has a good job, he has $ 100,000-something in his IRA and he was going to turn it into a small business that his friend is the CEO of in California, with 45 employees, and he calls me and he says Adam, I’ve read this bill. Should I do it? Because if I make this investment today, and this bill is approved, now I have two years to get rid of this investment. “
Bergman notes that mega-IRAs are already being limited through a separate provision in the same tax bill, which would limit tax-deferred retirement accounts to $ 10 million. (Very few people in the United States have IRA balances of more than $ 25 million. Meanwhile, Bergman says, “Ninety-nine percent of our clients have less than $ 1 million.” The average balance, he says, is $ 125,000.)
Tax expert Marcia Wagner of the Wagner Law Group in Boston finds the proposals surprising. “It is not entirely clear why this particular provision was included in the House Ways and Means Committee markup,” he says. “There are a number of provisions that are directed at very wealthy people with very significant amounts in their IRA accounts, but this proposal will affect a different category of people, perhaps upper-middle class.” She adds: “The category of individuals who qualify as accredited investors is not a super rich category.”
(Legally, an “accredited investor” must earn $ 200,000 a year as an individual or $ 300,000 as a couple, or have $ 1 million in assets, or qualify as a financial expert.)
It is too early to know if these provisions will become law.
On the other hand, for ordinary Joes and Joannas hoping to start their own businesses, these arrangements may have a silver lining today.
If you use your IRA to fund your business and the business fails, you will lose the money.
But if you use credit cards or bank debt to finance your business, if the business fails, your IRA money is safe. This is because IRA and 401 (k) accounts are protected from creditors, even in bankruptcy, under federal law.