A Guide to Raising Capital from Retirement Accounts

The tax advantages built into retirement accounts can potentially give fund sponsors a competitive edge when attracting capital, compared to those trying to raise money from other capital pools. In all, there's over $45.8 trillion in U.S. retirement assets, including nearly $18 trillion in IRAs, according to the Investment Company Institute(ICI).² Refer to IRS rules regarding IRAs for additional information.

In other words, there's a significant opportunity for fund sponsors to raise capital from these accounts. In particular, self-directed IRAs (SDIRAs) can be a great way to access this capital, given the opportunity for these accounts to invest in a wide range of alternative investments, beyond publicly traded assets.

In this guide, we'll dive deeper into how to raise capital from SDIRAs.

What is a self-directed IRA?

As the name suggests, a self-directed IRA (SDIRA) is a type of individual retirement account (IRA) that enables the account holder to take greater control over their investment decisions. Unlike a typical IRA that typically only allows account holders to invest in traditional, publicly traded assets like stocks and bonds, a SDIRA permits allocation to certain alternative assets within their IRAs, such as:

1. Real estate
2. Precious metals
3. Private equity funds/private companies
4. Promissory notes

There are still certain regulatory restrictions, such as requiring a SDIRA investor to be an accredited investor to invest in most private placements, but, in general, SDIRAs provide the account owner with the potential to invest in retirement funds in alternative assets that may be well-tailored to their individual goals.

Advantages and risks of raising capital from retirement accounts

SDIRA capital raising may offer advantages over traditional fundraising methods. The most obvious benefit is access to a potentially large, underutilized pool of capital.

The investor alignment is also powerful. SDIRA investors are using money specifically set aside for retirement, which means they're often thinking several decades ahead. This patient capital can remove pressure for quick exits and allow fund sponsors to focus on long-term value creation, rather than satisfying short-term investor demands.

Tax advantages also create built-in appeal for a fund sponsor’s investment opportunity. When investors can earn returns using tax-advantaged dollars (either tax-deductible contributions and tax-deferred growth with traditional SDIRAs or tax-free growth and withdrawals with Roth IRAs), that provides an incentive to use this capital. Refer to IRS Publication 590 for information regarding the deductibility and taxation of IRAs.

However, SDIRA capital raising comes with different compliance and operational complexities. For example, it's important to help investors avoid making " Prohibited transactions" (essentially self-dealing), so that they don't lose the tax advantages of these accounts.³ For that matter, there can be a big investor education lift, as many investors have never even heard of SDIRAs and don't know the administrative requirements. It is important for both the SDIRA investor and the fund sponsor to understand IRS rules involving IRAs to help ensure the IRAs continue to benefit from the potential tax advantages.

Partnering with qualified custodians like Forge Trust can help, as they streamline account openings and investment processes for clients, which can thereby potentially make fundraising processes easier.

Regulations around raising capital from retirement accounts

Some of the most important regulations to know before engaging in SDIRA capital raising include:

• The prohibited transaction rule prevents SDIRA owners and "disqualified persons", such as close family members, from using retirement accounts for personal benefit beyond normal retirement investment returns. Otherwise, the account could lose its tax-advantaged status and potentially incur new taxes.⁴
• To avoid prohibited transactions, fund sponsors cannot invest their own SDIRA funds into their own businesses if they own more than 50%. They also cannot provide goods, services or other benefits to SDIRA investors outside of normal investment activities.⁵
• Unrelated business income tax (UBIT) applies when retirement accounts earn income from active business operations or debt-financed investments. If a fund operates active businesses or uses significant leverage, SDIRAs may owe taxes on their share of that income.⁶
• Securities regulations still apply to SDIRA investors. Private placements typically require investors to be accredited, for example. In general, securities laws must be followed regardless of whether investors are using retirement accounts or not.

Beyond these areas, fund sponsors and SDIRA account owners also face regulations, such as those related to using a qualified custodian to hold SDIRA assets, as well as following certain documentation protocols. An experienced custodian can help with the administrative aspects to ensure that the fund sponsor and respective investors stay compliant.

Potential tax implications

As mentioned, there are several IRS rules related SDIRAs. SDIRA capital faces the same tax implications as other retirement capital. Also, the fund sponsor generally does not owe any difference in taxes whether they raise capital from SDIRAs, other retirement accounts, or non-retirement accounts.

As such, the main focus should be on helping investors understand their own tax implications. SDIRAs can come in many forms, including traditional, SEP, SIMPLE and Roth, just like regular IRAs. So, investors may need guidance in choosing which account structure best suits their tax situation and overall finances.

Along with IRS rules around IRAs, if fund sponsors are advising SDIRA owners, they need to help ensure investors are aware of the risks associated with investing in alternative assets, including private equity.

SDIRA vs. other funding methods

Understanding how SDIRA capital compares to traditional funding sources helps position a fund sponsor’s opportunity effectively. Some contrasts include:

SDIRA vs. angel investing

Angel investors typically want active involvement, such as board seats or advisory roles, in exchange for their expertise and significant initial capital. SDIRA investors might be willing to take a more passive role and potentially take smaller, longer positions.

SDIRA vs. venture capital (VC)

VC resembles angel investing but often comes with more extensive due diligence requirements and a more institutional approach overall. In contrast, SDIRA investors are individuals, and while they generally do not provide the expertise and networking benefits of VCs, these smaller investors might be more aligned with a long-term investing horizon, given the long-term nature of these accounts.

SDIRA vs. debt financing

Although SDIRA investing can involve private lending, it often involves equity investing instead. Either way, the financing process is generally less stringent and formal than with other types of debt financing, like bank loans, which might require personal guarantees, collateral, etc.

SDIRA vs. crowdfunding

Crowdfunding platforms tend to charge fees and require extensive marketing campaigns, while SDIRA capital raising works through more traditional investor relationship approaches without platform fees or viral marketing requirements.

While SDIRAs offer many benefits, it doesn't have to be an either/or choice. Fund sponsors can raise capital from all of these different sources, with SDIRAs providing the advantage of being an oft-overlooked pool of capital, thereby giving fund sponsors a new source to tap.

Documents and forms needed for SDIRAs

SDIRA investments typically require the same basic documents as traditional private placements, plus additional custodial forms and procedures.

• Standard investment documents include ones like Private Placement Memorandums (PPMs), subscription agreements, and operating agreements for fund structures. These documents outline the investment terms, risks, and legal structure just like any private placement.
• SDIRA-specific documentation involves additional steps, such as requiring account opening applications, funding transfers from existing retirement accounts, and custodial agreements that govern how the account operates.
• Investment authorization forms allow custodians to determine the administrative feasibility of custodying certain assets, although the investor is ultimately responsible for determining eligibility. Custodians do not provide investment advice, but an investor might be more comfortable investing via an SDIRA with a custodian that has a strong track record of safe recordkeeping and administering complicated assets.
• Ongoing reporting requirements include periodic valuations, distribution processing, and tax reporting that generally must flow through the SDIRA custodian. Fund sponsors need to coordinate with custodians on these administrative requirements throughout the investment lifecycle.

How Forge Trust can help

Successfully raising capital from retirement accounts requires more than understanding the rules and benefits. Fund sponsors need operational partners who can handle the compliance complexities and administrative requirements that make SDIRA investing possible.

Most traditional IRA custodians don't handle alternative investments because they lack the systems and expertise required for administering alternative assets, including private placements. This creates barriers between fund sponsors and potential SDIRA investors that may prevent transactions from happening even when both parties are interested.