Being an accredited investor comes with a whole lot of perks. The most important being the types of investments you can make. Sophisticated investments, such as hedge funds and venture capital, are not offered to everyone. The government feels that the average American does not completely understand the risks of these types of investments. Therefore, they have set certain requirements to invest.
- Accredited investor status allows you to make non-regulated investments
- IRAs can make these investments so long as they are owned by an accredited investor
- The new tax proposal may prohibited these types of investments in an IRA
What is an Accredited Investor?
Essentially, an accredited investor is defined as “an individual or a business entity that is allowed to trade securities that may not be registered with financial authorities.” Most investments are regulated by the Securities and Exchange and Commission (SEC). They are required to file with the SEC to disclose everything about the company or other investment type. Because of this, they offer more protection to the investor.
On the other hand, riskier, boom or bust-type of investments do not offer these protections. They have the potential for a huge payday, but the risk is much greater with the lack of regulations. For this simple fact, you must show accredited investor status to make these investments.
Who is an Accredited Investor?
Generally, you must be a high income earner to be deemed an accredited investor. This can be achieved in one of two ways. First, is having a net worth of at least $1 million (not including your primary residence). Secondly, you must have earned at least $200,000 over the prior two years, and expect to do the same in the current year.
Married couples are allowed to aggregate their assets for the $1 million test, but they must have a joint income of at least $300,000 annually to meet the income test instead.
Alternatively, you can reach accredited investor status “based on certain professional certifications, designations or credentials or other credentials issued by an accredited educational institution.”
2020 SEC Amendment
Since 1985, the accredited investor definition has been largely unchanged. However, in August of 2020, the SEC amended the definition to “modernize” it. The following was added in 2020-191:
- add a new category to the definition that permits natural persons to qualify as accredited investors based on certain professional certifications, designations or credentials or other credentials issued by an accredited educational institution, which the Commission may designate from time to time by order. In conjunction with the adoption of the amendments, the Commission designated by order holders in good standing of the Series 7, Series 65, and Series 82 licenses as qualifying natural persons. This approach provides the Commission with flexibility to reevaluate or add certifications, designations, or credentials in the future. Members of the public may wish to propose for the Commission’s consideration additional certifications, designations or credentials that satisfy the attributes set out in the new rule;
- include as accredited investors, with respect to investments in a private fund, natural persons who are “knowledgeable employees” of the fund;
- clarify that limited liability companies with $5 million in assets may be accredited investors and add SEC- and state-registered investment advisers, exempt reporting advisers, and rural business investment companies (RBICs) to the list of entities that may qualify;
- a Company Act, in excess of $5 million and that was not formed for the specific purpose of investing in the securities offered;
- add “family offices” with at least $5 million in assets under management and their “family clients,” as each term is defined under the Investment Advisers Act; and
- add the term “spousal equivalent” to the accredited investor definition, so that spousal equivalents may pool their finances for the purpose of qualifying as accredited investors
This amendment expanded the definition of the accredited investor. Because of it, more people can make these types of sophisticated investments.
What About Your IRA?
An IRA is not a natural person, so the question becomes how are the accredited investor rules applied? The industry consensus is that you would use the individual IRA owner’s financial status to determine if the IRA will satisfy the accredited investor rules.
Since an IRA is treated as a trust pursuant to IRC 408, under the accredited investor trust rules, if each of the people creating the trust is an accredited investor in his or her own individual right, then the trust will also carry accredited investor status.
In all likelihood, you would need a Self-Directed IRA to make private equity-type investments. When choosing the right provider, such as IRA Financial, you have been allowed to make accredited investor-type investments.
New Tax Proposal
However, in September 2021, a new tax proposal may put the kibosh on these types of investments with an IRA. One of the measurements in the proposed bill will prohibit IRAs from making investments that require accredited investor status. Therefore, whether you qualify to make these investments or not, you will no longer be able to use a Self-Directed IRA.
Using retirement funds to invest in these types of assets was a way to generate huge returns in a tax-advantaged way. However, thanks in part to Peter Thiel, the government does not want any one person to be able to shelter enormous gains. Although, according to the same proposal, there will be a $10 million cap on all retirement assets, regardless of what they are. So, it doesn’t seem to make sense to disallow these types of investments in an IRA.
Gaining accredited investor status opens the door to many exciting investment opportunities. If one has the wealth and the know-how, you should not be prohibited from making private equity investments. Obviously, this proposal has not been finalized yet and the Self-Directed IRA industry is trying to get this provision out of the final bill, as it greatly impacts entrepreneurs and start-ups from receiving the funding they may need to get going.
Stay tuned to see what happens in the coming weeks. One thing is for certain – this proposal will not be approved as is. Hopefully, the accredited investor provision will not make the final cut!