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Private Equity Investments with a Solo 401k

private equity investments with a solo 401k

Investing in private equity investments with a Solo 401(k) will give you freedom to make investment decisions on your own without custodian consent. Ultimately, investments with a Solo 401k allows you to eliminate the expense and delays of using an IRA custodian.

What is Private Equity Investing?

The term “private equity” is used to describe pools of money from several investors that are established through a passthrough entity, such as a partnership or limited liability company (LLC) that are then used to acquire stakes in companies.

Private equity funds make money by charging a small fee for managing the fund, typically around 2%, and then taking a cut of the gains from the investments above a certain set threshold. This is known as the carried interest and is typically 20%. The fees associated with investing in a private equity or venture capital fund are steeper than investing in a mutual fund or ETF, but the hope is that the returns will more than make up for the associated costs.

What is the difference between private equity and venture capital?

Private equity and venture capital investments are quite similar. Private equity typically invests in mature type and revenue generating companies in need of some revitalization. Whereas venture capital typically invests in very early stage companies with little to no revenues.

Both private equity and venture capital funds typically raise money from wealthy accredited investors, family offices, banks and financial institutions, other investment funds, pension funds, and even IRAs.

Private Equity Investments with a Solo 401k

With a Solo 401k retirement plan, the business owner or plan participant (you) can serve as trustee. As a result, you can make private equity investments simply by writing a check or wiring funds directly from the Solo 401k bank account, which can be opened at any local bank or credit union, such as Capital One.

By establishing a Solo 401k, you can make private equity investments without the formation of an LLC. Instead, the Solo 401k Plan can be adopted by any business including a sole proprietorship, LLC, C Corporation, S Corporation, or partnership.

Unlike a conventional Solo 401k Plan that can be opened at a traditional financial institution such as Fidelity, the Solo 401k Plan offered by the IRA Financial Group is open architecture and 100% self-directed. This provides you (the trustee) with “checkbook control” over the 401k plan assets and 100% control over the investments of the plan. With the Solo 401k, also known as a Self-Directed 401(k), you will have total control over your retirement funds so you can make private equity and 401k plan investments tax-free.

Solo 401k Prohibited Transaction Rules

Although you can make private equity investments with a Solo 401k, investors should be knowledgeable of the IRS prohibited transaction rules under Internal Revenue Code Section 4975. The IRS restricts certain transactions between the Solo 401k and a “disqualified person.” Disqualified persons include, but are not limited to the Solo 401k trustee and any of his/her lineal descendants.

The prohibited transactions rules tend to become more of an issue when the person using the retirement funds or any disqualified person related to the retirement account holder has a personal interest or relationship with the private equity fund investment.

In other words, you can generally make an investment into any private equity fund in which neither you nor another disqualified person has personal ownership or relationship with. Issues will arise from an IRS prohibited transaction standpoint when the retirement account holder wishes to use retirement funds to invest in a fund where her or she or a disqualified person is either an owner, employee or, in some cases, has a professional relationship with the fund in question.

If the transaction is structured correctly, there may be a way to use retirement funds to invest in a private equity that you are personally involved in. It is important to ensure that the investment into the private equity fund will not personally benefit the retirement account holder (directly or indirectly) or any disqualified person since that type of investment would likely trigger a prohibited transaction.

Triggering a prohibited transaction is based on the facts and circumstances involved. The retirement account holder must prove that he/she did not personally benefit from the retirement account investments (directly or indirectly). Failure of proof can trigger very steep taxes and penalties.

Who is Eligible for a Solo 401k?

In order to be eligible to adopt a Solo 401k plan, the individual must operate a business with no employees who work more than 1,000 hours during the year other than the owner(s) or their spouse(s). The business is not required to be profitable but there must be an active business with the anticipation of profit.

The individual can be employed by another business and still adopt a Solo 401k Plan through a side business. Therefore, if the individual does not have a business that generates self-employment income or has a business with employees, he or she will not be eligible for the Solo 401k Plan. Thus, the individual will be required to use a Solo 401k to make investments using retirement funds.

Putting it All Together

Private equity fund investments are among the most popular investment options with a Solo 401k. In general, private equity investments are passive and do not offer much prohibited transaction risks, assuming you or another disqualified person is actively involved in the fund.

Why IRA Financial

IRA Financial has helped over 15,500 self-directed retirement investors invest over $4.5 billion in alternative assets. IRA Financial has significant experience assisting private equity and venture capital clients navigate the IRS rules in connection with all types of domestic and foreign investments.

For additional information on using a Solo 401k to make private equity investments, please contact one of our Solo 401k Experts at 800-472-0646.

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