Last Updated on January 30, 2020
IRA Financial’s Pocket 401(k) will allow you to use your retirement funds to invest in all types of investment funds, such as private businesses/private placements directly from your mobile device or PC securely, and cost effectively. You no longer need a third-party 401k custodian involved in every aspect of your investment transaction. Make private placement investments on your own directly from a mobile device or PC with IRA Financial’s Pocket 401(k). Additionally, rollover, deposit, or transfer funds between your investment and 401k seamlessly and without delay.
Why Private Business Investments/Private Placements?
In order to grow a company and raise additional funds, many large companies go the initial public offering (IPO) route. An alternative way to raise capital for a small private business is known as a private placement. A private placement involves the sale of securities or membership interests to a relatively small number of select investors. Investors targeted include wealthy accredited investors, large banks, and pension funds. A private placement is different from a public issue in which securities are made available for sale on the open market to any type of investor.
Private placements can be used for a range of purposes. A company may utilize a private placement to raise capital for its business.
The SEC regulates how securities are sold to the public through the Securities Act of 1933. If a company wants to issue stocks or bonds to the public, it must register with the SEC and sell the security using a prospectus.
Regulation D of the 1933 Act provides a registration exemption for private placement offerings. Regulation D allows an issuer to sell securities to a targeted group of accredited investors that meet specified requirements. Instead of a prospectus, private placements are sold using a private placement memorandum (PPM) and cannot be broadly marketed to the general public.
Private placements are a popular way for companies to raise funds for a number of reasons. The private placement regulations allow an issuer to avoid the time and expense of registering with the SEC. The process of underwriting the security is faster, which allows the issuer to receive proceeds from the sale in less time. If an issuer is selling a bond, it can also avoid the time and expense to get a credit rating from a bond agency. A private placement issuer can sell a more complex security to accredited investors who understand the potential risks and rewards, and the firm can remain a privately-owned company, which avoids the need to file annual disclosures with the SEC.
What is an Accredited Investor?
An accredited investor is a person (or business entity) who can deal in securities that may not be registered with financial authorities. They are entitled to such privileged access if they satisfy one (or more) requirements regarding income, net worth, asset size, governance status or professional experience. Accredited investors include natural high net worth individuals, banks, insurance companies, brokers and trusts.
To be an accredited investor, a person must have an annual income exceeding $200,000, or $300,000 for joint income, for the last two years with expectation of earning the same or higher income in the current year. An individual must have earned income above the thresholds either alone or with a spouse over the last two years. The income test cannot be satisfied by showing one year of an individual’s income and the next two years of joint income with a spouse.
The exception to this rule is when a person is married within the period of conducting a test.
A person is also considered an accredited investor if he has a net worth exceeding $1 million, either individually or jointly with his spouse. The SEC also considers a person to be an accredited investor if he is a general partner, executive officer, director or a related combination thereof for the issuer of unregistered securities.
An entity is an accredited investor if it is a private business development company or an organization with assets exceeding $5 million. Also, if an entity consists of equity owners who are accredited investors, the entity itself is an accredited investor. However, an organization cannot be formed with a sole purpose of purchasing specific securities.
The advantage of using retirement funds to invest into private placement investments is that, in general, all the income and gains generated by the investment would not be subject to any tax or penalty. Instead of paying tax on the returns associated with the private placement, tax is paid at a later date, leaving the investment to grow unhindered. Using a solo 401(k) to make a private placement investment is tax advantageous because the tax on the interest payments can be deferred in the case of a pre-tax 401k or exempted permanently in the case of a Roth 401k.
In addition, solo 401(k) investments are made when a person is earning higher income and is taxed at a higher tax rate. Withdrawals are made from an investment account when a person is earning little or no income and is taxed at a lower rate.
Unrelated Business Taxable Income
Almost every retirement account investment that generates passive income will not be subject to Unrelated Business Taxable Income (UBTI or UBIT) or Unrelated Debt Finance Income (UDFI) Tax.
The UBTI tax is only triggered if:
- Retirement account uses margin to buy stock
- Retirement account invests in an active business through a passthrough entity, such as an LLC
The UDFI tax is triggered if:
- A 401k uses a nonrecourse loan (real estate acquisition financing to purchase real estate)
- Exemption for 401(k) plans
- IRC 514(c)(9)
The UBTI & UDFI trigger the same tax rate, which is a maximum of 37% for 2019.
Therefore, if you plan to make private placement investments using a solo 401(k) and the underlying investment will not involve an investment into a business operated via a passthrough entity, such as an LLC, will have debt or margin, the UBTI tax rules will likely not be triggered.
The good news is that your IRA Financial assigned specialists will help you understand the potential application of the UBTI/UDFI tax rules and potentially reduce or eliminate it.
With a Pocket 401(k) for private businesses/private placements , you will have the power to act quickly on a potential investment opportunity. When you find an investment that you want to make with your 401k funds, as manager of the Checkbook 401k LLC, simply write a check or wire the funds straight from your Solo 401(k) LLC bank account. The Pocket 401(k) for private businesses/private placements allows you to eliminate the delays associated with an 401k custodian, enabling you to act quickly when the right investment opportunity presents itself. In addition, with the Pocket 401(k) structure, all income and gains from 401k investments will generally flow back to your 401k LLC tax-free. Because an LLC is treated as a pass-through entity for federal income tax purposes and the 401k, as the member of the LLC, is a tax-exempt party pursuant to Internal Revenue Code Section 408, all income and gains of the 401k LLC will flow-through to the 401k tax-free!
You will be assigned to an IRA Financial specialist who will help you understand the potential application of the UBTI/UDFI tax rules and potentially reduce or eliminate it.
Why I Need a Solo 401(k) to Invest in Private Placements
Unfortunately, none of the major financial institutions will allow you to use 401(k) plan funds to invest in private placements or essentially anything outside of Wall Street. The reason for this is simple: banks do not make money when you invest in non-traditional equities, such as private equity or venture capital investments. They make money when you buy stock, mutual funds, and other financial products they market. As a result, a large number of individuals are turning to a Solo 401(k) to invest in private placements.
What is the Pocket 401k?
IRA Financial’s Pocket 401(k) is essentially a solo 401(k) with checkbook control. It is an IRS approved structure that allows one to use his or her retirement funds to make investment fund investments tax-free and without custodian consent. The Pocket 401(k) for private businesses/private placements involves the establishment of a limited liability company (“LLC”) that is owned by the 401k (care of the custodian) and managed by you or any third-party. As manager of the 401k LLC, you will have control over the 401k assets to make the investments you want and understand – not just investments forced upon you by Wall Street.
How it Works:
- Establish the solo 401(k) with IRA Financial Trust & Capital One online though our mobile app.
- Your 401k cash/assets can be rolled over to IRA Financial Trust tax-free directly from our mobile app.
- The assets will be transferred to a new Solo 401(k) plan checking account with Capital One Bank. Your assigned specialists will help you open a self-directed plan account with Capital One seamlessly and with no wiring fees or minimum balance requirement. Now you can establish a solo 401(k) with checkbook control and not visit a bank or deal with bank opening documentation. Our special partnership with Capital One Bank makes IRA Financial the only self-directed provider that can open a solo 401(k) plan bank account for our clients. This makes the process quick, easy, and cost-effective. As manager of the LLC, you will open a bank account for the LLC at any local bank. IRA
- Financial will draft an LLC Operating Agreement identifying you as manager of the LLC and the 401k as the sole member.
- You, as manager of the LLC, will then have checkbook control over all the assets/funds in the 401k LLC to make the real estate investment.
Since the LLC is owned 100% by a 401k , it will be treated as a disregarded entity for tax purposes. There is no requirement to file Federal income tax, and all income and gains will flow back to the 401k without tax.
With a Pocket 401(k) for private businesses/private placements, you will have the power to act quickly on a potential investment opportunity. When you find an investment that you want to make with your 401k funds, as manager of the Checkbook 401k LLC, simply write a check or wire the funds straight from your Solo 401(k) LLC bank account. The Pocket 401(k) allows you to eliminate the delays associated with an 401k custodian, enabling you to act quickly when the right investment opportunity presents itself. In addition, with the Pocket 401(k) structure, all income and gains from 401k investments will generally flow back to your 401k LLC tax-free. Because an LLC is treated as a pass-through entity for federal income tax purposes and the 401k , as the member of the LLC, is a tax-exempt party pursuant to Internal Revenue Code Section 408, all income and gains of the 401k LLC will flow-through to the 401k tax-free!
2019 Most Popular Private Placements Investments
The following Private Placement investments have been popular with our solo 401(k) clients in 2019:
- Direct start-up investment
- Investment into private unicorn companies
- Investments into small cap public companies
- Crowdfunding type investments
We’re here to help. When you want to use the Pocket 401(k) for private businesses/private placements investments, contact IRA Financial directly at 800-472-0646. You can also fill out one of our contact forms to get in touch with a tax specialist.