If you were thinking of starting a business with money from your individual retirement account, you might want to put that idea on hold for a moment.
Ditto if you were thinking of using tax-deferred retirement accounts to invest in a startup run by a friend or a member of your family.
The new tax bill on Capitol Hill is planning to ban those moves. Worse still, it will effectively act retroactively — so if you’ve made such investments before it becomes law, you’ll have two years either to sell them, or remove them from your IRA.
Selling could involve a loss. Getting them out of your IRA will hit you with taxes.
The bill is currently being considered by the Senate. It is expected to become law, in some form, within weeks.
Under the current proposals, no one will be allowed to invest their IRA money in any company where they are an officer, or own 10% or more of the stock—which would make it very hard indeed to invest in your own business, or one being started by a friend or family member.
(The new law will also bar so-called “accredited investors” from using IRA money for investments in private placements and higher risk ventures. So you won’t be able to tap third party “angel” investors through private placements either.)
These investments have previously been possible so long as you ran 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 PayPal billionaire Peter Thiel was able to accumulate a $5 billion IRA over almost 25 years through some controversial tax maneuvers and a big slice of luck.
Steve Rosenthal, tax expert at the liberal Urban Institute and one of the leading proponents of the change, explains the rationale for the new proposals. “Too many tax expenditures [i.e. tax breaks] go to the richest, whitest households, [and] reward those who don’t need rewarding,” he says.
But the law doesn’t just crack down on the super rich, says Adam Bergman, CEO of self-directed IRA provider IRA Financial.
“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 make it into a small business that his friend is the CEO of in California, with 45 employees, and he calls me up and he says Adam, I’ve read this bill. Should I do it? Because if I make this investment today, and this bill passes, now I have two years to get rid of this investment.”
Bergman notes that mega-IRAs are already being limited through a separate clause of the same tax bill, which would cap tax-deferred retirement accounts at $10 million. (Very few people in America have IRA balances over $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,” she says. “There are a number of provisions that are directed at very wealthy individuals with very significant amounts in their IRAs, but this proposal will affect a different category of individuals — perhaps upper-middle class.” She adds: “The category of individuals who qualify as accredited investors is not an uber-rich category.”
(Legally an “accredited investor” must make $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’s too soon to know whether these provisions will end up as law.
On the other hand, for ordinary Joes and Joannas hoping to start their own businesses there may be a silver lining to these provisions as they currently stand.
If you use your IRA to finance your business, and the business fails, you’ll lose the money.
But if you use credit cards or bank debt to finance your business instead, if the business fails your IRA money is safe. That’s because IRAs and 401(k)s are sheltered from creditors, even in bankruptcy, under federal law.