Investing retirement assets into private companies can be an attractive option for some Roth IRA holders, as it provides the potential for tax-free growth over the long run. However, there are limitations around liquidity and qualified distributions that need to be considered. This article will explore the basics around using a Roth IRA to invest in private companies.
High risk but tax-free rewards
One of the main benefits of using retirement accounts like a Roth IRA to invest into private companies is that all investment gains and dividends could compound tax-free over time. This differs from taxable investment accounts, where capital gains and dividends would be taxed. However, with the potential rewards comes significant risk, as private companies have high failure rates. Doing thorough due diligence is critical before investment.
Limitations around liquidity
Unlike publicly traded stocks or bonds, private company investments through Roth IRAs often have major limitations around liquidity. Trying to sell private shares can be very difficult, with limited buyers in the market. Roth IRA holders need to be prepared to hold the investment until a liquidity event like an IPO or acquisition. There also may be limitations on the percentage of Roth IRA funds that can be allocated to illiquid assets.
Restrictions on qualified distributions
In order to receive tax-free qualified Roth IRA distributions in retirement, the investment assets need to meet certain IRS requirements. Some alternative assets like private company shares do not create tax issues within the Roth IRA itself but may still incur taxes and penalties if distributed. Roth IRA holders need to be aware of these nuances before investment.
Using a Roth IRA to invest into a private company can provide tax-free growth potential but also introduces major risk and liquidity concerns. Doing thorough due diligence and understanding all the limitations is critical before investment.