Too often, self-employed professionals and business owners feel that their options for retirement savings are a bit lacking. That’s natural, as you do not have access to a Corporate 401(k) plan with contribution matching and other perks. However, a Solo 401k can be just as good, if not better. You can use a Solo 401k to invest in startups, tap into capital to build your own business, or help to grow other promising companies.
Startup investing has become increasingly popular since the early 2000’s. With the passing of the JOBS Act in 2016, crowdfunding became a great option for businesses looking for start-up capital. Today, there are several online platforms that allow you to easily invest in a number of new businesses. Companies like SeedInvest and Crowdfunder make capital raising easy and accessible. And, of course, if you have access to these young companies from your network, you can make direct investments from the self-directed Solo 401k plan.
However, it’s important to know the rules about investing in start-ups using retirement funds.
No S Corps
First, it’s important to realize that you have quite a bit of leeway here. When you use a Solo 401k to invest in startups, you can put your money into just about any type of business with the exception of an S Corp.
That means you can choose to invest Solo 401k funds in an LLC, C-Corp, partnership, or even a sole proprietorship. Only individuals can own shares in an S-corp, therefore the Solo 401k trust is excluded from participating.
Most new businesses with either be an LLC, LP (partnership), or C-corp so this shouldn’t slow you down with respect to which startups your Solo 401k can invest in.
Before you direct any of your Solo 401k funds into a startup, it’s important that you ensure you’re following the Disqualified Person rules. Your investment should not benefit a “disqualified person” in any way, or you risk serious penalties. The IRS has a full list of disqualified persons to help you navigate these waters. Disqualified persons are generally you, your businesses, your family, and their related businesses.
Therefore, your Solo 401k cannot invest in your son’s startup, for example.
In addition to the disqualified persons rule, you need to ensure that your funds are not used in any prohibited transactions. Don’t mix personal and retirement funds in a single investment transaction. If your Solo 401k is investing in a startup, you personally might not invest. Or, if you do, make sure the investment is done as two separate investors (with two distinct subscription documents). Only wire funds for your Solo 401k startup investment from your Solo 401k trust bank account. Keep personal and retirement funds separate! For more information on prohibited transactions, review more information from the IRS here.
Do Your Due Diligence
To have true financial freedom, you want a self-directed Solo 401k plan. This is where you have direct checkbook control over the funds. You are the Solo 401k trustee and plan administrator. Therefore, the responsibility of due diligence falls on you. It is up to you to thoroughly vet every private business and startup where you consider using Solo 401k funds.
This is particularly true if you will be purchasing stock in the company, rather than hard assets that could be sold if the startup were to fail. This could be the difference between putting your money into Uber and putting it into Theranos. Remember that private companies are not required to report their financials in the same way that public companies are, and that you, as a private investor, do not have the same capabilities and expertise that backs the decisions of a venture capital group.
Get Cash For Your Own Business
If you want to use your Solo 401k to invest in startups, why not fuel the growth of your own new business? Yes, you can use your retirement account to fund a startup that you launch yourself. However, there are rules to follow.
You cannot invest your retirement funds directly into a business you own. That’s because you are a disqualified person to your Solo 401k plan. Using your retirement funds to invest directly in your business would be a prohibited transaction, and can carry a tax of up to 115%!
The way to compliantly use your retirement funds to invest in your business is through a participant loan. You can take a tax-free loan of up to 50% of your 401k account value, maxing out at $50,000. The loan does not count as new income, as long as you pay it back within 5 years. Any interest earned on the participant loan goes right back into your Solo 401k plan!
There are many options open with a Solo 401k account, and it is important that you have accurate answers to your questions. It is also vital that you have accurate guidance regarding investment decisions. The Nabers Group can help set up your Solo 401(k) account and answer any questions you might have.