Menu

(866) 818-4472

Open Account Client Login

PENSCO Blog

PENSCO Blog

Fresh alternative asset insights and the latest news on real estate and private equity investing.

Private Equity: An Alternative Way to Invest for Retirement

  |  By Christopher Orr, SDIP

After a closely contested race, Britain stunned the world last month by voting in favor of Brexit — a British exit from the European Union. The unexpected vote threw global markets into turmoil, with the Dow falling nearly 900 points in two days.[1]

Wild market vacillations, like the ones seen after Brexit, are prompting retirement savers to explore ways to build diversified portfolios that are better positioned to weather the market’s ups and downs. According to a survey of PENSCO clients, retirement investors said they plan to buy more alternative assets, such as private equity or real estate, to diversity their IRA holdings due to heightened market volatility.

While many retirement savers mistakenly believe they can only use their IRA funds to buy traditional asset classes like stocks and bonds, investors can diversify their retirement portfolios by holding an array of alternative assets. As our CEO explained in a recent article, working with a custodian, like PENSCO, allows account owners to self-direct their IRA dollars into alternative investments.

Private equity is one of the most popular alternative asset classes among our self-directed IRA clients. Private equity investments can include everything from owning shares in billion-dollar global companies, to buying a stake in technology startups, such as the next Uber or Airbnb.

There are two primary ways that investors can use their IRAs to invest in private equity (PE):

  • Through a fund. This might include private equity funds, venture capital (VC) funds, and funds of funds.
  • Directly in a company. Investors looking for opportunities outside of a fund can put money into startup companies, such as their current employer, or make angel investments.

If you are new to the world of private equity, how can you determine which investment opportunity might fit your needs? One way is to think of private equity as two broad categories:

  • PE investments with a single focus
  • PE investments with a commingled focus

Private equity investments with a single focus tend to invest in one specific company or sector, or they tend to invest with a specific purpose. This might include funds that limit their investment to LLCs, LPs, options, warrants or foreign private equity.

PE investments with a commingled focus are made up of funds that invest in multiple assets, or commingled funds. Their diversified portfolios can include a mix of private hedge funds, funds of funds, exchange-traded funds, and private and non-traded REITs. 

Investors should assess their tolerance for risk and how much they are willing to take on before making a private equity investment. Investors who consider themselves to be risk-adverse might find they are more comfortable with diversified funds that attempt to mitigate risk by investing in a pool of assets. If part of the fund performs poorly, it has the potential to be balanced by another part of the portfolio that performs well or better than average. An investor who considers themselves to be more aggressive might prefer funds that concentrate on a specific company or purpose. This approach can maximize potential reward — although it involves taking on more risk.

Investing in private equity with retirement funds comes with tax advantages. Earnings in a traditional IRA can compound year after year on a tax-deferred basis and can grow that way until required minimum distributions must start when the account holder is 70½. By investing in private equity with a Roth IRA, account growth accumulates tax-free.[2]

But there’s a caveat: certain private equity investments can produce what is referred to as unrelated business taxable income (UBTI). Generally, this is income generated by an unrelated trade or business to the purpose of the tax-exempt investor (IRAs, etc.). When the business passes this type of income along to IRAs, an IRA account may be required to pay taxes on it (taxes are owned if an IRA incurs UBTI over $1,000 in a tax year). It is best to consult a tax advisor about whether or not a particular investment opportunity might generate UBTI for your IRA.

Of course, all investments come with risks, and private equity is no different. It is up to you and your advisor — not the IRA custodian — to evaluate the merits and suitability of any potential private equity investment. Be sure to conduct your due diligence and work with a financial professional whom you trust before pursuing these opportunities.

To learn more about investing in private equity with your self-directed IRA, download our private equity investment guide.
 

[1] “Brexit turmoil deepens: Dow down nearly 900 points in 2 days,” www.cnn.com, 6/27/2016

[2] Penalties are incurred for withdrawing from a Roth IRA before five tax years have passed. However, these penalties may be avoided for qualified withdrawals. You should consult with your tax professional to determine the most appropriate investment options for you. 
 


This Blog does not provide investment, tax, or legal advice nor does it evaluate, recommend or endorse any advisory firm or investment vehicle. Investments are not FDIC insured and are subject to risk, including the loss of principal.

PENSCO Trust Company performs the duties of an independent custodian of assets for self-directed individual and business retirement accounts and does not provide investment advice, sell investments or offer any tax or legal advice. Clients or potential clients are advised to perform their own due diligence in choosing any investment opportunity as well as selecting any professional to assist them with an investment opportunity. Alternative investments are not FDIC insured and are subject to risk, including loss of principal. PENSCO is indirectly affiliated with a registered broker dealer and with a licensed small business investment company through Opus Bank (“Opus Affiliates”). Other than the Opus Affiliates, PENSCO is not affiliated with any financial professional, investment, investment sponsor, or investment, tax or legal advisor.