Investing IRA and Retirement Assets in Private Funds: What Investors Need to Know


By Mohsen Ghazi, Managing Director, Deputy General Counsel

Did you know that you can use retirement assets, including an individual retirement account (IRA) or 401(k), to invest in private assets such as private equity, real estate, and other alternative investments? For years, billionaires have leveraged the strategy of using retirement and other tax-advantaged accounts to significantly grow their wealth … and for good reason. Investing in private markets through retirement accounts can offer investors a powerful combination of benefits: diversification, tax efficiency, and potentially higher returns

The Tax-Efficient Edge of IRAs
Retirement accounts like IRAs can be a tax-efficient way to invest in private assets. This is especially true if you don’t depend on these assets to fund your current lifestyle. However, there are potential tax implications to be aware of when investing in private markets through retirement accounts. The Unrelated Business Taxable Income (UBTI) tax is especially significant and can cause retirement accounts to incur taxes at rates higher than individual income tax rates. The good news? Many investment sponsors have solutions to help avoid UBTI.

Choosing the Right Custodian
When venturing into private markets, it’s crucial to collaborate with the right custodian. A custodian’s role is safeguarding and managing an investor’s assets. Some custodians might pose challenges for individual investors integrating private investments into IRAs. A qualified advisor can help you navigate this complexity and facilitate a smooth process to make the investment.

Understanding UBTI
UBTI was conceived to prevent tax-exempt entities from getting an unfair business advantage over taxable entities. UBTI taxes income from businesses unrelated to a tax-exempt entity’s primary purpose. For IRAs, UBTI can be triggered when the IRA invests in a business or investment fund that generates income associated with a trade or business, among other circumstances. It’s crucial to consult a tax or legal advisor before investing in private assets with IRA funds.

How UBTI Relates to Private Assets in IRAs
Private market investments can trigger UBTI in certain circumstances. This type of income can be subject to UBTI tax if generated through an IRA. For example, income from a private equity fund or income from a real estate property that uses leverage can generate UBTI. While you should always ask an investment manager whether an investment is likely to generate UBTI, seek independent tax or legal counsel to make your own determination.

Avoiding UBTI with the “Blocker” Strategy
A “blocker corporation” is a vehicle taxed as a corporation that can “block” investors from the UBTI tax. In this structure, an IRA invests through the blocker, which then invests into the underlying fund. By investing in an underlying asset indirectly through the blocker corporation, the IRA avoids UBTI. While the income earned by the blocker will be subject to U.S. corporate tax, the IRA maintains its tax deferral on any income.

Private Assets in 401(k)s
401(k) retirement accounts offered by employers can provide opportunities similar to IRAs for private markets investing. Further, 401(k)s are exempt from a specific type of UBTI generated from debt-financed income (so-called “UDFI”), which can be common in real estate or credit funds. Therefore, when investing in a fund or company that is expected to generate UDFI, it may be more tax efficient to invest through a 401(k) rather than an IRA.

PPLI/PPVA: Beyond Traditional Retirement Accounts
Beyond traditional retirement accounts, sophisticated investors and institutions can compound many of the same tax advantages referenced above by investing in private placement variable annuities (PPVA) or private placement life insurance policies (PPLI). High-net-worth investors and institutions often turn to these tax-advantaged insurance policies because of their potential to enhance wealth preservation, growth, and transfer. Among other advantages, these structures provide:

  • Tax deferral or tax-free growth
  • No cap on contributions
  • Liquidity through low-interest loans
  • Inter-generational wealth transfer, potentially free of estate tax
  • Asset protection

Their flexibility allows diversification across asset classes, making them an attractive option for certain types of high-net-worth individuals and institutions.

In summary, investing retirement account dollars into private markets offers potentially rewarding opportunities… but also presents complexities. Collaborating with a knowledgeable legal, tax, or financial advisor can help ensure that you optimize the benefits while minimizing pitfalls.

Contact us to learn more.

Disclosure

This article is provided for informational purposes only and is not intended to be, nor should it be construed or used as, comprehensive financial planning or investment advice, an offer to sell or a solicitation of an offer to buy any security. Investment decisions should be based on an individual’s specific financial needs, goals, and risk profile. Any references to securities, investment strategies, or types of accounts are for illustrative purposes only and do not constitute a recommendation of any particular security, strategy, or account type. No representation is made that any investment or strategy is suitable or appropriate for any particular investor. Decisions based on information provided herein are the sole responsibility of the reader.

Investments in securities and other financial instruments involve risk, including the risk of loss of the principal amount invested. Past performance is not indicative of future results, and no representation or warranty is made regarding future performance. The value of investments may fluctuate, and investors may lose money on their investments.

The opinions and views expressed herein are as of the date published and are subject to change without notice based on market conditions and other factors. We believe the information provided herein to be reliable but does not warrant its accuracy or completeness. The information provided is subject to change at any time without notice. Any third-party content, logos, or brands included herein are for illustrative purposes only and are the property of their respective owners.

All readers are strongly encouraged to consult with a financial advisor, attorney, or accountant before making any investment decision or implementing any investment strategy. Neither Mohsen Ghazi or Cresset Capital Management or any of its affiliates or representatives shall be liable for any damage or loss resulting from reliance on this article or any information, opinion, or advice contained herein.

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