Many individual retirement account custodians limit your investment options. Even a relatively liberal traditional IRA custodian can limit you to traditional units such as bonds, stocks, mutual funds, annuities, certificates of deposit and exchange-traded funds. While you probably won't be able to invest in a private placement in a traditional IRA, you can in a self-directed account.
A private placement is an offering of shares in a private company that chooses to offer its stock to a small group of investors instead of doing an initial public offering. To purchase a private placement, you must be an institution or an accredited investor with experience and a high net worth or income. Private placements can offer high returns when they are successful.
In a self-directed IRA, you get to choose which investments go into your account, subject to IRS limits. The only investments you can't put into a self-directed IRA are collectibles, life insurance and stock in "S" corporations. As with a regular IRA, a third party holds your money and actually holds the virtual checkbook for the account to make the investments for you. However, a self-directed custodian generally does what you tell it to do without limiting your options.
Private Placement Risks
Private placements are extremely risky. When you invest in a private placement, you are typically funding a start-up company that has a limited track record. The investment is also unregistered with the Securities and Exchange Commission. Many private placements are also illiquid, meaning they can be hard to sell. When you put them in a self-directed IRA, you have the additional risk that comes from not having a custodian review the investment's suitability. With this in mind, private placements are usually best chosen by highly experienced and knowledgeable investors.
IRA Tax Considerations
When investing in private-placements, it's also important to follow IRS rules for valid IRA investments. You can't, for instance, use your IRA funds to invest in an immediate family member's business. The same self-dealing rule that bans this can also ban you from making your own separate investment in the company outside of your self-directed IRA.
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