This post was co-written by David Verrill, ACA Chairman and Founding Manager and Partner of the Hub Angels, and Rob Spalding, Senior Advisor with Alternative Solutions Group, a self-directed retirement account consulting firm.
In the world of angel investing it is critical to know all the tools available for managing risk, creating value, and also addressing tax efficiency if possible. One of the most under-utilized tools for angel investing is a self-directed retirement account such as an IRA or 401(k). Many angels are just learning that private equity and private placements such as angel funds can be held in these accounts tax-deferred or tax-free. Hub members have been using this mechanism in the Hub funds for nearly 10 years, and we have five people in our current fund investing through self-directed IRAs.
It has been legal to use a retirement account to invest into private stock since the 1970’s when IRAs were born. Since it is fairly nuanced, large securities brokerage firms simply do not readily offer these types of accounts, preferring to stick with the easily-replicated and highly-profitable stocks, bonds, ETFs and the like.
But like any unconventional investment mechanism, you need to know the basics in order to succeed, so here they are:
To get started, you need to select a specialized custodian to hold your IRA that regularly handles private stock and private placements. For example, we have been using PENSCO Trust Company out of San Francisco (but with offices across the US, including Portsmouth, NH). And we are not alone, as it was discovered post-IPO that several of Yelp!’s investors used the same method. It will save you time and money to find advisors that have done these types of transactions before, so that they don’t learn the theory on your budget and with no experience to execute.
Investments in angel funds are the simplest approach to take, as the managers of those funds can manage the process and handle the valuation and reporting requirements with the custodian.
The IRS has rules on self-dealing that you need to watch out for. For example, if you are an investor in a company through a self-directed IRA, sit on the Board, or advise/consult for it with compensation, then you are self-dealing. You don’t want to disqualify your retirement account or worse, cause yourself to be penalized by the IRS.
If you follow the basic rules, you get the benefits of accessing this pool of capital and the tax benefits if the investment pops within the account…even a Roth IRA account where you can benefit from low initial valuations in a tax-free environment. And since IRAs alone are a roughly $5 trillion national pool of capital, that makes for a powerful mechanism to further angel investing. So, when you put together the knowledge, advisors, and strategy going in, retirement accounts can be a powerful tool for the angel community.
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FAQs
Angels can unlock the investment power of their retirement dollars using a Rocket Dollar Self-Directed Solo 401(k) or Self-Directed IRA. These accounts offer significant tax savings for angel investments, and accounts are created entirely online in just a few minutes.
How are retirement accounts invested? ›
An IRA can be opened through a bank, broker or robo-advisor. You contribute to an IRA and choose how you'll invest your money. Your contributions can be invested in stocks, bonds, exchange-traded funds or other assets.
How do I withdraw from my retirement account? ›
By age 59.5 (and in some cases, age 55), you will be eligible to begin withdrawing money from your 401(k) without having to pay a penalty tax. You'll simply need to contact your plan administrator or log into your account online and request a withdrawal.
Are angel investments risky? ›
Con: You're not in total control. Because angel investing comes with so many risks, some angel investors may want partial control over your company as well. Seasoned venture capitalists may see a great opportunity in your business but may also want more say in how things are operated.
Do you have to pay taxes on angel investments? ›
The angel investor will be taxed on this income at their individual income tax rate, which depends on their total income and other factors. It's important to note that the tax treatment of angel investing can be complex, and there may be other tax considerations and implications to be aware of.
What is the 4 rule for retirement accounts? ›
What does the 4% rule do? It's intended to make sure you have a safe retirement withdrawal rate and don't outlive your savings in your final years. By pulling out only 4% of your total funds and allowing the rest of your investments to continue to grow, you can budget a safe withdrawal rate for 30 years or more.
What is the best way to start investing for retirement? ›
A great way to save for retirement is in a retirement savings account. That's because retirement-specific accounts like IRAs and 401(k)s were created specifically to give people incentives to save for retirement.
What is the 7% withdrawal rule? ›
The 7% rule involves withdrawing 7 percent of your retirement savings each year. This strategy carries higher risk, especially during market downturns. It can lead to faster depletion of funds compared to more conservative approaches like the 4% rule.
At what age is 401k withdrawal tax-free? ›
401(k) withdrawals after age 59½
Once you reach 59½, you can take distributions from your 401(k) plan without being subject to the 10% penalty. However, that doesn't mean there are no consequences. All withdrawals from your 401(k), even those taken after age 59½, are subject to ordinary income taxes.
How do you impress an angel investor? ›
Angel investors want to see a clear vision for a high-growth business with a large potential market. Your pitch should succinctly explain the problem you're solving, your solution, the market opportunity, your business model, and your team. Focus on the key differentiators that will make your business stand out.
There's far more risk investing in a business when it's only a good idea, and angel investors typically ask for at least a 20% stake in the business; some may ask for as much as 50%.
Do most angel investors lose money? ›
50%-70% of individual angel investments result in a loss of some capital, according to the most authoritative academic data; the same is true for VC deals. and in any dataset there will be “unlucky” investors in the left hand tail of the distribution and some “lucky” ones in the right hand tail.
What is the smallest angel investment? ›
Angel investors are high net-worth individuals who invest on their own or together as a group in seed– or early-stage businesses. Initial investments are usually between $100,000 and $500,000, although they can be as low as $25,000.
What is a typical angel investment amount? ›
Most angel investors invest anywhere from $25,000 to $100,000 per deal, with the average return being somewhere in the range of 20–30%.
Can I invest money from my 401k? ›
You typically can't invest in specific stocks or bonds in your 401(k) account. Instead, you often can choose from a list of mutual funds and exchange-traded funds (ETFs). Some of these will be actively managed, while others may be index funds. So what kinds of funds and investments can you expect to see?
Can you donate stock from 401k? ›
It is always possible to donate retirement assets, including IRAs, 401(k)s and 403(b)s,1 by cashing them out, paying the income tax attributable to the distribution and then contributing the proceeds to charity. In many cases, though, there is little to no tax benefit associated with this type of donation.
What investments are allowed in a 401k? ›
401(k) Investment Options
The employee can choose one or several funds to invest in. Most of the options are mutual funds, and they may include index funds, large-cap and small-cap funds, foreign funds, real estate funds, and bond funds. They usually range from aggressive growth funds to conservative income funds.
Do millionaires invest in 401k? ›
Do Millionaires Use 401(k)s? Plenty of millionaires and superrich people use 401(k) plans to build wealth. But they don't necessarily put all their eggs in one basket. They may also supplement their 401(k) savings with IRAs, taxable brokerage accounts, annuities, real estate, and other investments.
