By Kris Kjolberg, Managing Director and Head of Capital Strategy, Pravati Capital
As private-market investments become increasingly accessible to qualified investors, wealth advisors are encountering new questions about how alternative assets fit within their clients' retirement strategies.
While private credit, private equity, real estate and specialized asset classes such as litigation finance may offer differentiated investment opportunities, accessing them through an individual retirement account introduces considerations beyond those associated with a traditional brokerage portfolio.
I recently explored many of these issues with Mat Sorensen, CEO of Directed IRA and author of "The Self-Directed IRA Handbook," during an educational webinar on self-directed retirement accounts. Our discussion reinforced an important distinction: The ability to hold an investment in an IRA doesn't necessarily mean it's appropriate for every retirement portfolio.
Not all IRA custodians accommodate private-market investments. While certain alternative assets may be permissible under IRA rules, conventional brokerage platforms often restrict investments that cannot be administered through their standard systems.
A self-directed IRA can provide access to a broader range of eligible assets, including private funds. However, the account remains subject to applicable retirement account rules and restrictions.
Confirm that the proposed investment is permissible within the account structure, and the custodian can administer the asset before proceeding with subscription documents or transferring funds.
Investors may be able to transfer all or part of an existing IRA to a self-directed IRA without triggering a taxable distribution when the transfer is handled properly.
Retirement assets held in employer-sponsored plans introduce additional considerations. Former-employer 401(k) balances may be eligible for rollover, while access to funds in current-employer plans depends on plan rules and the participant's eligibility.
Advisors should also consider whether transferring assets will affect the client's existing investment allocation or leave sufficient liquid assets available elsewhere in the retirement portfolio.
Review the source of funds, applicable transfer or rollover requirements and the implications for the client's overall retirement asset allocation.
One of the most important issues that Sorensen emphasized involves prohibited transactions and disqualified persons.
Under applicable IRA rules, certain transactions involving the account owner, specified family members and other disqualified persons are prohibited. For example, investors generally cannot use an IRA to purchase an asset directly from themselves or use IRA-owned property for personal benefit.
These restrictions can be particularly relevant when investors pursue private transactions involving businesses, real estate or other assets with which they have a personal connection.
Identify any potential relationships between the investor, the IRA and the parties involved in the transaction. Where questions arise, obtain qualified tax or legal guidance before proceeding.
Private-market investments generally involve more documentation than purchasing publicly traded securities.
Sorensen identified an incorrectly completed subscription agreement as a common operational issue. When an IRA makes a private investment, the account — not the individual investor — must be identified as the owner of that investment.
Investment documents, funding instructions and subsequent distributions must reflect the appropriate account ownership structure.
Coordinate with the IRA custodian and investment sponsor to verify account ownership, subscription documents and funding instructions before committing capital.
Many private-market investments involve multi-year commitments, limited redemption opportunities or uncertain distribution schedules.
While retirement accounts often have long investment horizons, advisors should not assume that retirement assets can remain illiquid indefinitely. Required minimum distributions, planned withdrawals, unexpected financial needs and the client's overall retirement timeline can create liquidity demands.
The nature of the underlying investment matters as well. In litigation finance, for example, legal proceedings and settlement timelines can affect when capital is returned. Similar timing uncertainties may arise in other private-market strategies.
Evaluate anticipated holding periods, redemption restrictions, potential delays and the availability of liquid assets to meet future retirement account obligations.
The ability to access a private investment through a self-directed IRA should never be confused with an endorsement of that investment.
As Sorensen explained, a self-directed IRA custodian generally administers the account and processes authorized transactions. It does not serve as the investor's investment advisor or determine whether a particular opportunity is suitable.
That makes independent evaluation essential.
Depending on the asset class, due diligence may include reviewing the manager's experience, investment strategy, underwriting process, portfolio concentration, fees, valuation methodology, collateral arrangements and potential sources of loss.
For example, law firm portfolio financing may involve evaluating financial strength, historical settlement activity, case concentration and repayment characteristics. Other private-market strategies require similarly specialized evaluation.
Assess the investment on its merits, independent of the account through which it is accessed. Understand what drives returns, what could impair performance and how the investment fits within the client's broader portfolio.
Self-directed IRAs retain the general tax characteristics of their underlying account type, but investing in private assets can introduce additional complexities.
Depending on the investment structure and activity, considerations may include tax reporting, account valuations, prohibited transaction rules and potential tax obligations within the IRA itself.
Investors and advisors should also understand how income and distributions are handled. When an IRA owns a private fund investment, distributions generally flow back to the retirement account rather than directly to the individual investor.
Consult with the custodian and qualified tax professionals to understand the investment's reporting requirements, potential tax consequences and ongoing administrative obligations.
Kris Kjolberg is managing director and head of capital strategy at Pravati Capital, leading allocator engagement, fund positioning and strategic partnerships.
Pravati Capital is an SEC-registered investment adviser and has no financial relationship with Directed IRA. This article is for educational purposes only.
