Can You Invest In Alternative Assets with a Retirement Plan?

What is an alternative asset?

Alternative assets, also referred to as alternative investments, are any financial assets that aren’t stocks, bonds, or cash. Common alternative assets include real estate, cryptocurrencies, and private equity. Typically, you cannot invest in alternative assets with most regular retirement plans offered by major financial institutions.

To invest in alternative investments, you’ll need a self-directed retirement account like a self-directed IRA (SDIRA) or solo 401k.

Characteristics of an alternative investment

Alternative assets usually are less liquid than traditional assets like stocks, bonds, and cash. In other words, they typically cannot easily be sold or converted into cash. This isn’t always the case, like with cryptocurrencies, but are a common trait when investing in things like real estate or startups. For example, it’s easier and faster to sell shares of Apple than it is to sell shares of a private company you have a stake in.

Alternative assets usually have a lower correlation to standard asset classes, and could be used as a hedge against inflation. They’re also less regulated by the SEC. Some alternative asset classes may have higher risk than traditional assets, but could also provide higher return potentials than something like mutual funds or bonds.

How to invest in alternative assets with a retirement plan

Most retirement plans are technically allowed to invest in alternative assets. However, your limitations are set by your plan provider.

To be able to invest in alternative assets, you must open a self-directed retirement plan. When a retirement plan is self-directed, you open up the door to unlimited investment options. You essentially have checkbook control over your account. If you want to invest in something, you can simply write a check as you would with an investment from your personal account.

A self-directed IRA or self-directed solo 401k are the most common choices.

Self-directed IRA vs self-directed solo 401k

A self-directed IRA (SDIRA) works slightly differently than a self-directed solo 401k.

First of all, the IRA has a much smaller contribution limit in general. You can only contribute $6,000 for 2022 and $6,500 for 2023. If you’re over 50, you can contribute $7,000 for 2022 and $7,500 for 2023. With a solo 401k, you can contribute up to $61,000 for 2022 and $66,000 for 2023. If you’re over the age of 50, you can contribute up to $67,500 for 2022 and $73,500 for 2023.

A self-directed IRA is also more limiting than a solo 401k. Unless you find a self-directed IRA provider that gives you checkbook control, you’ll have to have a custodian make all your investments for you. For example, if you find an investment property that you want to purchase, you’ll give the order to your custodian to write the check and invest in the property for you. If you need to pay a utility bill or just use some of the funds to make a purchase for supplies, you need to make the request to your custodian each time. To make things simpler, many self-directed IRA plan providers will specialize in one specific asset (eg. a crypto IRA).

With a solo 401k, most plan providers will give you full checkbook control. You act as the trustee of the account and can direct your funds the same way you direct your own personal bank account. If you want to invest in a retirement property, you have the power to write and sign the check yourself. If you want to invest in crypto, you can open a crypto account with an exchange in the name of your solo 401k plan.

Most major banks do not offer self-directed retirement plans and limit your investment options to just traditional assets like stocks, bonds, mutual funds, and ETFs.

Rollover your funds to a self-directed retirement plan

If you have funds sitting in an old retirement account like a traditional or Roth IRA, or even a 401k, you can rollover your funds to a self-directed plan and get immediate access to alternative asset investments. There are no taxes or penalties involved with rollovers, and they do not affect your contribution limits. There are no limits on how much you can rollover.

For example, if you have $100,000 sitting in a traditional IRA, and want to start investing in crypto or real estate, you can open a self-directed IRA or a solo 401k. To be eligible for a solo 401k, you’ll need to have some form of self-employment income and not have any full-time W-2 employees that work over 1,000 hours in your business. As long as you meet those two requirements, you can typically qualify for a solo 401k.

Types of alternative investments

The most common types of alternative assets are real estate, cryptocurrencies, private equity, and commodities.

Real estate: When you invest in real estate through a retirement plan, it must be an investment property. You cannot purchase a residential home for yourself through a retirement plan. The best part is that all investment income and profits from your property rising in value go straight back into your retirement account. Taxes are deferred until retirement if you’re investing through a traditional retirement plan; there are no taxes at all with Roth accounts (withdrawals from Roth accounts are tax-free).

Cryptocurrencies and NFTs: Cryptocurrencies and NFTs are considered capital assets by the IRS. Typically when you buy and sell crypto, you have to pay capital gains tax every time you sell for a profit. When you invest through a retirement account, you don’t pay any taxes on the gains. All profits go straight back to your own account where it can get reinvested. Crypto and NFTs can get tricky to keep track of cleanly. You must separate all transactions from your personal account. They must never interact with each other.

Private equity: Private equity includes things like venture capital, growth capital, and acquisitions. The most well-known example of a private equity investment through a retirement account is Peter Thiel buying his PayPal founder shares through a Roth IRA. He purchased all of his founders shares through a Roth IRA, costing him $1,700. In 3 years, PayPal was acquired by eBay, turning his initial investment into $28.5 million. He never withdrew the money and kept investing through his Roth IRA and 20 years later, his balance was sitting at just over $5 billion. Because it’s sitting in a Roth account, he doesn’t owe any taxes at all.

Commodities: Oil, natural gas, cows, and precious metals are all considered as commodities and are allowed to be invested in as an alternative asset class. Commodities are considered a hedge against inflation since there is not a high correlation between commodities and public equity markets.

Other alternative investments include:

Is there any alternative assets you’re not allowed to invest in through a retirement account?

The IRS does not have an official list of alternative assets that you can invest in through a retirement account. They only outline a small list of assets you cannot invest in, which includes collectibles (like art, rare coins, stamps, and alcohol) and life insurance investments.

Investing in alternative assets through a Roth retirement account

Alternative investments can come with higher risks, but can offer higher potential returns. If you’re investing in alternative assets through a retirement account, it’s important to understand the two different types of retirement accounts you can invest through: Traditional and Roth.

Traditional vs Roth accounts

All of the most popular retirement accounts like a 401k or IRA give you tax-free compounding. You never have to pay capital gains on any profits from your account. It all gets reinvested, giving you access to what Albert Einstein called the 8th wonder of the world, compound interest.

The main difference to understand is between traditional and Roth retirement accounts.

With a traditional retirement account, you contribute to your account with pre-tax dollars and receive a tax deduction each year you make a contribution. For example, if you made $50,000 this year and decide to contribute $10,000, your new taxable income would be $40,000. When you make withdrawals in retirement (eligible withdrawal age of retirement accounts is 59½ years old), they’ll get taxed as regular income.

With a Roth retirement account, you contribute to your account with after-tax dollars. Instead of getting a tax deduction, you pay income taxes on the money now. For example, if you made $50,000 this year and decide to contribute $10,000, your taxable income would still be $50,000. However, because you paid taxes when you contributed, your withdrawals in retirement are tax-free.

With the Peter Thiel example above, he invested in alternative assets through a Roth account, his Roth IRA. Therefore, his withdrawals after the age of 59½ are completely tax-free. Had he invested through a traditional retirement account, he would owe income taxes on over $5 billion in gains.

Things to look out for with alternative assets

Here are some key things to keep in mind when you’re investing in alternative assets.