House Democrats’ plan would ban private equity and hedge funds in IRAs

A tax package unveiled by House Democrats would bar individual retirement accounts from holding certain private investments typically reserved for the wealthy.

While supporters believe the proposal would increase investor protection and reduce the use of an IRA as a tax shelter for the rich, critics believe it could spell a big financial blow for some investors – even some daily savers.

House legislation, unveiled last week, would prevent IRAs from holding investments offered to “accredited investors.”

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This status is for investors who meet certain benchmarks, like $ 200,000 in annual income or $ 1 million in equity (excluding a home). It allows them to invest in securities such as private equity, hedge funds and venture capital; they are not publicly traded, unlike mutual funds and stocks available on a public stock exchange.

If passed, the rule would apply to all retirement savers. Current owners are expected to dispose of those IRA holdings by the end of 2023 or lose the tax benefits of the account, which could put them on a big tax bill.

The measure broadly aligns with the overall goals of the tax package, to make the tax code fairer and to raise funds from wealthy Americans to extend the U.S. safety net and make climate mitigation investments.

“IRAs should be about investments that are accessible to everyone, not exotic investments that potentially have a mega-return,” said Steve Rosenthal, senior researcher at the Urban-Brookings Tax Policy Center. “If you want to hold [these] offerings, keep them in your taxable accounts.

Current owners can sell holdings within their IRAs and use the proceeds to purchase a public investment without tax penalties.

However, it can be difficult to sell private stakes within the required two-year time frame, experts say. There may not be a ready market for such investments, possibly causing homeowners to sell at an undesirable price – a potentially unfair outcome for some investors, especially those with modest incomes who have followed suit. all the rules so far, they said.

“It’s like a fishing net,” said Ed Slott, an accountant and IRA expert based in Rockville Center, New York, of the proposal. “The net picks up a lot of small fish which are unintentional targets.”

William Barry is one example. The 52-year-old accountant, a resident of Clearwater, Florida, has taxable income of around $ 75,000 – well below the $ 400,000 income threshold that the White House and Congressional Democrats have generally considered a line dividing line for the rich.

Barry has built up a nest egg of over a million dollars through diligent savings, which makes him an “accredited investor”. He has nearly $ 500,000 locked in private investments in his traditional pre-tax IRA, and has another $ 100,000 investment in the works.

He fears he will have to pay tens of thousands of dollars in additional taxes if he is unable to liquidate his assets within two years.

“[Democrats] keep talking about the mega-rich, ”Barry said. “I’m not the guy with the $ 5 billion IRA. I’m the guy with the million dollar IRA. “

The Securities and Exchange Commission views accredited investors as financially sophisticated and better able to withstand the risk of losing a private offering of securities.

Investments that are not publicly traded do not require as much financial disclosure as publicly traded stocks, bonds, and mutual funds, for example.

Fraudsters also tend to target private markets more regularly, according to Joe Wojciechowski, managing partner at Stoltmann Law Offices in Chicago, who represents investors in fraud cases.

“They are so often the targets of Ponzi schemes,” Wojciechowski said of private investments held in IRAs. “If you do not allow [them], I think it would have a real benefit for investor protection. “

More and more investors have obtained the “accredited” label over time.

The associated income and wealth thresholds have not changed since the 1980s, even to account for inflation. About 1.6% of US households qualified as accredited investors in 1983, according to the SEC. About 13% of households were qualified in 2019.

The legislation of the House may not become law. Even if the Democrats’ tax program is ultimately successful, the policy regarding accredited investors could be removed or changed.

For example, lawmakers can allow existing IRA investors to keep their private holdings intact without penalty or allow a transition period longer than two years to ease the burden on retired investors, according to Rosenthal.