In fact, beyond investments like real estate, mortgage deeds or notes, which are also allowable with IRA assets, investors are able to use IRA assets to fund or invest in new or existing businesses. IRAs can be funded solely by new contributions, or by rollovers from pension plans like 401(k) plans of former employers. Rollover assets can be particularly useful as they are generally larger in dollar value than single year contribution limits and can be used for a more substantial investment. As with any IRA, there are rules when using these funds, but with the help of experienced professionals who understand the rules, using these funds can significantly open up opportunities for private equity investments.

Private equity investments do not need to be substantial in size to provide significant returns. For example, with startups, founders' stock is very inexpensive. Although not necessarily typical, some investors have turned less than $1,000 in founders' stock into multiple millions in a very short timeframe, as they take their businesses from the point of inspiration to operation, and then to an IPO. Along the way, as a product, service or idea evolves, the value of the business can multiply dramatically.

New investors brought in at subsequent stages of the business's development pay a much greater cost in terms of the purchase of stock, elevating the value of the founder's stock as well. Thus, a very small investment through a retirement account like a self-directed IRA can literally increase the value of a person's retirement funds overnight. The result is made even more impressive and valuable when the investment is made through a Roth IRA, which allows the increased value of the account to be withdrawn tax-free. There are of course 'rules of engagement' to understand and it is advisable that investors work with professionals familiar with these types of investments to ensure they don't encounter any snags along the way, but using self-directed IRA assets to invest in private equity remains a very viable, and potentially very profitable, opportunity worth exploring.

Now before you place your entire retirement savings on the line behind the brainstorm of an entrepreneur, a word of caution is in order. I remember from my college economics thesis that less than one in seven new businesses survives to its fifth anniversary. In fact, speaking from personal experience, the future of my own company was in doubt through its fourth year, when it finally broke even, and multiple rounds of equity financing were needed to keep it afloat in those early years. So I would never advocate betting the ranch in the form of your retirement account on a business purchase or a new venture. Of course, a more established business poses a much lower risk than a startup, and consequently, the entry cost is higher for an existing company with a positive income statement and balance sheet than it is for a conceptual proposal from an entrepreneur convinced he has the idea for next stock market "rocket"!

What is the process like? Let's assume your friend wants to start a business with a product that loads, washes, unloads, and restacks dishes, eliminating the drudgery of that process through machinery reminiscent of the automat (if you were born after 1970 you may have to look this term up!). He needs funds to get started and approaches you for some seed money. He has yet to form his company and needs sufficient funds to develop a prototype product, perform market research, develop a formal business plan and private placement documents, etc. You see this as a good investment opportunity and decide that you will invest some personal funds and a small amount of money from your Roth IRA.

You will need to move or fund your Roth IRA with a company who will act as custodian and administrator for your IRA and that allows, and can handle, the administrative details of investments in startups like your friend's. Once your IRA is established you simply instruct the custodian to invest it, or a portion of it, into the company he is forming (e.g., No More Dish Washing, Inc.). We will need to see certain documentation indicating the entity has been legally formed and that you and/or your Roth IRA are founding members. Once invested, you cross your fingers and hope for the best! Unless you are also have personal dealings with the company, something that is more complicated when your IRA is involved as an investor (as I will discuss later), your job is over and your friend's is just beginning as he works to fulfill his dreams and his investors'.

I have to interject some of the details that are essential in allowing your Roth IRA (or any other IRA or pension plan) to invest into such an arrangement while avoiding a prohibited transaction, as defined as a transaction between a "disqualified person" and a plan or IRA. Generally stated, a disqualified person includes the IRA owner, the IRA owner's spouse, descendants, ascendants, fiduciaries or any entity in which the sum of disqualified persons' equity interest is equal to 50% or more. Thus, if at the time of the transaction between the No More Dish Washing, Inc. and your Roth IRA, you already own 50% of the business personally (even if the cost of your ownership was a mere $500), your IRA cannot invest because it would be entering into a prohibited transaction, which could result in taxes and penalties and possibly even invalidate your IRA entirely. On the other hand, it can be perfectly legal for you to co-invest with your IRA provided that you follow the rules. In fact, there is a seminal legal case called "Swanson" and a Department of Labor (DOL) ruling called 2000-10A that provide legal support for doing so.

Unfortunately, I've seen many a wealth-building plan with great potential go awry because neither the investors nor attorneys working on their behalf understood the rules and, therefore, made some simple mistakes that ultimately precluded the IRA's ability to invest. This could be true when the investor who is investing his IRA also intends that the company have dealings (such as a lease) with the IRA investor or another "disqualified person".

While it is not possible here to explore all of the steps that must be followed to allow for this type of dealing, let me first say that it was easier prior to 2004. Prior to events in 2004, it appeared much easier for an operating company (defined as a firm providing goods and services such as a dry cleaner or gas station, for example, or engaged in venture capital investing or real estate development business) to deal with a disqualified person, provided that there were other non-related (non-disqualified persons) also invested in the company and who approved the dealings. Bringing other investors into the operating company avoided the company being viewed as a "plan asset" entity (one in which the entity's assets are treated as plan or IRA assets). These rules can be complex for the layman but are well understood by most pension attorneys. Sure, there were other rules to be concerned about to avoid self-dealing (e.g., the exclusive benefit rule, which means that the purpose of the IRA's investment was to benefit itself by making a good investment and not just benefit its owner), but these were relatively straightforward.

Things can get even trickier if the IRA owner/investor plans to work in the company in which his IRA invests and be paid a salary. Although there is no case history on such a scenario, nor any IRS or DOL ruling or notice opining on this approach, some practitioners might say that such scenarios would not create prohibited transactions, if ever challenged, provided that, 1) the level of the IRA investment is not commensurate (e.g., nominal) in relation to the salary drawn, so that the purpose of the investment is designed for a return on the investment and not to benefit the IRA owner in the form of salary compensation, and/or, 2) that all the control for employee hiring and pay are independent of the IRA investor. This, however, is not a bright-line issue, because there is no legal precedent addressing it. Anyone considering such a scenario, therefore, would be well advised to consult a qualified attorney before proceeding.

Enter some specific cases: IRS Notice 2004-8, Department of Labor Advisory Opinion 2006-01A, and the Rollins Tax Court case. These three legal developments have created concern by many attorneys that structures and investment scenarios that were felt to be within the rules were now in question. Simply stated, while 2004-8 was mainly aimed at Roth IRA abuses, it raised concern for all IRA transactions.

In addition, while neither the Rollins case nor 2006-01A involved directly prohibited transactions, and both involved fair or favorable business terms, they did not stand the Department of Labor's (the government body responsible for interpreting the prohibited transaction rules) tests for self-dealing. Thus, much more can be involved in structuring an investment scenario where the entrepreneur wants to deal with the business his IRA helps to fund while still avoiding a prohibited transaction. For example, the operating agreement of the LLC or the Articles and by-laws of a "C" corporation for such a startup would have to take the IRA owner out of the control position, and voting rules would have to be memorialized in the company's operating procedures such that salary and employment were entirely determined by independent decision makers and provided that the dealing is not preordained or prearranged.

In providing some details on rules to follow and precautions to take, I want to make sure that you are not scared off from any valuable investment opportunity. Like with most truly beneficial endeavors, you should be aware of the rules and know who can help guide you along the way. In fact, it is essential to involve an attorney who is very familiar with these rules, to avoid any inadvertent rule violations. Nevertheless, capitalism is not dead: more than 25 million small businesses currently exist in the U.S., and hundreds, if not thousands, are formed every day. Opportunities are out there.

Self-directed IRAs are an enormous source of capital for these new enterprises with current figures at $4.2 trillion total and growing at $200+ billion per year, particularly due to the increased number of pension plans rollovers into IRAs as the "baby boomers" retire. Whether you are an IRA investor wanting to expand your opportunities for IRA wealth potential, or an entrepreneur seeking new venues for capital, don't overlook the tremendous opportunity to grow American businesses through IRA funding. Simply find a good pension or business law attorney and use the services of an experienced and qualified custodian to help make your dream a reality.

The foregoing is a general discussion. It is not intended as, and may not be relied upon as, tax, legal, investment or other advice. Readers desiring such advice should consult their own advisors.

Tom Anderson is the CEO & Founder of PENSCO Trust Company . For over 18 years, PENSCO Trust has provided premier service in the custody and administration of IRAs and retirement accounts invested in non-traded assets, such as real estate and private placements. Contact PENSCO Trust for more information at (866) 818-4472 or online at www.penscotrust.com.