In order to participate in the private equity markets, individuals are required to meet the definition of an “accredited investor.” This definition was traditionally based on an individual’s level of income or overall net worth.
Specifically, an individual must have a net worth of at least $1 million (excluding the value of a primary residence) or annual income of at least $200,000 for the last two years (or $300,000 combined for married couples) to be considered an accredited investor. This high threshold has kept many investors from potentially benefitting by investing in the private capital markets.
Going Beyond Financial Thresholds
The Securities and Exchange Commission (SEC) recently adopted a change to this definition that will take effect on December 9. The new definition will go beyond these net worth and annual income thresholds and include defined measures of professional knowledge, experience or certifications. As a result, investors who are able to demonstrate a certain level of financial sophistication will be able to further diversify their portfolios with private equity and other private market alternative assets.
In announcing the new accredited investor definition, the SEC said that it does not believe wealth should be the sole means of establishing financial sophistication for purposes of the accredited investor definition. “Rather, the characteristics of an investor contemplated by the definition can be demonstrated in a variety of ways,” according to a statement from SEC Chairman Jay Clayton.
“For the first time, individuals will be permitted to participate in our private capital markets not only based on their income or net worth, but also based on established, clear measures of financial sophistication,” the statement added. The amended accredited investor definition is part of the SEC’s “ongoing effort to simplify, harmonize and improve the exempt offering framework, thereby expanding investment opportunities while maintaining appropriate investor protections and promoting capital formation,” said the statement.
New Qualification Criteria
The amendments to the accredited investor definition in Rule 501(a) of Regulation D add a new category to the definition that permits natural persons to qualify as accredited investors if they possess certain professional certifications, designations or credentials. These include Series 7, Series 65 and Series 82 licenses. The SEC said it plans to reevaluate or add more certifications, designations or credentials in the future.
In addition, the amendments also add “spousal equivalents” to the accredited investor definition. This will enable spousal equivalents to pool their finances in order to meet the net worth and annual income thresholds to qualify as an accredited investor.
The amendments also broaden the accredited investor definition with respect to certain entities like limited liability companies (LLCs) and family offices. LLCs with at least $5 million in assets and family offices with at least $5 million in assets under management (along with their family clients) will be considered accredited investors after December 9.
Notably, the amendments did not raise the financial thresholds for qualifying as an accredited investor. These thresholds — $1 million in net worth (excluding a primary residence) or $200,000 in annual income for the last two years — were set in 1982 and have been eroded by inflation, many believe.
Opening New Opportunities
The amended definition of an accredited investor will open up opportunities for some individuals to invest in alternative assets like private equity and hedge funds. As the name implies, these investments are alternatives to the regular asset categories of stocks, bonds and cash equivalents. Broadening your investing horizons to include alternative assets can help you increase your returns by tapping into the full potential of the investment universe.
It can be especially beneficial to invest in alternative investments using a self-directed IRA instead of discretionary funds. Investment income and capital gains are tax-deferred if held in a traditional IRA, and they’re tax-free if held in a Roth IRA. However, they’re taxed at ordinary income tax rates if held in a taxable (or non-retirement) account.
The lack of liquidity of some alternative assets also makes them good candidates for self-directed IRAs, given the long-term nature of retirement investing. This includes private equity and hedge funds, which can only be liquidated during certain time periods. And by investing in alternative assets using a self-directed IRA, you’re able to free up taxable funds for other purposes.
The information provided in this article is educational content and not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
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