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The Process of Raising Venture Capital

Key success factors and investment skills

Value to Investors or Strategic Investors and Buyers

Investment Agreements

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Tax-advantaged, or qualified, plans include qualified retirement plans (i.e., 401(k)s), traditional IRAs, variable annuities, and variable life insurance policies and the like. While each type of tax-advantaged investment has its own pluses and minuses, the following advantages and disadvantages apply to each.

With qualified plans, all investment income, such as capital gains, dividends. and taxable interest, is deferred until the owner takes distributions from the plan. At that time, the money is taxed at ordinary income rates, regardless of how long the asset has been held by the owner. Any dividends, taxable interest, or capital gains that would normally be currently taxable under directly owned investments isn’t. The distributions from these plans may be stretched out over many years, thus delaying the payment of taxes and allowing the tax-deferred feature of the investments to continue.

Any changes that are made within the tax-advantaged plan are done so tax free. This means that any selling or exchanging of investments can be done without triggering any capital gains taxes, as long as it is done within the qualified plan. The advantage here is that any asset that has appreciated in value may be sold or exchanged tax free, so as to fully realize the gain. However, any assets that would be sold for a loss are better to be sold outside of the tax-advantaged plan (as a directly owned asset) in order to use the capital loss for tax purposes. Unfortunately, there are some limitations to holding assets in these tax-advantaged plans. For starters, there is no step-up in basis at death for these plans. Second, although the gains in the assets may have been through capital gains, the capital gains tax rates don’t apply when the money comes out. Plus, participants must follow the guidelines of their particular plan when it is an employer-sponsored plan. The employer is also allowed to make changes to the plan for the future.

There are also tax implications for these types of plans. While deferring the gains on these plans is an advantage, pulling the money out and paying taxes on it at ordinary income rates may be viewed as a limitation. (The exceptions to this are Roth IRAs and education IRAs, where the money comes out tax free.) For many people, when they begin to draw from their tax-advantaged plans, they may be paying more in taxes than if they were pulling money out of their directly owned assets. For example, you take a distribution of $20,000 from your traditional IRA. You will pay taxes on this amount at ordinary income levels. However, if you were to pull out $20,000 from your paying capital gains tax on it, either at ordinary income tax rates or at long-term capital gains rates, depending on how long you held the asset.

Additionally, the balances of these plans must be distributed at some point. The government has imposed minimum distribution rules, which require the qualified plan owner to withdraw a portion of the money each year beginning at age 701/2. (This is discussed in more depth later.) However, you may be subject to penalties for early withdrawal of the money, as well as for failing to take any distribution. In most instances, people are not allowed to take distributions from their tax-advantaged plans until they are 591/2 years of age. Failure to comply with this rule results in a 10-percent IRS penalty. If you don’t take any distribution, you will be taxed 50 percent of the required distribution for not taking any out. So, if you were to take out $10,000 when you were 50, you would pay ordinary income tax on the whole amount plus $1000 for the 10-percent penalty. Likewise, if you were supposed to take out $10,000 and didn’t, your IRS penalty would be $5000.