How to Invest in a Credit Fund with an IRA Using a Foreign Blocker

With interest rates on the rise and traditional income sources under pressure, many savvy investors are turning to private credit as a compelling alternative. These funds can offer attractive, stable yields—often backed by real assets or business cash flows. For investors with retirement capital, the question naturally arises: Can I invest my Self-Directed IRA in a credit fund—and keep it tax free?

The answer is yes—but only if it’s structured the right way. That’s where the foreign blocker corporation comes in. In this article, we’ll explain how your IRA can gain exposure to high-yield credit investments without getting hit by unexpected taxes under the IRS’s Unrelated Business Taxable Income (UBTI) rules.

What Are Credit Funds?

A credit fund is an investment vehicle that primarily focuses on lending money or investing in debt instruments, rather than buying equity in companies. The goal of a credit fund is to generate returns through interest income, fees, and the repayment of principal, rather than through capital appreciation. These funds may invest in a wide range of credit assets, such as corporate bonds, private loans, and real estate debts. Credit funds can be structured as mutual funds, hedge funds, private credit funds, or even interval funds, depending on their strategy and investor base.

Credit funds appeal to investors seeking consistent income and portfolio diversification, especially in low-interest-rate or volatile equity market environments. They often carry less price volatility than stocks but come with their own set of risks, such as credit risk (borrower defaults), liquidity risk (difficulty selling certain debt instruments), and interest rate risk (decline in bond prices when rates rise). In recent years, investing in private credit funds—those that lend directly to businesses outside of public markets— using a Self-Directed IRA have gained popularity among institutional and high-net-worth investors for their potential to deliver higher yields with more control over loan terms and borrower selection.

The Problem: UBTI and Your IRA

Self-Directed IRAs open the door to a world of alternative investments: real estate, private equity, venture capital, and credit funds, among others. But many of these asset classes generate UBTI, which is taxable even inside an IRA.

Here’s the catch: IRAs are tax-exempt only as long as they don’t engage in certain kinds of business activity or use leverage in ways the IRS deems problematic.

Credit funds often cross these lines by:

• Originating loans (active business)
• Using leverage (triggering Unrelated Debt-Financed Income, or UDFI)
• Servicing loans (active business operations)

Once UBTI is triggered, the IRA itself becomes a taxpayer and must file Form 990-T. The tax rate can hit 37%, and that’s before any state taxes or penalties for noncompliance.

The Solution: A Foreign Blocker Corporation

The good news? There’s a well-established workaround used by institutional investors—and increasingly, by high-net-worth individuals and their advisors: invest through a foreign blocker.

A Cayman Islands corporation, in particular, can act as an intermediary between your IRA and the credit fund.

Why the Cayman Islands?

There are several reasons Cayman is the preferred jurisdiction:

• No U.S. tax filing (when structured properly)
• Streamlined entity formation and investor protections
• No Cayman income tax, so income flows through cleanly
• Well-regarded globally and widely accepted by U.S. credit funds
• Eligible for the Portfolio Interest Exemption, allowing tax-free interest flow

Think of the Cayman corporation as a protective wrapper. It separates your IRA from any “business activity” happening within the U.S., effectively shielding it from UBTI.

What Does the Structure Look Like?

Here’s how it works step by step:

1. Your IRA invests in a Cayman blocker corporation.
2. The Cayman corporation invests in a U.S. credit fund that:
   • Is structured to be passive (not originating or servicing loans)
   • Holds debt or other income-producing instruments
   • Does not engage in a U.S. trade or business

As long as the fund’s income isn’t considered effectively connected income (ECI) under U.S. tax rules, the Cayman entity avoids both U.S. income tax and filing obligations like Form 1120-F. And because the IRA holds shares in a foreign corporation, it receives income as dividends, not UBTI.

What About U.S. Withholding Tax?

Normally, interest payments to foreign entities from U.S. borrowers are subject to a 30% withholding tax.

But under the Portfolio Interest Exemption, this tax can be eliminated if:

• The loan is a registered debt instrument
• The interest isn’t tied to profits or ownership
• The recipient owns less than 10% of the borrower
• The entity provides a valid Form W-8BEN-E

When these conditions are met, interest payments from the U.S. fund to the Cayman blocker are completely tax free. And since the Self-Directed IRA sits behind the blocker, it receives its share of the returns without UBTI and without U.S. tax withholding.

Why Use an IRA Instead of After-Tax Dollars?

Even without UBTI, interest income from credit funds is typically taxed as ordinary income—meaning up to 37% federally, plus state taxes, when held in a taxable account.

But inside a tax-advantaged IRA, you can escape annual taxes, or eliminate the altogether. When using a pretax (traditional) IRA, there is an upfront tax break and taxes are deferred until you withdraw from the plan. When using a Self-Directed Roth IRA, there is no immediate tax break, but qualified distributions from the plan are tax free!

That’s a huge arbitrage opportunity. Your credit fund income can grow faster, compound over time, and be withdrawn either tax-deferred or tax free, depending on your account type.

An Example:

Let’s say your IRA invests $200,000 through a Cayman blocker into a passive U.S. credit fund earning 10% annually. That’s $20,000 per year in income.

• In a taxable account: You might lose $7,000+ to taxes.
• In an IRA (with a blocker): You keep all $20,000 compounding inside the account.
  • Over 10 years, the difference in after-tax growth will be substantial.

To use this strategy effectively, make sure:

✔️ Your IRA owns a foreign blocker (like a Cayman entity)
✔️ The blocker invests in a U.S. fund that is passive (not a U.S. trade or business)
✔️ The interest earned qualifies for the Portfolio Interest Exemption
✔️ You file the appropriate IRS forms

If those boxes are checked, your IRA can legally enjoy high-yield credit income without triggering UBTI, without paying U.S. withholding tax, and without sacrificing the tax benefits of your IRA.

Conclusion

Private credit is a powerful asset class—and when structured properly, it can be even more powerful inside your Self-Directed IRA. By using a foreign blocker, you can protect your tax-advantaged account from UBTI, avoid U.S. withholding, and preserve the full benefit of compounding returns. This strategy isn’t just for institutions. With the right planning and legal/tax guidance, individual investors can unlock these benefits too.

Frequently Asked Questions