IRA issue

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Jun 26, 2006 3:14 pm

I met with a gentleman a few days ago who has about $450,000 in this 401K.  He wants to start a business, and his original intention was to fund the business through his 401K via distributions.


Obviously, he's looking at massive tax consequences on taking the money (not yet 59 1/2)


I knew that you COULD invest in a privately held business via a self directed IRA (similar to investing in raw land via your IRA), so I did a little research and dug up some specifics...aka type of business structure needed, tax issues, etc.


Anyway, the long and the short of it is there are a couple different options, both of which are much better than simply taking the cash and paying the taxes.


My question is...has anybody done much of this?  Just curious to hear your experiences.

Jun 26, 2006 3:31 pm
BankFC:

I met with a gentleman a few days ago who has about $450,000 in this 401K.  He wants to start a business, and his original intention was to fund the business through his 401K via distributions.


Obviously, he's looking at massive tax consequences on taking the money (not yet 59 1/2)


I knew that you COULD invest in a privately held business via a self directed IRA (similar to investing in raw land via your IRA), so I did a little research and dug up some specifics...aka type of business structure needed, tax issues, etc.


Anyway, the long and the short of it is there are a couple different options, both of which are much better than simply taking the cash and paying the taxes.


My question is...has anybody done much of this?  Just curious to hear your experiences.



Let me see if I have this right.  You have an intricate tax question and you're looking for advice on a "Rookies and Trainees" forum on the internet?


Beam me up, Scotty.

Jun 26, 2006 3:33 pm

Hey newbie, check the forum you're in before you post that.  We're in the "General" forum. 

Jun 26, 2006 3:45 pm
NASD Newbie:
BankFC:

I met with a gentleman a few days ago who has about $450,000 in this 401K.  He wants to start a business, and his original intention was to fund the business through his 401K via distributions.


Obviously, he's looking at massive tax consequences on taking the money (not yet 59 1/2)


I knew that you COULD invest in a privately held business via a self directed IRA (similar to investing in raw land via your IRA), so I did a little research and dug up some specifics...aka type of business structure needed, tax issues, etc.


Anyway, the long and the short of it is there are a couple different options, both of which are much better than simply taking the cash and paying the taxes.


My question is...has anybody done much of this?  Just curious to hear your experiences.



Let me see if I have this right.  You have an intricate tax question and you're looking for advice on a "Rookies and Trainees" forum on the internet?


Beam me up, Scotty.



First off, you're an idiot. 


Secondly, I am not asking for an answer to my "intricate tax" question (I already know the answer), I am simply asking how the experience is/was for others...you know, ACTUAL advisors who do more than push products or play advisor on rr forums.

Jun 26, 2006 3:53 pm

I think there is an exception to the 10% penalty if your client is at least 55 and has separated from employment.  Best part is, you don't have to do 72(t) distributions for 5 years minimum.


Don't quote me on that, but I believe it to be true...

Jun 26, 2006 4:18 pm

He's not yet 55...and regardless, just the ordinary income taxes alone are brutal on the type of distributions he's talking about.

Jun 26, 2006 4:41 pm

This may be a chicken and egg question...but, if he can establish a business and then an owner-only 401k (funded by 450k rollover), he could borrow...but I guess that's still limited to 50k.  So, a very partial solution at best.

Jun 26, 2006 4:43 pm
BankFC:

Secondly, I am not asking for an answer to my "intricate tax" question (I already know the answer), I am simply asking how the experience is/was for others...you know, ACTUAL advisors who do more than push products or play advisor on rr forums.



For those who don't know let's explain what this child does.


The typical bank broker is assigned to three to five branches.  On Monday they're on Elm Street, on Tuesday they're on Oak Street and so forth.


While there they have a little desk--almost like a child's desk--that is over in the corner.  There is a sign that explains that the investments being discussed at that desk are not insured by the bank and may fluctuate in value.


There is a running conflict between the "advisors" sitting at that desk and the bank on several levels.  The "advisors" are constantly trying cute tricks to obscure that warning sign--putting a plant in front of it is a typical trick.  They, the "advisors" are such poor salespeople that they cannot deal with questions such as, "What does that sign mean when it says that values may fluctuate?"


Banks are afraid that the investment "advisor" may convert time deposits in the bank to mutual funds and/or annuities which will reduce the bank's deposits--making it more difficult for the bank to make loans.  Consequently banks have a habit of hiring fairly dull witted people as the advisors--like most broker dealers they give IQ tests.  Unlike most firms they use these tests to identify smart people so they will not be offered a job.


If you work for a real firm you will have home office types who are there to help you with issues such as a guy who wants to know how to use his 401(k) to fund a dream, but he's not yet 55.


If there's a way to do it that home office expert will know.  You won't have to pose the question on an Internet message board where it could be answered right or wrong, by somebody who may or may not even have a securities license much less an understanding of the tax code.


Be very very careful of what you read on the Internet--including what I have to say.

Jun 26, 2006 4:44 pm

Bank FC, check your sources again. The owner of the IRA can invest in a privately held business, (if he wants to pay UBIT) just not his business. He's a party in interest and that's a prohibited transaction. Doesn't matter if he structures it as a C Corp, S Corp, LLP, partnership, sole prop, etc, he is a "disqualified person".

When the transaction comes to light, the IRS treats the amount invested as distribution from the IRA. That makes it taxable ordinary income in the year received. If he's under 59 1/2, there's a 10% premature distribution tax and because it's a prohibited transaction, he gets whacked with a 10% excise tax to top it off.

This is not a pretty sight and you do not want to be in the splatter zone.

Google "IRA prohibited transaction" at the IRS.gov web site for all the gory details.



 

Jun 26, 2006 5:01 pm

Doesn't your client have a CPA or tax advisor? I would consult with him/her and I wouldn't give him any advice in this area as it is tax related and very specialized.  You are an investment advisor, not a tax consultant and are not qualified to advise him on this topic.  If you give him the wrong information even while qualifying the previous statement to him and he acts on it and is hit with fines.....[email protected] is grass. 


As a former commercial lender, I would look very askance at somebody who is liquidating his retirement to fund a speculative business.  First of all, a start up business usually has a high percentage of failure and especially so if the person has never been in business before.  Your client would probably be best served by you introducing him to the bank lending officer and having the client draw up a formal business plan with cost and income projections and have a professional give it the once over.   It may be that he can borrow funds and finance his "dream" until he is in a position to draw on his 401K as a suppliment if at all. By then his dream will either be a reality or a nightmare.


Otherwise I see his 401K doing down a dark and swirling wet orifice.

Jun 26, 2006 5:10 pm

Ok guys...calm down.  Once again, I am not posting asking for ADVICE.  I left out just about every detail imaginable BECAUSE it doesn't matter.  I am speaking in generalities.  I already have the specifics down, and YES, were are working with his CPA.  Ok? 


I was simply inquiring to see if anyone had done this type of transaction.  Obviously few have. 


Ya'll need to get a drink!! 



Jun 26, 2006 5:11 pm
babbling looney:

Otherwise I see his 401K doing down a dark and swirling wet orifice.



Behold, boys and girls, a wordsmith.


Years ago the best man in my wedding dropped about $20 grand chasing interest rate futures.


One evening we were having dinner and I was drawing an inverted yield curve on a yellow pad and trying to explain what was happening.


He interrupted me and grabbed my pen and pad.  He turned to a fresh page and drew a typical spiral--looked up at me and said, "I don't give a schidt about positive or negative yield curves--that's what I see, my money going down the toilet!"


I asked if he was sure that the toilet flushed that way in the northern hemisphere, that it looked like a southern hemisphere vortex.  That broke the tension, we laughed and ordered another beer.

Jun 26, 2006 5:15 pm
NASD Newbie:
BankFC:

Secondly, I am not asking for an answer to my "intricate tax" question (I already know the answer), I am simply asking how the experience is/was for others...you know, ACTUAL advisors who do more than push products or play advisor on rr forums.



For those who don't know let's explain what this child does.


The typical bank broker is assigned to three to five branches.  On Monday they're on Elm Street, on Tuesday they're on Oak Street and so forth.


While there they have a little desk--almost like a child's desk--that is over in the corner.  There is a sign that explains that the investments being discussed at that desk are not insured by the bank and may fluctuate in value.


There is a running conflict between the "advisors" sitting at that desk and the bank on several levels.  The "advisors" are constantly trying cute tricks to obscure that warning sign--putting a plant in front of it is a typical trick.  They, the "advisors" are such poor salespeople that they cannot deal with questions such as, "What does that sign mean when it says that values may fluctuate?"


Banks are afraid that the investment "advisor" may convert time deposits in the bank to mutual funds and/or annuities which will reduce the bank's deposits--making it more difficult for the bank to make loans.  Consequently banks have a habit of hiring fairly dull witted people as the advisors--like most broker dealers they give IQ tests.  Unlike most firms they use these tests to identify smart people so they will not be offered a job.


If you work for a real firm you will have home office types who are there to help you with issues such as a guy who wants to know how to use his 401(k) to fund a dream, but he's not yet 55.


If there's a way to do it that home office expert will know.  You won't have to pose the question on an Internet message board where it could be answered right or wrong, by somebody who may or may not even have a securities license much less an understanding of the tax code.


Be very very careful of what you read on the Internet--including what I have to say.



Lol, you make me laugh. 


Without even knowing you, I can rest assured that I make more money than you, am more respected in my community than you, and am a whole lot smarter than you. 


The smarter you get, the more open you become from LEARNING for others, not attempting (unsuccessfully) to bash them.

Jun 26, 2006 5:15 pm

Did you meet that guy in Hunts Point????? And you later developed a true friendship???? Thats cute...

Jun 26, 2006 5:16 pm

NASD...why do you share your stories?  No friends?

Jun 26, 2006 5:17 pm
BankFC:

I met with a gentleman a few days ago who has about $450,000 in this 401K.  He wants to start a business, and his original intention was to fund the business through his 401K via distributions.


Obviously, he's looking at massive tax consequences on taking the money (not yet 59 1/2)


I knew that you COULD invest in a privately held business via a self directed IRA (similar to investing in raw land via your IRA), so I did a little research and dug up some specifics...aka type of business structure needed, tax issues, etc.


Anyway, the long and the short of it is there are a couple different options, both of which are much better than simply taking the cash and paying the taxes.


My question is...has anybody done much of this?  Just curious to hear your experiences.



You cannot invest in your own business as it is considered self-dealing under ERISA code.

Aside from that issue, you would also have to find a custodian who would be willing to handle the asset, and have very careful accounting for the inflows and outflows of the business.  And...you would have to undergo the expense of having an official independent valuation made of the business every year.

This before we even discuss how stupid it would be to take a large percentage of one's retirement savings and invest it in one single company.

Jun 26, 2006 5:19 pm

I think there is an exception to the 10% penalty if your client is at least 55 and has separated from employment.  Best part is, you don't have to do 72(t) distributions for 5 years minimum.


You lose that exception the moment you roll the 401K funds out of the plan and into a traditional IRA.  The exception holds as long as the client can leave his funds in the 401K or if transfered into another 401K.   If a client wants to take a large distribution from their 401K after separation from service, it should be done before rolling the funds out of the company plan if allowed by the plan.  Many company plans want you to be gone after separation from service (quiting, retiring, getting fired) and won't allow you to hang around.  It costs them money to service your account.


Another consideration for the OPs question. If the client can leave his funds in the plan, he might be able to borrow against his 401K with no immediate tax issues.  Of course he has to pay it back sometime or pay the taxes.  And if he is forced out of the plan, in addition to taxes owed the amount withdrawn will count as ordinary income all in one tax year. It could bump him into a higher tax bracket causing even more pain. 


Still a bad idea either way. IMNSHO.

Jun 26, 2006 5:19 pm
Cowboy93:

This may be a chicken and egg question...but, if he can establish a business and then an owner-only 401k (funded by 450k rollover), he could borrow...but I guess that's still limited to 50k.  So, a very partial solution at best.


Thank God for a legitimate post.


That's actually another alternative...like you said, a partial solution, but better than none at all.

Jun 26, 2006 5:20 pm

Thanks BL and Joe.

Jun 26, 2006 5:23 pm

Lol, thanks to everyone who actually posted something worthwhile.