Does your ROBS plan allow alternative 401K investments? A new client came to with an existing ROBS plan created by one of the big promoters. He wants to invest funds from his plan into a privately held LLC. The promoter told him he could not make that investment. It is allowed, if one follows the rules. Should your plan include alternative 401k investments? Different discussion.
Alternative 401K Investments
A 401K plan is not allowed to invest into life insurance contracts, collectibles, entities that are disqualified persons (other than the parent company under the qualified employee securities exemption). Real estate is typically not a good idea either.
The issue many ROBS clients will discover, however, is that the generic plans created for them by the ROBS promoters do not allow for alternative 401K investments. The client mentioned above found an LLC which appealed to him as an investment opportunity for his plan. He was told by his plan record-keeper that he could not make that investment. True, under the plan as they designed it. They did not tell them whether a plan may make that investment, just that he could not. Then he found me.
His plan is now with a third party administrator who amended his plan and is handling most of the paperwork. I am helping with some board resolutions and stock ledger update. Easy, not necessarily simple.
When a plan invests into the sponsoring corporation, that corporation is not under any restriction from what it may or may not do with those funds. The corp just follows generally accepted accounting principles and the tax code. The corporation’s use of the plan’s money will reflect in the stock price which is the plan assets. The corporation may buy life insurance for executives, for example, something prohibited for the plan to do directly.
The Corporation may invest into an LLC for which the client is the manager. The plan may not. Before amending his plan, the client and I discussed his involvement with the target LLC. He is not a member, manager or employee of the target LLC. Excellent. Not a prohibited transaction issue.
Pass Through Tax Status
People often overlook this issue when making alternative plan investments. An LLC may be set up to pay its own taxes or to pass that responsibility on to its members. However, one should not pass business income through to the 401k plan. May the plan file a return and pay the tax on the business income? Perhaps. Plans do not have deductions, have a high tax rate and the payment must come from plan funds, not personal or company funds. I strongly recommend not investing into a pass through LLC that creates business income.
Same as always. Cookie cutter plan from a ROBS promoter or their plan record-keeping not working out well for you? Give me a call. You might have more options than they present.