Section 501(a) pension transfers

[Wayne Brasch]

Are any of you familiar with anything about Section 501(a) pension transfers where taking money from an IRA or 401(k) for the purpose of establishing a new business avoids the 10% early withdrawal penalty? If so, would you please tell me a little more about it? Thank you in advance for any information you may provide.

Wayne

[OldJack]

I have never heard of such exemption and I think you are confusing the withdrawal of retirement money to purchase a home for a first time buyer. I don't believe there is such an exemption to avoid income tax or the penalty. Here is the statute you quote and it has nothing to do with a new business, as you can see it is the statute that generally exempts a not-for-profit organization from taxes.

-STATUTE-

USC Sec. 501 (a) Exemption from taxation

An organization described in subsection © or (d) or section

401(a) shall be exempt from taxation under this subtitle unless

such exemption is denied under section 502 or 503.

[JohnH]

Jack; They exist, but I understand it's a minefield. I've read a few articles about Pension Transfer Trusts - mainly from promoters of the strategy for buying franchises, but haven't done any real research and haven't actually been involved in one. Here is a link to a promoter - not an authoritative resource but maybe a way to begin gathering info. It seems that I recall one of the major drawbacks being the investor can't draw a salary or any type of compensation from the business in which the plan assets are invested.

http://www.pensiontransfers.net/_wsn/page5.html

[jainen]

>>An organization described in subsection © or (d) or section 401(a) shall be exempt from taxation<<

There is a scheme out there that supposedly takes advantage of this. For a handsome fee, the company will establish a new retirement fund that you can transfer your pension into. Then the rollover fund invests in your project! Voila--tax-free money to start a new business (which statistically has an 85% chance of failing within the first two years, thus risking your future for an unlikely profit).

[Wayne Brasch]

Jack; They exist, but I understand it's a minefield. I've read a few articles about Pension Transfer Trusts - mainly from promoters of the strategy for buying franchises, but haven't done any real research and haven't actually been involved in one. Here is a link to a promoter - not an authoritative resource but maybe a way to begin gathering info. It seems that I recall one of the major drawbacks being the investor can't draw a salary or any type of compensation from the business in which the plan assets are invested.

http://www.pensiontransfers.net/_wsn/page5.html

JohnH,

Some people had come to me after being directed to the website you highlighted. They said their accountant said this was the thing to do. I looked over the website and am still very skeptical. I told them they better be careful in this matter. Thank you for your information.

Wayne

[Wayne Brasch]

I have never heard of such exemption and I think you are confusing the withdrawal of retirement money to purchase a home for a first time buyer. I don't believe there is such an exemption to avoid income tax or the penalty. Here is the statute you quote and it has nothing to do with a new business, as you can see it is the statute that generally exempts a not-for-profit organization from taxes.

OldJack,

I'm not confusing the withdrawal of retirement money to purchase a home for the first time buyer. This is a different situation as outlined at this website: http://www.pensiontransfers.net/_wsn/page5.html.

Wayne

[OldJack]

The website info all looks good but I would not go there with a qualified retirement plan.

Five basic steps to small business funding:

We form a closely-held business corporation in your behalf.

The corporation adopts a tax-deferred trust and replacement plan.

Funds are then transferred from your existing custodian into your new trust bank account.

The trust buys stock in your new corporation.

The corporation is now cash rich and debt free.

The 5 steps look like a plan to evade taxes to me. The last step says the C-corp would be debt free. I guess if you don't consider equity due shareholders as a debt that would be true. It is interesting, and I don't understand, that step 2 requires the C-corp to adopt a tax-deferred trust and replacement plan.

I think they are pushing the concept with misleading information, such as showing their determination letter for the trust as meaning something more than just the fact that they established a trust.

[joanmcq]

It looks to me as though the code section was established to allow retirement plans to hold company stock or to establish a profit sharing plan. This is through a self-directed IRA. Clients of mine came in asking about doing this to help finance a B & B they want to start, and I was extremely skeptical, especially of the no self dealing requirement of a self directed IRA. They had Guidant Financial pitching to them.

[kcjenkins]

The biggest problem is that a self-directed IRA can not invest in a business that the beneficiary runs, and most of these 'pitches' include setting up some slight-of-hand to hide the self-dealing. Besides, I would never advise a client to even consider such a deal, even if it were legal, tax wise. Because this is their 'safety net', their retirement income, and way too many new businesses go under in the first five years. That is NOT the money they should be gambling with. If the business is a sound one, they should be able to get normal financing for it. If they can't, they should be thinking again about why the bankers don't think it's a viable investment.

[Gail in Virginia]

The biggest problem is that a self-directed IRA can not invest in a business that the beneficiary runs, and most of these 'pitches' include setting up some slight-of-hand to hide the self-dealing. Besides, I would never advise a client to even consider such a deal, even if it were legal, tax wise. Because this is their 'safety net', their retirement income, and way too many new businesses go under in the first five years. That is NOT the money they should be gambling with. If the business is a sound one, they should be able to get normal financing for it. If they can't, they should be thinking again about why the bankers don't think it's a viable investment.

Amen, KC. I also get nervous about 401(k) investments that are too heavily in company stock. The person's normal job income is already riding on the health of the company they work for, and many of their benefits are tied to it - do they really want to put all their eggs in one basket by investing the retirement savings in it as well? It might work out, but not always. I think diversification should be emphasized more even for small investors.

[OldJack]

Then there is the problem that the trust owns 100% of the common stock in the new business and therefore is running the business with the beneficiary wanting a salary and employee benefits. Thus, the beneficiary is directly or indirectly benefiting from the trust.

The first prohibited transaction in the code is when the trust "(1) lends any part of its income or corpus without receiving adequate security and a reasonable rate of interest" [§503(b )(1)]. Would 100% of the common stock of a new business provide any security when the new business has no assets other than the investment from the trust? I think not. Would common stock of a new business be providing a reasonable rate of interest? Common stock does not pay interest.

The second prohibited transaction in the code is "(2) pays any compensation in excess of a reasonable allowance for personal services actually rendered"[§503(b )(2)]. Would the beneficiary employee of the business work for a reasonable wage? What is a reasonable wage? Is it what the IRS auditor determines or what the beneficiary employee had paid himself?

But more important is the sixth prohibited transaction "(6) engages in any other transaction which results in a substantial diversion of its income or corpus to; the creator of such organization (if a trust); a person who has made a substantial contribution to such organization; a member of the family (as defined in section 267(c )(4)) of an individual who is the creator of such trust or who has made a substantial contribution to such organization; or a corporation controlled by such creator or person through the ownership, directly or indirectly, of 50 percent or more of the total combined voting power of all classes of stock entitled to vote or 50 percent or more of the total value of shares of all classes of stock of the corporation [§503(b )(6)]. If this 6th prohibited transaction does not apply to this scheme, then I would certainly not think it would apply to most any other situation.