Using 401K rollover to loan to unrelated company
I have two clients that want to do business with each other. The one client has an existing business that is in need of funds to expand. The other client is an individual with a rollover 401K account in cash ($150,000). The latter client wants to loan money to the aforementioned company over a period of 5 years. The interest (or dividends if structured as a stock purchase) will be 1.5% of the business gross income paid monthly. At the end of the 5 yrs the principal is repaid. Collateral is 51% of the stock.
How can this be done legally? We’ve been given two potential options. 1) Self directed 401K: Transfer funds to a 401K trust acct; create a corp; buy that corp’s stock with the 401K funds; invest in the company mentioned above; annually required valuation and filing of form 5500
2) Self-directed IRA: Not clear how this works but it appears that, as long as the 401K owner has no interest in the business where he will be loaning the funds, this may be allowed.
Why are we asking you: We cannot find anyone who really knows the answer. Most nos; some yeses but no one is certain that we have talked to. Referred by Martin Pate with Merril Lynch in Houston.
If this can be done, can you guide us and, if yes, what are the details and the fees?
Thanks,
Tom Crayton, CPA
Sugar Land, TX
Permalink Submitted by Alan Spross on Thu, 2010-07-15 19:17
What you refer to as a “rollover 401k” sounds like it is really a “rollover IRA” from a 401k plan.
These types of IRA investments can be done if all the potential prohibited transaction pitfalls are successfully addressed. It does not sound like the business client presents a problem with respect to a “disqualified person” with respect to the IRA.
But in the end, this can only be done with the full support and assistance of a self directed IRA custodian, and there are perhaps a half dozen large and successful such custodians. Some of them specialize in real estate investments, so it seems wise to seek out those who can provide support for corporate loan investments. While Plan 2 seems more simple and direct than Plan 1 with the added complexity of corporate stock, the custodian may have reasons for favoring the first plan (subject to the 401k vrs IRA question mentioned above). These custodians work with many clients and have first hand knowledge of the potential pitfalls and also the current mindset of the IRS relative to the various issues. I would not consider using any custodian who is less than 100% sure that the structure will work and has several clients using the elected structure without incident. As a precaution, the client with the IRA should partition the balance needed for the investment into a single IRA account instead of using a larger IRA with this investment only part of that IRA.
One requirement the custodian will have is to develop a year end value for the IRA every year, and report it to the IRA owner and the IRS on Form 5498. This obviously requires a method to value the outstanding loan balance. Finally, if the IRA owner is subject to RMDs, funds must be left available for the RMDs, either from the subject IRA or other IRA accounts that can fund the total RMD for all IRAs.