STATUTORY AUTHORITIES

Financing your business from your retirement accounts

Because people have always thought of their retirement plans as “untouchable”, the practice of using retirement funds as a source of business capital may seem unusual.

Actually, the federal pension laws allow entrepreneurs to transfer funds from a qualified plan, like a 401(k)or an IRA, into the Pension Transfer Trust Plan. The Pension Transfer Trust Plan is then allowed to purchase stock in a closely-held corporation as long as the IRC and other rules are followed.

With the significant accumulation in 401(k) plans in the last twenty years, the concept of using retirement money to fund a new business has become increasingly popular.

The ERISA Act of 1974

The Pension Transfer Trust Plan is designed in accordance with ERISA Sections 407(b)(1) and 409(e) as a statutory exemption to the prohibited transaction rules under IRS Code Section 4975. For over 30 years now, taxpayers have been allowed to transfer funds from a qualified plan into a new pension plan. The new pension plan is then allowed to purchase stock in a closely-held business under specific guidelines provided by the IRS and the Department of Labor. Proceeds from the sale of this stock can then be used for small business funding, franchise financing, as equity for a SBA business loan, or for other business purposes.

These laws mean a taxpayer can transfer qualified funds into a new pension plan to invest in a business, through the purchase of privately-held stock, without triggering early distribution taxes and penalties.*

Favorable Determination Letter from the IRS

The Pension Transfer Trust Plan has received favorable letters of determination from the IRS multiple times indicating that the plan document satisfies applicable tax-qualification requirements. A copy of the most recent one is available by clicking here.

Department of Labor Letter Ruling

In the DOL’s Advisory Opinion 96-08A issued in June 1996, they advised the purchase of qualifying employer securities by an eligible individual account plan is exempt from prohibited transaction treatment if certain conditions are met.

STATUTORY AUTHORITIES:


There is an exemption to the “prohibited transaction rules” in Internal Revenue Code section 4975 that allows your new pension plan to purchase “qualifying employer securities”. Your CPA or attorney can easily confirm IRC 4975(d)(13) and ERISA 408(e).

  1. IRC 4975(d)(13) and ERISA 408(e): A profit sharing plan can purchase “Qualifying Employer Securities” without being in violation of the prohibited transaction rules.
  2. IRC 4975(e)(8): Definition of Qualifying Employer Securities includes stock of the Employer.
  3. ERISA 408(e): A plan’s acquisition of “Qualifying Employer Securities” which is otherwise a prohibited transaction is exempted from ERISA’s prohibited transaction rules and its limitations if certain conditions are met: the acquisition or sale is for “adequate consideration” (ERISA 408(e)(1)); the plan is an “eligible” defined contribution plan (ERISA 408(e)(3)(A).
  4. ERISA 407(b)(1): ERISA’s limitation on the acquisition and holding of Qualifying Employer Securities (normally 10% of plan assets) does not apply to “eligible individual account plans” (ERISA 407(b)(1)). In addition, these plans do not violate ERISA’s diversification and, to the extent it requires diversification, prudence requirements (ERISA 404(a)(2).
  5. ERISA 407(d)(3): As long as it includes appropriate plan language, a profit sharing plan is an “eligible individual account plan” for purposes of the exemption from the 10% limitation on acquiring and holding employer securities.

ADDITIONAL REQUIREMENTS / SUGGESTIONS TO SUPPORT THE ARRANGEMENT:

 

  1. Participation: Allow each eligible employee to participate in the Plan.
  2. Diversification: If at all possible, do not invest all of the funds into Qualifying Employer Securities. Invest a significant portion into other traditional investments. However, diversification may also be achieved through subsequent annual contributions.
  3. Fair Market Value: You must have some method of reasonably ascertaining a Fair Market Value for the transaction and subsequent valuations for participant accounting purposes.
  4. “Substantial and recurring” contributions: This means your new pension plan will take the place of your old 401(k) or Rollover IRA and that you plan to put money away each year in the form of annual contributions, as much as you can afford to put into tax-free savings.
  5. Sponsor must be a C-corporation: The stock must not be Subchapter-S stock because a retirement trust cannot be a shareholder of a Subchapter-S corporation. An LLC does not issue stock like a C-corporation does, so the plan cannot invest in and be a member of an LLC and still meet the requirements to qualify under the ERISA 408(e) exemption.

* Note: Because the taxpayer is using direct rollover money to purchase shares of stock in his new business, there is no withdrawal; therefore, there will not be a penalty or tax due on the transaction. Retirement plan assets are not being used to run the business, instead, cash proceeds from the sale of stock from the business to the plan are used to run the business. Therefore, the plan owns the shares in the business and so long as the shares are not distributed or liquidated from the Trust, the rollover remains sheltered from taxes by the trust provisions of IRS section 501(a).