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Rollovers as Business Startups (ROBS)

Rollovers as business startups (ROBS)

“One of my clients, who participates in his employer’s 401(k) plan, asked me about an arrangement whereby he could use a tax-free rollover from the plan to start his own new business?  Are you aware of such a scheme?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

Highlights of Discussion

  • Your client is likely referring to “Rollovers as Business Start-Ups” (ROBS). The IRS has commented that promoters in the industry are aggressively marketing ROBS (described below) as a means for prospective business owners to access accumulated tax-deferred retirement funds, without paying applicable distribution taxes, in order to cover new business start-up costs. While the IRS does not consider all ROBS to be abusive tax avoidance transactions, it has found that some forms of ROBS violate existing tax laws and, therefore, are prohibited.
  • Anyone considering a ROBS transaction should consultant with a tax and/or legal advisor before proceeding as there are several issues the IRS has identified that must be considered on a case-by-case basis in order to determine whether these plans operationally comply with established law and guidance. These issues and guidelines for compliance are detailed in a 2008 IRS Technical Memorandum.
  • Here is an example of a common ROBS arrangement.  An individual sets up a C-Corporation and establishes a 401(k)/profit sharing plan for the business.  The plan allows participants to invest their account balances in employer stock. (At this point the business owner is the only employee in the corporation and the only participant in the plan.)  The new business owner then executes a tax-free rollover from his or her prior qualified retirement plan (or IRA) into the newly created qualified plan and uses the assets from the rollover to purchase employer stock. The individual next uses the funds to purchase a franchise or begin some other form of business enterprise. Note that since the rollover is moving between two tax-deferred arrangements, the new business owner avoids all otherwise assessable taxes on the rollover distribution.
  • The two primary issues that the IRS has identified with respect to ROBS that would render them noncompliant are 1) violations of nondiscrimination requirements related to the benefits, rights and features test of Treas. Reg. § 1.401 (a)(4 )-4; and 2) prohibited transactions resulting from deficient valuations of stock.
  • Other concerns the IRS has with ROBS relate to the plan’s permanency (which is a qualification requirement for all retirement plans, violations of the exclusive benefit rule, lack of communication of the plan when other employees are hired, and inactive cash or deferred arrangements (CODAs).
  • The Employee Plan Compliance Unit of the IRS completed a research project on ROBS in 2010. The research revealed that while some of the ROBS studied were successful, many of the companies in the sample had gone out of business within the first three years of operation after experiencing significant monetary loss, bankruptcy, personal and business liens, or having had their corporate status dissolved by the Secretary of State (voluntarily or involuntarily). The full project summary is accessible here.

 

Conclusion

Caution should prevail when considering a ROBS arrangement. Those interested should seek the guidance of a tax and/or legal advisor, and consider the guidance from the IRS’ 2008 Technical Memorandum.

 

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pension benefits
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401(k) and Nonqualified Deferred Compensation plans

 

“My client has a 401(k) excess contribution as a result of a failed actual deferral percentage (ADP) test.  However, he was told he could roll over the excess contribution to another of his employer’s plans.  How could that be; I thought excess contributions were ineligible for rollover?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

Highlights of Discussion

  • You are correct; 401(k) excess contributions are not eligible to be rolled over to an “eligible retirement plan” pursuant to Internal Revenue Code Section (IRC §) 402(c)(8)(b). The term eligible retirement plan is defined as an individual retirement account under IRC §408(a); an individual retirement annuity under IRC § 408(b); a qualified trust; a qualified annuity plan under IRC § 403(a); a governmental plan under IRC §457(b); and an IRC §403(b) plan.
  • However, it is possible that, in addition to the 401(k) plan, your client’s employer maintains a plan that is not an eligible retirement plan, such as a nonqualified deferred compensation plan (NQDC) under IRC §409A.
  • An NQDC plan is an agreement, method, or arrangement between an employer and an employee (or service recipient and service provider) to pay the employee or independent contractor compensation in the future for service presently performed. NQDC plans allow employees to defer compensation until retirement or some other predetermined date. A thorough discussion of NQDC plans is beyond the scope of this writing.
  • NQDC plans are an attractive benefit for highly paid employees because they are free from the contribution limits, participation requirements and nondiscrimination restrictions that apply to qualified plans. Because NQDC plans are not subject to the limitations of qualified retirement plans, they can allow some executives and high-level managers to defer a much larger portion of their compensation than permitted under qualified plans.
  • If permitted under the terms of the plan document, participants may have the option to contribute to the NQDC their excess contributions that occurred in their 401(k) plans. These NQDC plans may be referred to as “401(k) excess plans” or “401(k) wrap plans.” The contribution to the NQDC plan is not a rollover, but is considered an additional type of permissible deferral under the NQDC plan.
  • A best practice would be to get a copy of the NQDC plan document and check to see if there is language in the plan that addresses the ability of participants to defer excess contributions. The consultants at the Learning Center review NQDC plans documents, as well as other types of plan documents, daily.

 

Conclusion

While 401(k) participants may not roll over excess contributions to another eligible retirement plan, it may be possible for them to defer their excesses into a NQDC or 401(k) wrap plan, if one exists. Check the NQCD plan document for accommodating language.

 

 

© 2017 Retirement Learning Center, LLC

© Copyright 2017 Retirement Learning Center, all rights reserved
rules
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Non Spouse Beneficiary Rollovers

“My client, who is a nonspouse beneficiary of a deceased 401(k) plan participant, requested and received a distribution of the inherited account balance.  Can she complete a 60-day rollover?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

Highlights of Discussion

  • No, the IRS does not allow nonspouse beneficiaries to complete indirect or 60-day rollovers of amounts received from a 401(k) plan.
  • If a nonspouse beneficiary wants to complete a rollover of inherited plan assets, he or she must do so through a “direct rollover” to an inherited IRA.  (See IRS Notice 2007-7  Q&A 15). The Pension Protection Act of 2006 introduced this option for nonspouse beneficiaries, effective for 2007 and later years. The direct rollover option for nonspouse beneficiaries applies to IRC §401(a) qualified retirement plans, as well as IRC §§403(b) and governmental 457(b) plans.
  • A direct rollover is a transfer of plan assets from the trustee of the plan to the trustee of the inherited IRA (i.e., a trustee-to-trustee transfer), without receipt by the beneficiary of the assets.
  • A qualified plan can (but is not required to) offer a direct rollover of a distribution to a nonspouse beneficiary, provided the distributed amount satisfies all the requirements to be an eligible rollover distribution.
  • The direct rollover must be made to an IRA established on behalf of the designated beneficiary that will be treated as an inherited IRA. If a nonspouse beneficiary elects a direct rollover, the amount directly rolled over is not includible in gross income in the year of the distribution.
  • The receiving IRA must be established in a manner that identifies it as an IRA with respect to the deceased plan participant and the beneficiary, for example, “Tom Smith as beneficiary of John Smith.”
  • If a nonspouse beneficiary receives an amount distributed from a plan, the distribution is not eligible for rollover, and is includible in income in the year of the distribution.

Conclusion

The plan-to-IRA rollover rules for nonspouse beneficiaries are different than those that apply to spouse beneficiaries. If a nonspouse beneficiary wants to complete a rollover of inherited plan assets, he or she must do so through a direct rollover to an inherited IRA.

 

 

© 2017 Retirement Learning Center, LLC

© Copyright 2017 Retirement Learning Center, all rights reserved