Hard to value assets in one-man plan

[Bird]

Are there any particular consequences to having a small amount of hard to value assets in a one-man DB plan?  ($15K out of $650K.)

It's some kind of private equity; it shows up on a brokerage statement as an alternative investment/held outside the account and they show the purchase price as the value.

That Q on the SF is grayed out for a one-man plan.  Do I just say "give me a true fair market value" and move on or...?  (I'm not the actuary, just the one providing info.)

[John Feldt ERPA CPC QPA]

Regardless of the 5500 handling, the actuary needs the fair market value. Especially if the sponsor wants to contribute the absolute maximum, as undervaluing this asset could set the maximum above the true 404 maximum allowed. Or, if the sponsor wants to contribute the bare minimum, overvaluing this asset could show a minimum that is not truly sufficient to cover the true minimum.

[Larry Starr]

Who was watching this plan?  Who allowed the client to invest in a hard to value asset in ANY plan?  The problem here is the relationship between the client and the consulting firm that is running the DB plan.  

As to the consequences, he theoretically needs to hire someone who specializes in valuation to let him know how much this is really worth; and he needs to do that every year.  And it needs to be someone who's work would stand up to scrutiny (not "his accountant").  One very big reason why it was stupid to do this in the first place.  

PLUS: private equity is bought for the hope of hitting a home run, and then paying only capital gains rate on the increase in value.  Here, he has converted potential capital gain into ordinary income, plus if he did hit a home run, it doesn't provide him any extra benefit (as he would get in a DC plan where the earnings is his).  

So reality: what will happen?  He will probably value it at cost and go on his merry way until something actually blows up. Sheesh!

[jpod]

Larry Star:  Yes, it's a bit problematic, but no need to be so dramatic.  Should he have dipped his toe in the water with this investment outside of the plan?  That probably would have been best, but what's the point in making a speech about this?  Bird is just looking for some suggestions of how to make the best out of a bad situation.

Bird, is $15K what he paid for it, or is it what he seems to think it is worth now?  

[Bird]

Quote

Who was watching this plan?  Who allowed the client to invest in a hard to value asset in ANY plan?  The problem here is the relationship between the client and the consulting firm that is running the DB plan.  

Ouch!  That would be us...even though we explicitly warn them about this when we set up the plan:  "Keep the investments simple - don’t buy real estate or other hard to value investments in the plan!"

The problem is the brokerage firms make it easy to buy this stuff through a brokerage account and even show it on the statements but they are really not held in the account.  Same thing with variable annuities but we can at least get values for them.

On 1/12/2018 at 5:00 PM, jpod said:

Bird, is $15K what he paid for it, or is it what he seems to think it is worth now? 

It's what he paid for it (Nov 2017) and what shows up on the brokerage statement Dec 31 2017 - but they just carry it at the purchase price.

[Larry Starr]

JPod: Starr has TWO r's, it's MORE than a bit problematic, and  the purpose of my "drama" is EDUCATION (I ain't an ASPPA Educator of the Year for nuthin!).  Hopefully, other people who visit these boards will read those comments and remember them the NEXT TIME they are involved in a situation where, for example, a DB client comes to them and wants to invest in XYZ Widgets in their maximized DB plan because it's going to be a big winner.  DB Plans Don't Need Big Winners!  Return OF INVESTMENT is more important than return ON investment in a DB plan.

And all of my speeches have my REAL NAME attached to them, "JPod".  :-)

[Mike Preston]

I'm on Larry's side on this one, jpod.  It sounds like the perfect time for a little client education.  With that said, with the investment ($15k) being so little of the total value, I'd be tempted to see whether there isn't an administrative tack we can take to insulate the client from "bad things".  Calculate a recommended contribution range which establishes the minimum consistent with the investment worth $0 and the maximum consistent with the investment worth what the investor thinks it might be worth (i.e, its highest potential value).  Then do the Schedule SB calculations using the Trustee's best estimate.  Wash, rinse, repeat until the investment is sold.  A slightly lower contribution (if the client wants to contribute the maximum) or a slightly higher contribution (if the client want to contribute the minimum) seems like just the right amount of consequences for investments like this.

[jpod]

Larry Starrr:  Thanks for the education.  Were you also voted Mr. Congeniality of the Year? 

[Brenda Wren]

Just want to chime in on this topic.....IRS Auditor sanctioned my DC client, EZ filer $15,000 (reduced from her original sanction of $25,000) for failure to value a real estate investment at fair market value.  This "failure" created no harm to anyone and RMD's were not an issue. She threatened plan disqualification, not to go away and would find something else if the plan sponsor didn't "accept" the sanction.  She picked up her $15,000 check (9/30/13 as I recall) and went on furlough that evening! Good advice from Larry!  Qualified plans are NOT the place for non-traditional assets.

[Mike Preston]

Brenda, while I don't disagree that fair market value is the appropriate measure, in the case you described I think there MUST have been something else involved other than the fair market value issue.  Otherwise, it should have been a simple matter to request a manager's review where I would expect the IRS Auditor in question would have been convinced to back away somewhat more than indicated.

[Bird]

Thanks Mike for the on-point commentary.  I am not unfamiliar with the problems of hard-to-value assets, and would never allow someone to do this if asked.  Unfortunately, as noted in the original post, brokerage firms make it easy to buy some of these things through a brokerage account and in fact they show up on the brokerage statements, and we only noticed it because we reconcile fully and have a lot of experience picking through statements - I imagine there are a lot of TPAs who just assume the numbers showing up on a brokerage statement are fair market values.

[jpod]

Not an actuary, so I can't quibble with Mike Preston's advice, which seems quite sound.  However, if the client is willing to pay for one good valuation and nip this in the bud once and for all you can probably then get a prohibited transaction exemption from the DOL under the EXPRO rules for the Plan to sell this asset to the client personally.