Using a 401(k) Plan to Finance Franchise Business

[401 Chaos]

I am interested in hearing others' opionions or experience with 401(k) plan products that appear to permit individuals to use their 401(k) plans to invest in / fund the startup of new companies.

My understanding is that an individual looking to start his or her own business can transfer or roll over his or her 401(k) plan balance under a former employer's plan to a new 401(k) plan sponsored by a private company newly established by the individual. The new 401(k) plan then presumably uses the funds to invest / buy shares of stock in the new company. The end result is that the account holder (as head of the new company) gets to use his or her 401(k) funds to finance the new company without having to take a distribution from the plan or having to borrow money from the bank, etc. The stock in the new company remains a plan asset. As I understand it, one such program is marketed by Guidant Financial (among others) and is marketed frequently to those wishing to start their own franchise.

I haven't discussed the legal aspects of all of this with ERISA counsel but i cannot see how this would not raise a host of at least potential self-dealing and prohibited transaction issues. I am also unclear exactly how the plan holds the investment in the company stock--is that an investment option for all plan participants or is there a way to limit that investment option just to the owner's account? Is that treated as an investment in "employer securities/" or is that some pooled plan investment? Does it make any difference if the 401(k) account holder is the only plan participant? Does it make any difference if account holder the sole owner of the business?

My usual instinct is to run from such products but I am intrigued that these appear to continue to be heavily marketed.

[masteff]

Two threads in the past year I can think of have touched on this topic. You seem to have hit on several of the concerns expressed by others.

http://benefitslink.com/boards/index.php?showtopic=38352 (this has a link which can lead to some other threads that might be of interest)

http://benefitslink.com/boards/index.php?showtopic=36288

My personal thought on it is mixed (assuming one takes sufficient care to structure it properly). On one hand, putting a huge portion of a person's retirement assets into a single startup venture is extremely risky and not necessarily the best investment choice (and even worse if you have employees and offer it to them). On the other hand, too many people take taxable withdrawals from their retirement plans to fund these same startup ventures, so at least this is giving them a mechanism to invest the money w/out the immediate tax burden and possible early withdrawal penalty.

[401 Chaos]

Masteff,

Thanks for the links. I promise I did (an obviously deficient) search before posting and came up empty. You make a good point about people doing this by distribution anyway so from a retirement / policy perspective it seems they may end up in the same situation. I guess my only concern would be that the folks that seem to be most interested in these types of arrangements are also the ones least likely to spend money on good counsel and so could find themselves with prohibited transactions and penalties, etc. and not just early distribution costs. Thanks again

[Belgarath]

I've seen some of these in the past. A cursory look at some of the statutes (ERISA 408(e), 407(b)(1). 407(d)(3); IRC 4975(d)(13), 4975(e)(8), probably others I've missed) would seem to indicate that it might legitimately be possible. I wouldn't dare opine any further than that, however - a lot of what is involved is outside of my experience. I'd want expert ERISA counsel involved if I were the client.