Prohibitive Transaction

[Guest elang]

Is it a prohibitive transaction for a Grandfather to lend money from his Profit Sharing plan to a company that is owned 25% by his Grandson?

[My 2 cents]

If the loan is not going to be repaid, that would make it a prohibitive transaction.

Your question actually should be whether it is a prohibited transaction. The answer to that question would not depend on whether the loan would be a prudent investment of plan assets. My guess is that it would be a prohibited transaction. Would the grandfather make a similar loan from the profit sharing plan to a similar company with which there was no apparent connection to him? The reason for the loan appears to be solely to help his grandson. The profit sharing assets are not available to be applied for personal advantage until after distribution.

[austin3515]

How much is Grandpa looking to loan? If $50,000 or less Grandpa should take a regular participant loan from his account (assuming it allows for participant loans and he is still working). What he does with the money is a moot point. He can then turn around and loan the money to his Grandson's company.

[My 2 cents]

Using the proceeds of a loan or withdrawal would obviously not be a prohibited transaction. Having the plan loan assets to the grandson would be much more likely to cause problems.

[Guest elang]

Hi, thank you for the response.

For clarification, it is a larger loan - $500,000. He is not making the loan to help his grandson, but rather to invest in a company that is in the process of raising debt and has been actively raising debt for the past year. He is aware of the investment opportunity because his Grandson is a minority owner (25%) in the company (he wouldn't be aware of it otherwise); but it is an investment that he would like to make based on the merits of the investment. He just wants to make sure he can do so legally without putting his plan at risk.

I appreciate your help.

[QDROphile]

Grandpa cannot be sure there is no risk. The raising of the credit is a benefit to a 25% shareholder, and generally providing a benefit to a family member is recgnized to be an intangible benefit. The Department of Labor is not forthcoming about where it draws the line, so we cannot say for sure that the DOL would not take issue. The circumstances may suggest that there should be no trouble, but I don't like to argue facts and circumstances when it comes to prohibited transactions.

[austin3515]

I assume rolling the $500K to an IRA would not help, but I think I would ask that question of someone in the know. There are a lot of alternative investment IRA providers, just not sure if the same PT rules apply.

[Peter Gulia]

elang, even if one could be confident that grandson's company is not a party in interest [see ERISA section 3(14) and 3(15)], the loan might be an ERISA section 406(b) prohibited transaction because it might be, indirectly, a transaction between the plan and grandfather because of grandfather's interest concerning his grandson.

Also, each fiduciary might evaluate whether investing $500,000 in one non-diversified debt instrument meets a duty to diversify the plan's investments. What might be sufficiently diversified for a $5 billion plan might be less so for a $5 million plan.

If grandfather wants communications with a lawyer for which the confidentiality privilege belongs to grandfather rather than to the plan, grandfather should pay his lawyer from personal resources, not plan assets.

If you are not that lawyer and you prepare the plan's Form 5500 reports, consider what professional-conduct or tax-preparer duties you might have if the plan does the transaction and you believe that it likely is a non-exempt prohibited exemption.