Participant loaning money to individual as an "investment"

[t.haley]

Self-directed plan participant directed "investment" of portion of his account ($40,000) to individual, secured with a promissory note. Individual has not been making payments for two years. Participant is also a co-trustee. Other trustee not comfortable with this. Have not seen plan document yet, but initial question is whether this is even allowed as an "investment"? Can a participant direct the plan to transfer a portion of his account balance to an individual and "secure" the investment with a promissory note? Is this any different that using plan account funds to invest in a business? real estate?

[QDROphile]

What you describe is feasible if everything is designed and documented correctly. However, it can get uncomfortable, such as the circumstnaces you describe when some serious thinking needs to be done about managing the investment (e.g. how long to wait to foreclose or whether or not it is worth it to spend enforcement money based on prospects of recovery. Also, a very watchful eye is needed with respect to prohibited transactions. Then there is the valaution issue. This is not for the unshophisticated or the timid.

[Lou S.]

We had a client who kept his PS plan going after retirement because ~90% of his investments were 3rd party arms length loans, usually as 2nd mortgages. It was cheaper for him to pay annual admin fee and 5500 filing than to roll them to an IRA and have non-traditional IRA assets subject to hefty trustee fees. He did very, very well with this investment strategy. But he was very savy in evaluating the risks.

That said, we've also seen it blow up on some folks who have tried to do the same. It's not something I would generally recommend to most but as QDROphile correctly points out, nothing in the code that specifically prohibits it. Though the Plan's investment policy might.

[t.haley]

Thank you for the replies.

Regarding the potential prohibition transaction issue - that was one of the first red flags that went up in my mind. The person who received the money is an accountant and previously had common clients with the participant (who owns a TPA business), however, the accountant does no work for the plan or for the participant personally or for the TPA business. The prohibited transaction statute defines a prohibited transaction as between the plan and a disqualified person. Would a participant investment (of the type I described or any investment in a mutual fund, etc.) ever be considered a transaction between the plan and that investment/fund? Maybe if the participant was also an owner of the plan sponsor and the investment was a separate business venture of his. Outside of those type of circumstances, I don't think there could be a prohibited transaction issue.