Investment Free for all?!

[justanotheradmin]

Owner wants to allow all legal investments under the 401(k) plan, for all participants. The plan is fairly plan vanilla uses a popular custodian / recordkeeper. The owner wants to invest in some small startup LLCs and wants to use his plan money. Plan has about 40 participants. 

For a whole host of reasons I can think of why this is a bad idea, but I'm not great at articulating them, and don't want to look up citations if I don't have to. 

Does anyone have suggestions for articles, threads, publications that explain why this is such a bad idea? 

There are practical ones - like I don't know if the existing advisor will want to deal with outside accounts. Nor do I know if the pricing at the custodian will change if a large chunk of the assets are moved out. But I'm more interested in things that articulate the risk from a fiduciary and prudence standpoint. 

 

[Larry Starr]

27 minutes ago, justanotheradmin said:

Owner wants to allow all legal investments under the 401(k) plan, for all participants. The plan is fairly plan vanilla uses a popular custodian / recordkeeper. The owner wants to invest in some small startup LLCs and wants to use his plan money. Plan has about 40 participants. 

For a whole host of reasons I can think of why this is a bad idea, but I'm not great at articulating them, and don't want to look up citations if I don't have to. 

Does anyone have suggestions for articles, threads, publications that explain why this is such a bad idea? 

There are practical ones - like I don't know if the existing advisor will want to deal with outside accounts. Nor do I know if the pricing at the custodian will change if a large chunk of the assets are moved out. But I'm more interested in things that articulate the risk from a fiduciary and prudence standpoint. 

 

FWIW, if I had a client who insisted on this, we would tell him to find a new admin firm.

There are a ton of problems, including that he is now responsible for the decisions made by the employees with regard to "bad" things they might buy.  And an investment in an LLC is a bad one; how is it going to be valued?  Is he willing to spend maybe $10k a year for a professional valuation of EACH of his LLCs that would stand up with IRS and in court?  Lots of other problems (like changing capital gains into ordinary income, and more).  Just say no.

[justanotheradmin]

Thanks @Larry Starr. I agree with all the problems you point out, unfortunately firing the client isn't my decision. 

[BG5150]

Also to ask:  would a prudent trustee allow (probably) non-savvy participants access to all sorts of investments, especially ones that a) involve tremendous risk and/or b) are complicated and difficult to understand?

 

[Larry Starr]

2 hours ago, justanotheradmin said:

Thanks @Larry Starr. I agree with all the problems you point out, unfortunately firing the client isn't my decision. 

"It's Good To Be The King"!  

 

[Kansas401k]

justanotheradmin: Here is a bit more ammo for your argument:

1. prohibited transactions can happen pretty easily with unregistered investments unless everyone has a really good handle on what they are doing (and they usually do not);

2. unregistered investments must have 100% ERISA bond coverage, not the 10% required with registered investments;

3. some LLC's can trigger UBIT (unrelated business income tax) in which case taxes are filed under the plan name but the investment owner(s) generally are held responsible for the taxes

4. illiquid investments like LLC's can cause issues down the road if there are not enough liquid assets for fees and RMD's

 

 

[Luke Bailey]

1 hour ago, Kansas401k said:

justanotheradmin: Here is a bit more ammo for your argument:

1. prohibited transactions can happen pretty easily with unregistered investments unless everyone has a really good handle on what they are doing (and they usually do not);

2. unregistered investments must have 100% ERISA bond coverage, not the 10% required with registered investments;

3. some LLC's can trigger UBIT (unrelated business income tax) in which case taxes are filed under the plan name but the investment owner(s) generally are held responsible for the taxes

4. illiquid investments like LLC's can cause issues down the road if there are not enough liquid assets for fees and RMD's

 

 

justanotheradmin,  it can (and has), been done, but Kansas401(k) has a pretty good list of the problems here, to which I will add that theoretically the plan could be involved in a lawsuit regarding the investment, e.g. real estate development.  Doing this, if the plan must, requires really good forms with indemnification provisions.