Alternative Investments in Retirement Plans

Mutual funds, stocks, bonds, and cash investments are the basics in most retirement plans.  But we get calls every week from people who are looking for alternative investments for their retirement plan.  They ask about investing in real estate or gold, or using their retirement plan for business start up cash.  ERISA is pretty flexible with respect to what a retirement plan can invest in.  As a plan sponsor or a plan participant you need to take precautions before choosing an alternative investment for your plan. 

First a few words about what you CAN’T do with your retirement plan account:

  1. No self-dealing.  Plan assets cannot be used to buy, sell, loan or trade anything with a “party in interest” (see below).
  2. No personal use.  Plan assets cannot be used to buy anything that you (or a “party in interest) use or enjoy personally, such as:
    1. Home or office or vacation property or timeshare.
    2. Cars, art, jewelry, gems, or collectibles.
    3. Loans (other than participant loans within specific parameters).
If a prohibited transaction is identified, the transaction must be reversed.  In addition, a penalty tax of 15% of the amount involved in the transaction is imposed on the disqualified person for each year or part of the year in which the transaction remains uncorrected.

The Party in Interest rules that are outlined by ERISA have a pretty wide reach.  The following are considered a Party in Interest to a retirement plan:
  1. The Employer whose employees are covered by the plan and more than 50% Shareholders of the company.
  2. A person providing services to the plan or a plan fiduciary
  3. Family members of people included in “A” or “B” above
    1. Spouses
    2. Children
    3. Parents
    4. Siblings
  4. Shareholders, officers, directors and employees of the company sponsoring the plan
  5. Partners, owners or employees of a party in interest
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Real estate can be included in a plan, but again there are special considerations. REITs and second deeds of trust to unrelated parties are pretty simple.  Unimproved property is a lot like a stock – buy and hold, sell for a profit (hopefully).  Before you jump in to a real estate investment keep a few things in mind:
  1. Rental property and “flipping”
    1. The Plan will not likely qualify for a mortgage, but cash purchases of property may work.
    2. All expenses and taxes related to the property will need to be paid for from plan assets.
    3. The plan is not in the real estate business, so rental income may be considered Unrelated Business Taxable Income (UBTI) and subject to income tax.
    4. Annual independent appraisals are required.
  2. Limited partnerships, Joint Ventures, Private Placements
    1. Make sure that the managing partner is not a Party in Interest.
    2. Annual valuations (aka ERISA valuations) are required.  The K-1 capital account cannot be used for this purpose.
    3. UBTI may also come into play.
  3. Brokerage accounts/managed accounts/hedge funds
    1. For a trustee-directed account the challenge for the plan trustee is to determine the appropriate level of risk to take in the account.  In many cases the trustee and the investment advisor can determine a risk-appropriate strategy that is suitable for the participants in the plan.
    2. For individually-directed accounts the risk involved with these investments comes in the form of the fee disclosure rules.  It is very difficult for the Plan Sponsor to meet the DOL fee disclosure requirements when a participant has thousands of investments from which to choose.
    3. Valuations for certain managed accounts or hedge funds may be problematic.  If the investment is not traded on an exchange, independent valuations are required under ERISA.
Gold and precious metals can be held in a retirement plan.  Valuation and custody are the biggest challenges with these investments.  Some holdings may have a market value that is available on days that the markets are open.  Diversification and liquidity are important considerations for the Plan Sponsor before investing.

Perhaps the entrepreneurial spirit has overcome you, but all of your start up cash is locked up in your former employer’s retirement plan.  What are your options?  Maybe you’re a candidate for a Roll Over Business Startup (ROBS) plan.  A ROBS plan is a good way to find business start up cash.  Following are some of the steps required to make this work:
  1. Set up a corporation for your new company
  2. Establish a retirement plan for your new company that is considered an “individual account” plan (BRI is here to help you with that!)
  3. Roll over your eligible retirement plan funds into your new company plan
  4. Use the rollover cash to buy shares of stock in your new company.  Now the plan holds the shares, and the company has the cash.
Again, there are considerations before making this decision. 
  • Are you willing to risk your retirement account on your new business venture?
  • Valuations will be required whenever there is a purchase of shares, and each year the plan holds the funds.
    • The initial valuation for a new company is typically the cash invested
    • Annual valuations can cost $5,000 and up

The ERISA bond for the plan may have to be increased to 100% of any alternative investments held by the plan.  The requirement for the additional bond depends on the investment and whether the plan is subject to ERISA. 

Alternative investments must be disclosed on the annual Form 5500 filing.  Certain investments will restrict you from using the 5500-SF (short form).  The IRS and/or DOL may be more likely to pull a plan for audit if alternative investments are reported.

What investments are right for you and your plan participants?  Are alternative investments worth the additional scrutiny and bonding that may be required?  Maybe you think outside of the regulated investment box.  Alternative investments are available in retirement plans if you follow certain rules.  What we’ve outlined here is just a high-level overview.  Since 1987 BRI has been open to new ideas and we love to help our clients understand what the limits are within the rules.  Contact us today if you are someone who wants help in putting alternative investments in your plan.  Click here to have one of our experienced consultants contact you today.

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