Need Funding for Your Business? Can You Use Your 401 (k) or IRA????

Are you considering purchasing a business? Buying a franchise? Need money? There may be a pot of it in your 401 (k) or IRA. Can that be used? I am hearing lots of ads on the radio that promise a way to use your retirement accounts as a source of funding for a start-up or to purchase an existing business. Is it a good idea? What about the taxes and penalties for early withdrawal???




Here is generally the way it works: First, create a state law corporation or LLC that reports its taxes as a Subchapter C corporation. That means that the company will pay taxes as an entity rather than passing all profits/losses through to the owners. Generally used for larger companies and has serious tax implications. Please don't make this election without competent accounting and legal advice. Anyway, once you have the corporation set up, the company adopts a 401 (k) plan. You then join the company as an employee and also join the 401 (k) plan. You then roll-over your existing retirement account into the new plan which  promptly buys all of the stock of the new corporation. Now the plan has the stock and the corporation has the funds to buy the franchise or existing business. You have successfully taken money out of your retirement account without incurring the penalties or paying the income tax on the funds held by your IRA or 401 (k). Or have you?




If you think this sounds too good to be true, you are probably right! This plan or something similar is being promoted by franchise companies, brokers and promoters and it is possible that it could work. The IRS has indicated that while it is not per se unlawful, they do not like it. If done absolutely correctly- and you will need sophisticated legal and accounting counsel, not just the promoter- this may work but the complications are immense:

1. The first issue is that the overriding rule regarding these retirement plans is that the retiree is not supposed to gain a "benefit" from them until retirement at least 59 1/2 year old. Is there a direct benefit from this plan? Presumably so but maybe it is only an "indirect benefit."
2. The stock in the new company must be fairly priced otherwise this may be a prohibited transaction, not just an investment by the 401 (k). How does one determine a fair price? The best way would be with a qualified business appraisal but that can be expensive and most accountants and appraiser's will tell you that an accurate appraisal of the worth of a start-up is difficult if not impossible.
3. The investment in the stock must be a reasonable investment. If this type of investment was made by the trustee of your current plan, i.e., someone else invested your retirement money in a start-up, would you be pleased? Would you think that was appropriate? Enron anyone???
4.  Once the investment has been made, the franchise bought and the company is up and running, all employees must be given the right to participate in the 401 (k) plan and for their account to purchase company stock, other wise the plan is unlawfully discriminating. You could lose control of your own company.
5. Who will vote the shares in the new company? Presumably the Trustee of the 401 (k) plan. Who will that be? If that is you, the entrepreneur, you run the risk of a prohibited transaction. If it is not you, again, you run the risk of losing control of your own company.
6. Tax consequences: A subchapter C Corporation reports its profits and losses directly. Theoretically, profits (after wages, of course) are paid out as dividends to the plan. Taxes on those profits are presumably deferred as with all 401 (k)s. But what about losses? Most new business suffer losses, usually real but sometimes paper losses. These are advantageous to the investors as offsets to other income. Here losses will also go to the 401 (k) not the entrepreneur.  In addition, there is the very real possibility of double taxation both on operating profits but also when, and if, you sell the business.
7. This idea creates two distinct entities: the state law corporation and the 401 (k) plan. Each has its own rules and reporting requirements. A 401 (k) plan falls under the federal law known as ERISA (The Employee Retirement Income Security Act of 1974 (ERISA) (Pub.L. 93–406, 88 Stat. 829, enacted September 2, 1974, codified in part at 29 U.S.C. ch. 18)). This law is very complicated and it takes a lawyer and accountant who concentrates in this area to truly understand it and properly advise you.. Not every lawyer or accountant is competent to offer advice or to provide the reporting necessary. Again, please do not lean solely on the broker or promoter for advice- thee have a vested interest.
8. And last but not least, a large number of new business fail. If this new business fails, you will have lost your retirement account and you may then be subject to taxes, fines and penalties from the IRS with no money with which to pay!

In summary, this kind of financing may work but it is not for the unsophisticated investor nor for the faint of heart. If you are considering such a plan, please, please, seek advice from a competent attorney and accountant. Do not rely solely on the promoter or franchise company!

Medicaid Estate Recovery- the Problem with Expanded Medicaid 

Expanded Medicaid Could Cost Some People their Inheritance

As many of you know, the State of New Hampshire is allowed by federal law to file liens against property and to recover from the estates of Medicaid recipients who have died. See ww.dhhs.nh.gov/oos/eru/index.htm for an explantion of how this works normally. Such liens and recoveries are only for Medicaid recipients who are age 55 or older. Your estate assets for this purpose include assets in the name of the estate, most assets held in joint tenancy, revocable trusts and most life estates.

Federal Law: Medicaid Agencies may (but are not required to) file liens against such assets as part of the eligibility process except in the case of the family home if he or she is reasonably expected to be discharged and to return home, 42 U.S.C. § 1396p(a)(1)(B)(ii) (and some other exceptions)

Those of us who work in Elder Law are well familiar with this in the nursing home context. However, the same concept applies to those who receive Medicaid help from several other programs such as Aid to the Permanently and Totally Disabled (APTD) cash assistance and/or from individuals who have received OAA, ANB, Medicaid for Employed Adults with Disabilities (MEAD), or APTD medical assistance (Medicaid).

Expanded Medicaid

So how does this work with Expanded Medicaid? Under the Affordable Care Act (Obamacare), the states had the option of accepting an expanded version of Medicaid. The idea was that while the very poor had Medicaid for health insurance, there were those who could not afford private health insurance even with the ACA subsidies. Accordingly, those people with an income (MAGI- Modified Adjusted Gross Income) of 138% of the federal poverty limit can be eligible for Medicaid to purchase health insurance through the ACA Exchange for them. As noted, there are income limits but no asset limits. Thus, recipients may well own homes or other assets but have fairly low income levels.If the recipient is between the ages of 55 and 65, the State of New Hampshire can recover any amounts paid on the recipient's behalf from his/her estate.

With monthly premiums for the Exchange insurance, this can add up in a hurry.

Managed Medicaid

Managed Medicaid raises the ante. With managed Medicaid, the State of New Hampshire pays a flat fee (called a capitated fee) to a management company for case management. The cost of case management is also a cost recoverable from the estates of the recipients. So even if the recipient is healthy and never actually receives medical treatment, the cost of the insurance and/or the cost of the case manager may by recovered from the estate. Such recovery may be well in excess of the total value of the estate. 

What to do?

One possible solution is to gift property now, either to children or to a properly drafted irrevocable trust. Since assets aren't counted, there is no look back period. This, of course, runs the risk that the individual will require nursing home care before the end of that look back period- 5 years or 60 months. If so, that person will be deemed disqualified from Medicaid for a period of time equal to the value of the asset transferred. If that happens, only a hardship appeal can offer a chance of receiving proper care.

Several states have changed their rules and will not pursue estate recovery in this situation. New Hampshire has so far not changed any such rule.

If you or a family member are between the ages of of 55 to 65, and you are eligible for Expanded Medicaid ,you should consult with a competent Elder Law Attorney