Using the Family Investment Company to Access Your Pension Plan Assets

by Gerald Nowotny


The wait is over. The taxpayer got dangled over the Fiscal Cliff and was allowed to have a controlled fall. For the high income taxpayer, the fall resulted in a broken ankle, bruised ribs and a minor concussion.

The top rate for earned income jumped to 39.6 percent plus the 3.8 percent tax on investment income. Add in the impact of state income tax and it will make you flinch. Top earners in states with high state marginal tax rates will pay over 50 percent in taxes on earned income.

Investment income was spared. However, when you add in the impact of the Medicare tax, and state income tax, you might think twice about whether or not the investor was spared. The top marginal estate tax bracket only increased by five percent to 40 percent.

The combination of these taxes continues to spell trouble for income in respect of a decedent (IRD) assets such as pension plan and IRA assets. The impact of taxes on these assets can still erode 70-75 percent of the value of these assets.

The ROBS (Rollover as Business Startups) strategy has received some attention over the last five-seven years. Many commentators cried “Foul” louder than the IRS did. Most of the commotion was related to perceived abuses as well as the reality that taxpayers could lose their retirement savings in a new business venture financed by plan assets.

This article is a summary about a technique that allows you to tap your funds in a qualified retirement plan (specifically 401(k) or profit sharing) to start a new business- a family investment company. However, this start up may have greater business certainty than investing in a new franchise.  The same ROBS strategy  may be more powerful as a family investment company while simultaneously freezing the value of the qualified plan or IRA for future income and estate tax purposes. In actuality, the value of the qualified plan may actually be reduced by the ROBs strategy.

The technique may be more powerful than just providing start up funds for that new consulting business. This summary will highlight the key points.

Tax Overview

The ROBS strategy has primarily been used to finance business startup. In an economy where credit has dried up for small businesses, a 401(k) as a source of new business capital is attractive particularly when you consider that plan loans are limited to $50,000 and must be repaid over a five year period. When you are a “downsized” executive with no prospects of a job that pays you what you previously made, “necessity is the mother of invenetion ” as the cliché says  but even “necessity” requires some cash.

The IRS in a 2008 memorandum reviewed the technique and expressed concerns that were primarily technical in nature. More importantly, in the memorandum the Service stated that it did not regard the technique as an abusive tax avoidance transaction (at least not yet!).

The Service’s concerns focused on a few technical tax points dealing with qualified plans – (1) a filing exemption for Form 5500 does not apply for the Plan. Expect to file Form 5500 or Form 5500 EZ for the plan. (2) In the case of ROBS for a business startup that hires employees; those employees should become participants in the Plan subject to regular pension participation rules.  This scenario is highly unlikely in the context of the family investment company.

The Family Investment Company

The Family Investment Company is a legitimate corporation under state law and federal tax purposes. The business purpose of the corporation is the consolidation and management of family investments and business opportunities. However, unlike the family investment company described  in prior articles in which the company was structured as a limited liability company, this version of the company is structured as a regular corporation aka C Corporation.

It should be pointed out that the C Corporation offers some tax leverage. The first $50,000 of taxable income is taxed at a 15 percent marginal bracket for federal brackets. The next $25,000 is taxed at a 25 percent rate. Note that these rates are considerably less than the top individual marginal bracket.

One concern regarding use of the C Corporation structure is the imposition of the Personal Holding Company tax which imposes an additional 15 percent on personal holding company income – interest, royalties, dividends etc. In this instance, the Family Investment Company will invest its capital in a private placement life insurance (PPLI) contract which will prevent the creation of personal holding company income. As result, the Company will not generate the type of income that is subject to the tax.

Strategy Overview

The strategy is relatively straight-forward. The first step involves the tax-free rollover from an existing IRA or 401(k) or profit sharing plan into a new 401(k) Plan established in a new corporation that the client establishes. The new corporation must be a regular or C corporation and not an S corporation or LLC.

The Plan document for the new 401(k) has an amendment for the Plan authorizing the Plan participant (you) to purchase employer is securities, i,e, shares in the new corporation. Following the sale of corporate shares to the 401(k) Plan, 401(k) proceeds are in the corporation to use for any valid corporate purpose. This sequence of steps does not result in any taxation to the Plan participant or corporation.  

Tax Review

  1. The Rollover

IRC Sec 4975 outlines prohibited transactions for qualified retirement plans as well as tax exempt organizations. IRC Sec 4975(d)(13) provides a list of exemptions. ERISA Sec 408(e) provides an exemption stating that ERISA Sec 406 will not apply to the purchase of qualifying employer securities. The transaction must be for adequate consideration. The Plan must be an individual account plan described in ERISA 407(d)(3). 401(k) plans and profits sharing plans meet this requirement.

The strategy requires the purchase of stock in the new corporation from the corporation itself in order to avoid the application IRC Sec 4975(f)(6). IRC Sec 4975(d) blocks the exemptions of IRC Sec 4975(d) for owner-employees for transactions involving self-dealing. The direct acquisition of stock avoids a prohibited transaction.  

Normally investments in qualifying employer stock would be limited to ten percent or less of plan assets under ERISA Sec 407(b)(1). ERISA Sec 407(d)(3) has an exemption from these diversification requirements for individual account plans such as 401(k) and profit sharing plans. As a result, the Plan holding more than ten percent of the shares of qualifying employer securities does not violate ERISA Sec 404(a)(2). How about 100 percent? No problem!

The IRS issued a memorandum clarifying its concerns in 2008. This memorandum largely focused on two aspects of the transaction. First, if the new corporation has employees, adequate notice of the program must be detailed for the company’s employees. Secondly, the purchase must be an arms-length transaction supported by an independent valuation.

  1. Private Placement Life Insurance

PPPLI is a form of variable universal life insurance. The policy is strictly available for accredited investors and qualified purchasers as defined under federal securities law. The policy is institutionally priced and is virtually a “no load” product. The insurer provides the policyholder with the ability policyholder to customize the investment options within the policy. The range of investment options can include a customized fund managed by the client’s existing investment advisor as well as a range of asset classes including hedge funds, real estate and private equity. 

  1. New Age Split Dollar Life Insurance

New Age split dollar life insurance aka inter-generational split dollar is a form of collateral non-equity split dollar life insurance. The technique utilizes a restricted collateral assignment that restricts the assignee’s access to the policy cash value until the earlier of the death of the insured or termination of the arrangement. In the context of the Family Investment Company, the taxpayer’s irrevocable life insurance trust (ILIT) would be the applicant,, owner and beneficiary of the policy insuring the taxpayer’s life.

The Family Investment Company would be the premium payor. The Corporation would have a restricted collateral assignment interest in the policy cash value. The taxpayer would be subject to income and gift tax consequences of the economic benefit, i.e. the term insurance cost, for the death benefit payable to the ILIT annually.

D.Planning Considerations

Example 1 – Family Investment Company Basic Model


Dr. Jones, age 65, is a retired orthopedic surgeon. Dr. Jones has $5

million in his IRA which is a rollover from his medical practice pension plan. Dr. Jones would like to mitigate the income and estate tax impact of  his IRA assets.


Dr. Jones creates a new corporation that is organized as a C or regular corporation. He creates a new 401(k) plan within the new corporation. The Plan allows for the purchase of employer securities. Bob executes a tax-free rollover of his IRA into the new 401(k) plan.

The trustee of the Plan purchases 100 percent of the unissued treasury stock in the New Corporation (Newco). The price is supported by an independent valuation at $5 million. The funds are wired into the corporate operating account. Bob is able to use these funds for any valid and legal purpose including payment of a salary or shareholder loan.

Newco is the applicant, owner and beneficiary of a PPLI contract insuring Dr.. Jones. Dr. Jones’s investment advisor is the sub-advisor of an insurance dedicated fund managing the portfolio within the contract.

Newco is subject to tax valuation discounts for lack of marketability and control. Arguably, the shares of Newco owned by the Plan are worth 25-40 percent less within the Plan following the transaction.

Example 2


Same facts as Example #1


Newco decides to sponsor a split dollar life insurance program insuring the lives of Dr. Jones  and his wife. The policy provides for annual premiums of $1.25 million per year for four year, or a single premium of $5 million. The death benefit is $15 million. The owner of the policy is an irrevocable life insurance trust (ILIT). The transaction is structured as a New Age Split Dollar program. (See my prior articles on New Age Split Dollar).

The corporation transfers its split dollar receivable in the beginning of Year 2 for $250,000 to the trustee of the ILIT. The $15 million death benefit will be paid the ILIT income and estate tax-free. The discount on the transfer is approximately 95 percent which is supported by a third party valuation of the split dollar receivable.

Following the transfer, Newco has a substantial reduction in value as it no longer retains the restricted collateral assignment interest in the split dollar arrangement. Effectively, Dr. Jones has been able to transfer IRD assets that would have been subjected to a combination of income and estate taxes of approximately 90-95 percent of the Plan value. The Plan value following the arms-length transfer has been reduced to approximately $250,000 before valuation discounts.

This planning result occurs at a minimal tax cost compared to the income and estate taxation on qualified plan and IRA assets.


This strategy is important for a number of reasons. First, IRD assets continue to remain highly taxed from an income and estate tax perspective.

It has become increasingly difficult in the current economic environment to borrow money to start or purchase a small business. This technique makes it possible to use tax deferred assets to finance a business without incurring taxation on those dollars. Plan loans are of limited value due to the limit - $50,000.  Deferred compensation assets (qualified or non-qualified) are heavily taxed being subject to income and estate taxation.

The pension strategy also provides a substantial wealth transfer benefit as pointed out in Example 2. Many high net worth individuals with significant pension assets would prefer to reallocate those dollars in a more tax efficient manner rather than being exposed to both income and estate taxes. Family investment companies as LLCs or LPs are a mainstay in advanced estate planning.

Additionally, IRAs can’t invest in life insurance. The outlined strategy provides  a straight-forward approach to change the adverse tax characteristic of IRD assets. The resulting tax benefits are noteworthy.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Gerald Nowotny, Law Office of Gerald R. Nowotny | Attorney Advertising

Written by:

Gerald Nowotny

Law Office of Gerald R. Nowotny on:

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