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The 401(k) Scam

Be aware that there are firms that do not speak the whole truth. They claim that the IRS requires a 401(k) plan for a ROBS Plan . . . and that the entrepreneur must immediately:
— own greater than 5% of the stock, and
— take salary, and
— make salary deferrals for himself, and
— make 3% of salary safe-harbor contributions for all employes.

However . . .

ERISA 407 requires the plan to be an "eligible individual account plan."
ERISA 407 requires the "eligible individual account plan" to be a profit sharing plan.*
A profit sharing plan may have a 401(k) salary deferral feature, but it is not required.
ERISA 407 states that any such 401(k) salary deferral feature must be segragated from and is not part of the "eligible individual account plan."

So . . . why do others say a 401(k) is required?

If the Entrepreneur:
— owns 5% of the stock, he is deemed "Highly Compensated" — think billionaire, jet owner.
— takes an immediate salary, he can make an immediate salary deferral,
— makes an immediate salary deferral, the plan goes "top heavy" immediately, and
if the plan goes "top heavy" the employer immediately needs to make 3% of salary "safe-harbor" contributions to the plan for ALL non-highly compensated employees.
The employer has seven days after each payroll to make the payment of the salary deferrals and safe harbor contributions to the plan Trust, which must be immediately invested, and
someone is getting a commission.

Does this mean you cannot use your 401(k) money?

No, your 401(k) money from a previous employer may be rolled over into an "eligible individual account" profit sharing plan and used. Only 401(k) salary deferrals from the current employer in the current plan must be set aside.

What did the IRS say, anyway?

In the October 2008 Memo (pg.12-13), the IRS stated that they found ROBS plans with 401(k) language that was not being used. The Service stated that "there [is] no such thing as an inactive CODA" [401(k)]. Therefore, if you have one you best use it. We do not include one unless needed, which is seldom.

We have a 401(k) vs. Profit Sharing Plan presentation that goes into greater detail.

* Profit sharing and pre-1974 money purchase pension plan designed for the purpose, stock bonus, thrift and savings, and ESOPs.