Sometimes I just get amazed at the programs some of the people marketing 401(k) rollovers use. My latest moan, is how exit strategy programs are designed.
Essentially, several of the companies offering 401(k) rollovers suggest the following as an exit strategy:
- In year 2 or 3 the corporation redeems the stock owned by the retirement plan.
- The corporation then elects Subchapter S tax status.
- A formal business valuation is done.
The rationale for this strategy is that the business can now be sold as an asset sale rather than a stock sale. (Most accountants and attorneys prefer asset sales because of the avoidance of unknown liabilities)
The transaction redeeming the stock is done early in the corporation existence for two reasons:
- The value of the stock will be lower.
- The built in capital gains will be lower.
All this sounds fine on paper, however in the real world where businesses operate this exit strategy usually makes “no sense”.
First when a corporation redeems stock the transaction is an after tax strategy. I hate paying taxes and I hate almost as much advising clients to enter into after tax strategies when there is an alternative.
Second this strategy takes money from the business just when it probably needs it most to ensure its maximum profitability and success.
Third, through proper planning asset sales can usually be done at any time without double taxation occurring, in part the taxes upon sale will usually be less than the so called “magic exit strategy”.