Contractors and other surety bond Principals are often frustrated that surety bond underwriters will not count retirement assets towards their bond capacity. This article explains how surety bond underwriters account for retirement assets and what Principals can do if they want to use these assets for surety bond purposes.
What are Retirement Assets?
Retirement assets can include a variety of account and plans as defined by the IRS. Common retirement accounts include 401(k), 401(b), Individual Retirement Accounts (IRA), Roth IRA and pension accounts. You can find the full IRS listing here.
Retirement accounts are normally protected against creditors in some fashion. This can be entirely, or on a limited basis depending on the account. This includes protection from surety bond companies as well. Contractors and surety bond Principals often associate surety bonds with insurance because they are often written by insurance agents and insurance companies. However, surety bonds are a credit product and based on the creditworthiness of the Principal and indemnitors. Therefore, Bond Principals need to have assets available to qualify for surety bond credit. Because they cannot access a Principal’s retirement assets in a claim situation, they also will not give any surety credit based upon those assets.
This can create a problem for Bond Principals. On one hand, saving for retirement is a prudent strategy for everyone and protects hard earned money against lawsuits and other creditors. However, principals will need to hold sufficient assets outside of retirement accounts if they want to get surety bond credit.
Options for Surety Credit and Retirement Accounts
At times we find Principals who are new to surety bonding or who need more bond capacity, but the majority are assets are in retirement accounts. There are options for those Principals. We do not necessarily recommend any of these options but cover them for informational purposes. To get retirement assets to be considered by surety bond underwriters, they must be removed from protected status. This opens those assets up to loss and Principals should discuss them with a qualified financial planner or advisor before proceeding with any such actions.
Borrow Against the Retirement Plan
Retirement plans such as 401(k)s may let you take a loan against your plan assets. By taking this money out of the retirement plan, it allows the proceeds to be used in your company or for surety bond purposes. The advantages of this strategy are that the funds can be obtained quickly. There are also no credit checks or underwriting. This can be helpful if a Principal is already fully extended on their borrowing capacity. Additionally, the interest is paid to yourself and likely less inexpensive than other borrowing options. Most 401(k) plans also have a 5-year payback which may be better term than you can get from a lender.
However, there are downsides as well. First, you could be hurting your future self by pulling money out of a retirement plan. Secondly, there are limits to how much you can borrow, and it may not be enough to get the surety bond credit you need.
Another option is simply to cash out part or all your retirement account. However, this is probably the least attractive option in any circumstance. Depending on the type of account, you will likely pay both taxes and penalties on any distributions. The exception may be a Roth IRA if certain requirements are met. Still, that does not necessarily make this an attractive option. Again, you potentially taking money from your future self.
Roll Overs as Business Startups (ROBS)
A ROBS transaction allows somebody to take their secured retirement and fund a business. In short, the transaction requires a new entity to be set up as a C-Corporation. A new retirement plan such as a 401(k) is then established for the new corporation. Then the old retirement plan is rolled over into the new 401(k) which purchases stock in the C-Corp. The proceeds from the sale of that stock can now be used in the business. This mechanism allows people to use their retirement savings in a business without paying a penalty. We are not experts on ROBS but you can read more here.
As great as that sounds, ROBS have some significant downsides. First, these are complicated transactions and most companies that specialize in ROBS have hefty fees for setting them up. Secondly, you can only use a C-Corp. which may lead to double taxation. Third, you may draw extra attention from the IRS who considers these arrangements “questionable” as they may only benefit one individual. Finally, like all these strategies, you are risking your retirement.
Surety Bond Considerations
We do not encourage the use of retirement accounts as a good long term strategy for writing surety bonds. Before looking at any of those options, a Bond Principal should consider why they are having to contemplate these strategies. Is it because they have pulled too much money out of their company and put all their assets in retirement accounts? If so, a plan should be implemented to keep enough assets in the business to support the surety bond needs of the company.
Are retirement assets being contemplated because the Principal has lost money, and these are the only assets left? Surety Bond Principals should be even more careful in these situations. What steps have been taken to reduce the losses and ensure a return to profitability? Without properly addressing the problems, a Surety Bond Principal may be taking a significant risk with their future. For example, consider the statement on the IRS’ website regarding ROBS.
“Preliminary results from the ROBS Project indicate that, although there were a few success stories, most ROBS businesses either failed or were on the road to failure with high rates of bankruptcy (business and personal), liens (business and personal), and corporate dissolutions by individual Secretaries of State.”
That statement should give Surety Bond Principals significant pause before considering these transactions or any use of retirement assets. Surety Bonds are also written on the Principle of Indemnity. That means that the surety bond company will seek reimbursement in the event of a valid loss. By removing retirement assets from protected status, you make these assets available to creditors such as surety bond companies. Before doing so, a Principle should exhaust all other options.
Retirement accounts has unique creditor protections which is why they are not considered in surety bond underwriting. We believe it most circumstances, its best to leave those assets in place and look to other options to support surety bond credit. Contact us anytime and we can discuss available options for those needing surety bonds.