Gyroscopic Investing

Hi all,

A close relative of mine has access to the retirement plans of a major state.  One of the funds has a guaranteed (yes, guaranteed by the taxpayers) annual return of 7%.  This particular fund is one of many investment options inside of the state's retirement plan umbrella, and my understanding is that if the guarantee evaporates for whatever reason, the money can be moved to other funds or rolled over into an IRA.  It's effectively close to an IRA already, since contributions are tax deferred.  I believe it's a 403(b).

Anyway, there's a cap on annual contributions, and this person isn't going to be able to contribute the full amount.  He's generously offered to allow me to use up some of his cap space.  People apparently do this commonly, and he doesn't believe there's anything illegal or unethical about it, although we'll be wanting to make sure about all that before doing anything.

The initial thought was to "give" this person a big chunk of money, and then after retirement (which is in many decades) he'd "give" me back what I put in plus its gains.  There are many reasons this approach is unappealing: it may be convoluted to figure out who owns what, the taxes would be paid by him on withdrawal and then negotiated, we'd have major problems with the IRS gift limits on withdrawal, it's tremendously long-term, I'd have no control over when to withdraw (if, say, the interest rate is no longer such a winner) or where to go from there, it requires complete trust for decades on end, etc.  It's just terrible.

Another option I thought of was this: it's to his advantage to max it out, both because it's 7% guaranteed and because of the tax deferral.  What if we drew up simple loan paperwork, whereby I lent him some amount of money, and he agreed to pay me back over five years at 5% interest on a monthly amortization schedule?  Would this be a win/win?

Finally (and this is the reason this is in the Cash forum), should I consider this investment to be part of the Cash portion of my PP, or is this a VP investment?  And to make this of more general interest, should somebody with access to this fund directly consider it to be Cash or VP?

It's been my experience that long-term financial plans involving relatives never work, so I wouldn't touch this with a 10 foot pole.

That said, I am in a state pension system. My contributions have a cash-out value that accrues interest at a fixed rate, similar to the program you're describing. I choose to consider that part of my PP cash allocation, as you suggest.

IMO, treating the annuity benefit as a sure thing is naive yet treating the contributions as lost is too pessimistic/conservative. They do have a guaranteed* value and treating them as deep PP cash allows me to buy more of the volatile/profitable PP assets.

(* State/PBGC-guaranteed, which isn't as good as Treasuries, but we live in an imperfect world.)

Xan wrote: The initial thought was to "give" this person a big chunk of money, and then after retirement (which is in many decades) he'd "give" me back what I put in plus its gains.

Xan wrote:What if we drew up simple loan paperwork, whereby I lent him some amount of money, and he agreed to pay me back over five years at 5% interest on a monthly amortization schedule?  Would this be a win/win?

To be honest, this seems like the kind of thing that could turn into Judge Judy material in the future. I've had bad experiences loaning and borrowing money to and from friends and family in the past. Even if you get the money, it may strain the relationship if this person has different expectations or brings imagined or real previous family obligations into the picture. Sounds like a great deal if it works, but are you willing to risk the relationship if it doesn't?

I wouldn't get involved with this arrangement with your relative.

If I was in the state plan, I would count the 7% return fund as cash.  What tends to happen with these things is that the 7% will be reduced at some point in the future, but the reduction will be prospective only, so you wouldn't lose any past earnings.

Real life tends to throw up events such as your relative loosing his job, having a fatal car crash etc etc. Such a financial entanglement is the absolute last thing you'd want to add to any real life nightmare scenario like that.

If you want to give your relative a gift of money for his 403B, that's okay as far as I know.  (Money is fungible.)

As far as lending money to him that he then puts into his retirement plan, where you expect any return:  NO. 

As everyone else mentioned, life happens, death happens.  Divorce also happens.  If the latter happens between your relative and her/his spouse, the spouse will automatically get half of the retirement account--with no obligation to pay you, since the loan is with the relative. 

Pointedstick said it best--embarrassing material for TV judges.

Good advice, everyone.  Thanks.  Too much to go wrong with too much (far more than money) on the line.