A rollover for business startups (ROBS) allows you to invest funds from an existing 401(k) or individual retirement account (IRA) into your business without paying early withdrawal penalties or taxes. A ROBS isn’t a business loan nor a loan from your 401(k), which means there are no interest payments to make or debt to repay. It’s a way for you to leverage retirement funds to provide capital to your business. A ROBS can also be used to purchase or invest in an existing business or franchise. A C corporation (C-corp), which allows for shareholders, is established, and a new 401(k) plan is set up.
Most small business owners utilize a ROBS provider to help them navigate this transaction. We have compared several ROBS providers and ranked Guidant as the best overall in a recent ranking because it offers a free consultation and also provides very good customer service.
Who a ROBS Is Right For
A ROBS is best suited to individuals who want to start or fund a new or existing business who also have a large amount of money saved for retirement. While you may not need to use your entire retirement portfolio to fund your business, most ROBS plans require at least $50,000 to start, and some franchises or business startups require much more to get up and running.
How to Set Up a ROBS
1. Determine If a ROBS Is Right for Funding Your Business
Before tapping your retirement accounts and setting up a ROBS, consult a ROBS provider to discuss potential ramifications. If you’re confident that the potential rewards outweigh the risks and you have sufficient capital to invest, a ROBS may be a great option.
2. Form a C-corp
A C-corp is required for any ROBS plan and would be used to own the assets of the business as it can issue stock and have shareholders. The IRS prohibits transactions involving qualifying employer securities that only a C-corp can complete. More common business structures, such as limited liability companies (LLC) or sole proprietorships, aren’t allowed to be used for a ROBS.
3. Set Up a Retirement Plan for Your New Business
The new retirement plan can be established as a 401(k), a profit-sharing plan, a defined benefits plan, or a defined contribution plan. Roth accounts don’t qualify for ROBS. A custodian, such as Charles Schwab or Fidelity, would manage the active parts of the retirement plan. Your ROBS provider would be able to recommend several custodians from which to choose.
4. Transfer Funds From Your Retirement to Fund New Retirement Plan
Once the C-corp is incorporated and your new business’s retirement plan is established, retirement monies are moved over to fund the new plan.
5. Retirement Plan Buys Stock in New C-corp
The funds from your retirement plan will buy stock in the new C-corp. The business issues shares that the new retirement plan, along with any potential outside investors, will purchase. You don’t need to issue 100% of your business’s shares in the initial round of funding in case you wish to raise money by issuing shares in the future. Your ROBS provider can walk you through that process should you choose to pursue that strategy.
6. Funds Now Available to New C-corp
Monies from your ROBS can now be used to buy an existing business or start a new business. You can use these funds for normal business activity but not for personal gain. Typically, the funding process can take a couple of weeks.
Rollover for Business Startup Requirements
Before you dive in and establish a ROBS, it’s important to know that there are some eligibility requirements regarding your current retirement account, how much money you have in it, and your status as an employee in your new business.
Eligible Retirement Plan That Is Current
You must have a retirement plan that is tax-deferred and eligible for conversion to a ROBS. Unfortunately, Roth IRAs and Roth 401(k)s wouldn’t be eligible. However, a 401(k), a 403(b), a Keogh plan, a simplified IRA (SEP-IRA), a thrift savings plan (TSP), and a traditional IRA all are eligible.
Sufficient Money in Your Retirement Account
ROBS plan providers typically require a minimum of $50,000 to start. However, your business may need more capital than that to fund initial operations.
Be an Employee of the New Business
You’re required to be an active employee in your business and draw a salary. However, taking too much compensation may be considered a ROBS-prohibited transaction and could put you at risk for an IRS audit.
Eligible Employees Must Have Opportunity To Invest in Company’s Retirement Plan
If your business will have additional employees, you may be required to offer those employees the ability to participate in your company’s retirement plan. Eligibility requirements for retirement plans vary by state and plan design but often are based on the employee’s age, length of employment, and employment status (full-time vs part-time).
ROBS Costs
A ROBS isn’t a startup business loan, which means there’s neither debt nor interest to pay back. However, there are some costs associated with a ROBS. You could use an attorney and an accountant to set up and help administer your ROBS; however, a ROBS provider is more knowledgeable about the nuances of IRS regulations in this space and would be a better option.
Setup Fee
Setting up a ROBS plan typically costs around $5,000. These funds must be paid out-of-pocket and cannot come from the monies you’re using for the ROBS. The setup costs will generally include setup of the C-corp, creation of the retirement plan, and submission of paperwork to the IRS.
Ongoing Maintenance Fees
The average ROBS plan costs around $130 a month to manage, but the cost can increase based on the number of employees you have taking advantage of your company’s retirement plan. These fees may be assessed annually instead of monthly depending on the ROBS provider but—like the setup cost—cannot come from the retirement plan.
Maintenance fees for ROBS include filing paperwork with the IRS to ensure compliance with 401(k) rollover rules, as well as notifying and educating eligible employees about the company’s retirement plan.
Prohibited Uses of Rollover for Business Startup Funds
Most operational business expenses are allowed with a ROBS. These include lease and mortgage payments, payroll, and other normal expenses that the business incurs. However, some expenses aren’t allowed:
- Personal use of business property: The IRS prohibits the use of business property for personal use. This would include a company car or company-owned real estate. Any transaction where an owner or family member is the recipient of business property is also subject to a 15% tax.
- Direct compensation to the owner: Having a ROBS requires an owner to be an active employee in their business. That said, you cannot pay yourself a salary that isn’t considered appropriate for the role you serve nor appropriate for the company’s revenue. Note that your salary must come from operating expenses and not directly from the ROBS.
ROBS Compliance & Audits
ROBS plans are held to compliance standards with the IRS and United States Department of Labor and ROBS plans may be audited. Those plans not in compliance with government regulations could face tax penalties and fines. While the risk of an audit is rather low, an audit by the government will check for the following:
- That the retirement plan was set up correctly: Also, that your business is set up in the correct corporate structure (C-corp).
- All annual filings have been completed and submitted: Among the required filings is IRS Form 5500.
- You meet all employee requirements: This means you’re an employee of the organization, you’re providing eligible employees access to the company’s retirement plan, and all necessary plan documents are provided to your employees.
Using a ROBS provider will give you the support necessary to ensure that you’re meeting compliance requirements.
Unwinding ROBS
Starting a business with a ROBS is one way to use your financial assets to your benefit without needing to take out a small business loan. When it’s time to exit out of your business, whether through a sale or through closing the business down, many steps are necessary to unwind your ROBS. These steps vary based on the situation. Regardless, each scenario requires compliance reporting to the IRS that a ROBS provider will assist you with:
- Asset sale: In some instances, business owners may choose to sell assets instead of stock to prevent the new owners of the business from assuming potential future liabilities that the current business may have. If any business assets are sold, the funds are used first to pay off liabilities and administrative obligations within the business. The remaining net proceeds after those payments are then distributed to the owners of the business, including your retirement plan.
- Stock sale: If you sell your business’s stock, unwinding a ROBS is relatively easy. After any funds necessary to wind down your investment or other potential business obligations are subtracted, all individuals that own a percentage of stock in the business typically receive that portion of the sale proceeds. The remaining funds given to the retirement plan for its owned stock in the business are subsequently rolled into an IRA for your benefit.
- Business failure: If your business fails, unwinding a ROBS requires closing out your company’s retirement plan. You must educate your employees on what options they have for any funds that they have invested into your company’s plan. When your business fails, you don’t have any obligation to pay back your original funding, but you’ll lose the money.
Pros & Cons of ROBS
There are risks and rewards associated with starting or purchasing a business. A common concern of potential business owners is that if they use retirement funds and their new venture isn’t successful, they could lose their investment. However, the financial risk involved with any business startup and the risk of failure isn’t unique to a ROBS. According to the Bureau of Labor Statistics (BLS), roughly 45% of corporations cease to exist within five years.
| PROS | CONS |
|---|---|
| No interest or debt payments | Risk of business failure and loss of retirement funds |
| ROBS-funded businesses have a higher success rate | Business must operate as a C-corp |
| No income taxes or early withdrawal penalties on your retirement | Administration of a company-sponsored 401(k) plan |
| No impact on personal credit | Administration of the ROBS plan is costly |
| Potential for retirement funds to grow as business succeeds | Possibly higher risk of IRS audit |
Bottom Line
A ROBS can be an excellent option for funding a small business. If you have sufficient funds in a retirement plan and feel that the potential rewards outweigh the risks, it may make sense to consider using a ROBS to help finance the start of or acquisition of a small business.
