Starting a new business or purchasing an existing business isn’t usually a pursuit for the faint of heart. Using retirement funds as capital for the business takes a bit of courage. If you play your cards right and play by the rules, your retirement funds can be withdrawn without getting a huge tax bill in return and your bold move could pay off in the long run.
How it Works
The term for rolling over your retirement funds into a business is called ROBS (Rollovers as Business Startup). You can use your retirement funds to buy an existing business, purchase a franchise, or start a new venture from scratch. The basic steps for entering into a ROBS arrangement include:
You establish a new C Corporation that will act as the main business and issues shares of this corporation.
The C Corporation adopts a 401(k) plan that allows participants to purchase employer stock as one of its options.
You enroll in the new 401(k) plan and roll over your existing retirement account into this new plan.
You direct your retirement funds account to purchase the issued shares of the C Corporation.
The C Corporation takes the proceeds from the sale of its stock to purchase an existing business, purchase a franchise, or begin a new venture.
Too Good to Be True?
While it might sound like an easy way to get to your retirement funds, the process must be done with great care and with the guidance of banking and tax professionals to make sure you’re following the rules. It is important to understand that a ROBS arrangement is not considered a tax shelter or unlawful in any way.
As long as all the guidelines are followed and requirements are met, the IRS has determined that these arrangements are legal and legitimate. In 2008, the IRS issued a memorandum stating as much while identifying common pitfalls that entrepreneurs face when entering into a ROBS arrangement.
What to Know
In order to be sure you don’t run into any of these pitfalls, you should work directly with an experienced professional who can become familiar with your particular arrangement. There are, however, a few common guidelines that anyone considering a ROBS arrangement should understand.
Eligible Employees. If your corporation has employees other than yourself and your spouse, you must allow participation in the retirement plan. Your corporation cannot hold a secret retirement plan that excludes eligible employees either expressly or by omission.
Salary Limitations. You may draw a salary from your corporation, but there are limitations to how much you can pay yourself using these funds. Some advisers would suggest that you not draw a salary from the proceeds of the stock sale and, instead, draw only from the proceeds of the business. This will eliminate any scrutiny over the fact that you entered the ROBS arrangement just to earn a salary.
Personal Use. The retirement funds used to finance the business cannot be used to purchase items for personal use. Every dollar must go towards valid business expenses. This may seem obvious but without strict accounting records, it can be easy to accidentally mingle your money.
Documentation. The bookkeeping, records and documentation that are required to satisfy the IRS requirements can be daunting. Professional advisers are generally recommended, especially for accounting and tax preparation purposes.
Termination of the Retirement Plan. You have to be able to hang on to the new 401(k) plan for at least three years or more. Part of the IRS requirements of a qualified retirement plan is that it is meant to be permanent and terminating the plan too soon can cause the IRS to question whether you intended it to be permanent or were seeking short-term gain.
The main risk of using a ROBS arrangement to finance your business is the loss of assets due to the failure of the business. Some of this risk can be decreased if the individual purchases a franchise of a successful company or purchases ownership of a successful business rather than starting from scratch. Of course, no business owner wants to attract the attention of the IRS so strict adherence to ROBS guidelines is essential to make sure that you don’t receive any tax penalties due to prohibited activities.
Rewards for a Lifetime
With the right business plan, a ROBS can help you gain control of your future and your retirement. Instead of attaching your retirement funds to the success of other companies that have no interest in your long-term financial success, your retirement will be tied directly to your own personal achievements.
You will also be able to finance your own operation without resorting to a loan and being tied to monthly interest charges and payments. It might be a risky move, but it is a move that has the potential to pay off in the long run both in financial stability and personal freedom. This information is provided for informational purposes only and should not replace information from a qualified tax representative. Please always consult a CPA or other qualified tax representative before making any financial decisions.