LAST REVIEWED May 01 2020 9 MIN READ
By The Human Interest Team
If you are looking for a way to fund a small business, startup, or franchise while putting your retirement savings to use without paying early withdrawal and tax penalties, then you might want to learn more about Rollover for Business Startups (ROBS). Through this process, someone with a sizable 401(k) account or IRA who is not quite ready to retire can invest in a business by rolling their retirement fund over into a source of financing for a new business. If it sounds a little risky and complex, that’s because it can be. While this strategy might be exactly what a daring entrepreneur is looking for, it may not be perfect for everyone.
What Is ROBS?
Rollover for Business Startups is a financial option that allows individuals to withdraw funds from their qualified retirement accounts in order to invest in starting or buying a business. A person who is younger than the traditional retirement age of 59 1/2 can tap into their retirement savings without paying the early withdrawal fee or tax penalties that usually go along with the process.
Why Is ROBS a Good Investment Option?
There are several reasons why you might want to put your retirement capital to work for you in this way. First, you may have a great opportunity to create a business, but you might not have the cash on hand to do so. If you are reluctant to go into debt or don’t qualify for a business loan, freeing up your retirement savings might be a good option.
Second, some choose ROBS over a traditional approach to retirement savings because it seems like a faster way to make money, despite the fact that a ROBS strategy is far riskier. A traditional 401(k) or IRA accrues interest over time, while a ROBS investment lets you use the capital you already have to invest in yourself right away, putting your retirement savings to work as a funding source for your own entrepreneurial endeavors. Although this seems like an easy way to put your money to work, it’s important to remember that many new businesses fail within the first few years of operation. This makes ROBS a bit of a gamble.
ROBS: How It Works
In a ROBS 401(k) plan, retirement accounts such as a 401(k) or a traditional IRA are rolled over and invested in a new or existing business or franchise. The rules governing the process are not entirely simple, so most people beginning a 401(k) Rollover for Business Startup usually do so with the help of experienced attorneys, accountants, and financial advisors.
Before you can invest in the target business, a C corporation must be formed. This is a kind of corporation in which shareholders can own stock. Next, a new 401(k) plan is created for the new business. The investor’s existing 401(k) plan becomes a ROBS investment by being rolled into the new company’s 401(k). Then, these rolled-over funds are invested in the stock of the business. The stock is sold, and the cash is used to fund the business. That’s the ROBS plan, in a nutshell.
Things to Keep In Mind
It is often pointed out in the financial world that a Rollover for Business isn’t an ideal solution for everyone. First, it doesn’t make sense for an investor with less than $50,000 in retirement savings to put their savings to use as a ROBS rollover. Second, only non-Roth fund sources are eligible for the Rollover for Business Startup plan.
It’s also important to keep in mind that unlike a traditional 401(k), ROBS plans are subject to strict regulation and increased scrutiny from the IRS. There are several things to consider when it comes to the type of business into which you can invest your retirement assets.
As mentioned before, only a C corporation is eligible. This means that sole proprietorships or S corporations do not qualify. Additionally, the business must provide goods or services, so other types of businesses such as passive investing businesses are not eligible.
When the C corporation is formed, the 401(k) plan that allows the investor to buy stock in the company must be fair and legal. The stock must be purchased at fair market value, and no commission can be charged on the purchase. Additionally, the stock must undergo annual valuation, and all the company’s other employees must have the option to roll their 401(k) over into the ROBS account as well. These are areas that the IRS pays particular attention to when they look into the company’s ROBS plan.
Advantages and Disadvantages of ROBS
There are several important considerations to bear in mind when you’re looking into the possibility of rolling your retirement savings over into a ROBS account. Here are the pros and cons.
A ROBS strategy is an investment in yourself.
It opens up a source of funding for a new business without starting you off in debt.
With no loan payments or interest, you can reinvest your profits back into the business.
There are no penalties or taxes to pay on your use of your 401(k) or IRA funds, even if you are withdrawing them before retirement age.
Your entire retirement fund could be at risk, and financial analysts have pointed out that many ROBS-funded businesses have either failed or are on their way to failing.
You can miss out on the steady gains that may have gone along with more traditional retirement investment strategies. You will lose out on the benefits of a rising stock market, tax-deferment benefits, and compounding investments.
Setting up a ROBS investment can be costly. The financial transactions required to do so are numerous and complex, and ROBS providers charge steep initial fees as well as monthly maintenance fees for administrating your accounts.
Any mistakes made while setting up the ROBS account could disqualify the entire plan, incurring steep penalties and nullifying the exemptions from taxes and early withdrawal penalties.
A Rollover for Business Startup model might be exactly the retirement investment option that you’re looking for. On the other hand, it might be a venture that is riskier and more complicated than you’re willing to get into.
Whatever you’re looking for when it comes to retirement options, Human Interest has the expertise to guide you. Complete our online form and talk with one of our financial professionals to begin securing your future today.
The Human Interest Team
We believe that everyone deserves access to a secure financial future, which is why we make it easy to provide a 401(k) to your employees. Human Interest offers a low-cost 401(k) with automated administration, built-in investment advising, and integration with leading payroll providers.