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ROBS Solution & How it Works

How does roll over business solutions work
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The ROBS Solution

The Rollover as Business Startup (ROBS) Solution allows you to use your retirement funds within an eligible retirement account, like an IRA or 401(k), to invest in a new or existing business/franchise. You can be an employee and even earn a salary without tax or penalty. The structure is great for entrepreneurs in need of capital to actualize their business dreams, but there are intricacies behind the Rollover as Business Startup solution.

Establishing a C Corporation

When you want to use your retirement funds to invest in a new business that adopts a 401(k) Plan, you will need a C corporation. You cannot use an LLC, because an LLC does not satisfy the definition, and you cannot use an S corp. because only individuals can be shareholders, and a 401(k) plan is a trust. It absolutely must be a C corp. A C corporation is the most common type of corporation in the United States. As a corporation, it doesn’t cease to exist even when the owner or shareholder leaves the corp. or passes away.

How Does the ROBS Solution Work?

Once again, in order to finance your business with your retirement funds, you need to do this through the ROBS because of the exemption in the tax code, known as ‘qualifying employer securities’. You can find this exemption under IRC section 4975(d).

Therefore, this differs from a traditional IRA. As you may know, with an IRA you are unable to withdraw funds from your retirement account (until you reach age of retirement), without paying or incurring fees. However with this avenue, the ‘qualifying employer securities’ exemption allows you to do so. But let’s assume you were to use a self-directed IRA. As a disqualified person, you will trigger the prohibited transaction rules.

In general, the Rollover as Business Startup Solution involves the following steps:

  1. Roll over a prior IRA or 401(k) plan account into a new 401(k) plan.
  2. A start-up C corporation will sponsor the 401(k) plan.
  3. You then invest the rollover 401(k) funds in the stock of the new C corp.
  4. Your funds are deposited in the C corp. bank account to be used for business purposes.

In sum, the ROBS solution basically requires that your prior IRA or 401(k) rolls over to your newly established 401(k) plan. And an existing or newly established C corp. must sponsor this newly established 401(k).

The three ROBS components include:

  • Retirement funds available for roll over
  • A C corporation
  • A newly established 401(k) Plan

IRC Section 4675(d) and ERISA section 408(e)

IRC Section 4675(d) and ERISA section 408(e) shields employers from scrutiny of routine (non-abusive) corporate transactions by the plan sponsor and other “disqualified persons.” This might otherwise constitute technical violations of the prohibited transaction rules. This is due to the employer-sponsored retirement plan’s ownership of employer securities.

If the plan sponsor and other fiduciaries’ routine corporate transactions did not fall within the full scope of ERISA Section 408(e), the prohibited transaction rules then needlessly prohibit a myriad of legitimate business transactions. Ultimately, this nullifies the exemption that Congress intended to provide.

In order to accomplish its purpose, ERISA Section 408(e) must be read to exempt the natural and necessary commercial consequences of owning corporate stock, rather than just the stock purchase or divestiture.

Important tax and economic policy considerations also compel a different result for 401(k) plans than IRAs. Congress wants to encourage 401(k) plans to invest in employer securities, within certain limits. The opportunity to invest in employer securities through retirement plans benefit employers and employees alike by aligning their economic interests.

Outside the context of ROBS arrangements, many 401(k) plans permit participants to invest in employer stock. A number of large 401(k) plans, including plans sponsored by Apple and Pepsi, include substantial allocations of employer stock.

Cons to Consider

To begin explaining how this solution can harm you, we’ll pull a quote out of Turning Retirement Funds into Start-Up Dreams.

“Even though the ROBS solution is 100% legal per the IRS, it is probably my least favorite self-directed retirement solution…I think the idea of using a majority of your hard-earned retirement funds to invest in a business is a risky and a potentially self-defeating proposition…The ROBS solution should be looked at as a last resort when there are no other options available.”

Strong words, but valid, nevertheless. As we mentioned in the benefits of using the ROBS solution, 50% of new businesses fail within the first five years, according to the Small Business Administration. And most people who use the solution use most, or all their retirement savings to invest in their new business venture.

If you are looking into the ROBS solution, it’s much wiser to invest just a portion of your retirement funds to start/finance your business. That way, you don’t list your entire nest egg. Questions or concerns? Speak with one of our IRA specialists today.

If you have any questions or concerns, the IRA specialists at IRA Financial are just a phone call or email away. If you choose to establish a ROBS, you will be assigned a specialist who will complete all the necessary paperwork for you and guide you along the way.

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