ROBS stands for Rollover for Business Startups. The IRS describes ROBS as “an arrangement in which prospective business owners use their retirement funds to pay for new business start-up costs.” Essentially, the ROBS solution lets you use your retirement funds (IRA, 401(k), etc.) to start your own business. Note: you can also use ROBS to invest in a current business as well. There are certainly pros and cons associated with the ROBS solution. The following will give you a blueprint as to how ROBS works, along with the benefits and risks of it.
How Does the ROBS Solution work?
As we mentioned, the ROBS solution uses retirement funds to use for a business venture. A “C Corporation” is formed. A C Corporation is a structure that allows for shareholders, which is taxed separately from its owners (shareholders). A new 401(k) plan is then created for the business. Now, you can roll over your retirement funds into the new 401(k) plan. These funds are used to purchase stock in the corporation. The sale of the stock is then used to purchase (or invest in) the business. Read this for a more detailed look at how ROBS works, including why you must use a C Corp.
Pros of Using the ROBS Solution
Tax Savings – If you plan on using retirement funds to invest in a business, you could simply withdraw the funds. However, you will be hit with a huge tax bill and may owe penalties. All contributions to traditional plans are tax-deferred. This means you will owe taxes on all distributions. If you were to take a large sum of money to invest in a business, the tax hit will be enormous. Further, if you are under age 59 1/2 when withdrawing from the plan, you will be hit with a 10% early withdrawal penalty. Using the ROBS solution allows you to take distributions tax- and penalty-free!
No Debt – When using a ROBS for your business, you won’t incur debt. ROBS is not a loan, so there’s no money to pay back to a bank. No high interest fees and no chance of defaulting. Therefore, all profits can now be reinvested into the business to make it grow faster.
No Credit Check – Speaking of a bank loan, there’s no need for a credit check when using ROBS. Securing a traditional loan is hard for many people. While you may have plenty of savings in your retirement account, you might not have the credit-worthiness to obtain a loan.
Invest in Yourself – Why bet on the stock market or other investment vehicles when you can invest in yourself? Take control of your retirement by going into business for yourself. This way, it’s up to you if you fail or succeed.
Earn a Paycheck – In order to participate in the 401(k) plan, you must be an employee of the C Corporation. This gives you the advantage of earning a salary AND being involved in all aspects of the business, including decision making.
Cons of Using the ROBS Solution
Failure – According to the Small Business Administration, about half of all new businesses fail within five years. Therefore, the biggest risk with ROBS is losing most, if not all, of your retirement savings due to a failed business venture. It’s imperative to make sure your business succeeds!
Fees – Many ROBS providers charge up to $5,000 to set up the structure. Plus, there’s a monthly administration fee (up to $150/month). It’s a very costly way to invest your retirement funds. IRA Financial Group has very competitive pricing for its ROBS solution. It’s just $2,500 for setup and less than $1,000 annually for record-keeping services. Still a hefty chunk of change!
Audit – After performing a ROBS, the IRS might look at you a little more closely. The chances of an audit are still slim, however they do increase. So long as you have a good facilitator (such as IRAFG), you should be okay even if the IRS starts looking into you.
Losing out on Potential Gains – Once you move your money out of your current retirement plan, it’s no longer earning money for you. Great years in the Stock Market can yield 10-15% earnings. Additionally, you lose the power of compounding. On the other hand, during a down year, you won’t lose money either.
Is the ROBS Solution Right for You?
The honest answer to that questions is “It Depends.” It’s certainly not right for everyone. You must have enough funds in your retirement account(s) to purchase the business. More importantly, you need a fail-proof business plan or else you put your entire future in jeopardy. Lastly, you need to be a risk taker. The ROBS solution can be an all or nothing gamble.
IRA Financial’s Adam Bergman has written a book all about the ROBS solution, entitled Turning Retirement Funds Into Start-Up Dreams (available for purchase here). Do yourself a favor and spend the $12.99 (only $8 on Kindle) to educate yourself fully about the ROBS Solution.
If you have any questions, you can always give us a ring at 800.472.0646!