Last Updated on June 7, 2021
ROBS Solution, or the Rollover Business Start-up (aka Rollover as Business Startups), is an IRS and ERISA approved structure. It allows you to invest funds from your retirement account into a new business/franchise. You can remove funds from a Traditional 401(k) or IRA Plan to purchase a new or existing business or franchise tax-free and penalty-free.
The ROBS arrangement typically involves rolling over a prior IRA or 401(k) plan account into a newly established 401(k) plan, which a start-up C Corporation business sponsors. You then invest the rollover funds in the stock of the new C Corporation.
If you’re an entrepreneur, you’ll benefit in many ways by using the ROBS retirement option. With the ROBS option, you:
Won’t take on debt: You can always invest more money into your business which is crucial for start-ups. Remember, a ROBS isn’t a loan, therefore there’s no debt to repay.
Won’t pay penalties or taxes: With the Rollover Business Startup Solution, you can withdraw funds from your retirement plan before 59 ½ without incurring taxes or penalties.
Receive Funding: Your credit score doesn’t matter, and typically other factors that may go against you aren’t considered. Your business receives funding when it needs funding. If you’re passionate about starting your business and you have a significant retirement “nest egg”, turn this into capital for your new business venture. The ROBS solution allows you to kick-start your new business by accessing the money in your retirement account.
The ROBS Solution – How Can I Benefit?
When it comes to using retirement funds to buy or finance a business that you or another “disqualified person” have personal involvement in, there’s only one way to do this: the Rollover Business Start-Up (ROBS). The ROBS solution takes advantage of an exception in the tax code under Internal Revenue Code (IRC) Section 4975(d). This allows you to use 401(k) plan funds to buy stock in a “C” Corporation, which is known as “qualifying employer securities.”
This is the reason you cannot use a Self-Directed IRA LLC to invest in a business you or another disqualified person has personal involvement in. Additionally, it’s why a 401(k) plan cannot invest in an LLC in which the plan participant or disqualified person will be involved in without triggering the prohibited transaction rules.
5 Advantages of the ROBS Solution
The primary advantage of establishing a ROBS solution is the ability to use your retirement funds to invest in a business you have a personal involvement with. You’re able to invest retirement funds into the business without having to take a taxable distribution and a 10% early distribution penalty if under 59 1/2. As a result, the ROBS solution can save you close to 45% of the distribution amount.
For example, if you’re under 59 1/2 and you want to use $100,000 of retirement funds to fund a business, you have the option to take a taxable distribution of that amount. But you will likely pay approximately 45% of the 100,000 in tax to the IRS when declaring the distribution on their tax return. That’s a whopping $45,000.
Of course, the tax rate can lower depending on whether you’re in a lower income tax bracket. It can also decrease if the retirement funds you need are insignificant.
Nevertheless, a ROBS solution saves you from paying tax and potentially a 10% penalty on that amount.
Invest in Yourself
The ROBS solution allows you to invest your retirement funds in yourself rather than Wall Street. Of course, not all businesses are successful. According to Bloomberg, close to 80% of new businesses fail in the first 18 months. Therefore, investing your retirement funds in a new business is certainly risky. However, it is a risk that you are legally permissible to take as per the Internal Revenue Code.
Using retirement funds to invest in your business is not for everyone. However, for those entrepreneurs who prefer to invest in themselves rather than Wall Street, the ROBS solution is an option.
There is a growing sentiment among financial advisors that in order to protect your retirement funds from a market downturn, you must diversify your retirement funds. This belief grew after the 2008 financial crisis.
You cannot eliminate investment risk completely, but you can manage your level of risk. If you invest your retirement funds in different types of investments, such as stocks, real estate, and even private businesses, you can better protect your retirement funds.
Also, diversification may enable a retirement portfolio to grow both when markets boom and returns crumble in one sector. Work with a financial planner and tax professional when looking at investment options. This is especially important when using your retirement funds to buy a business.
Earn a Salary
In order to be a participant of a 401(k) Plan, you need to be an employee of the business adopting the plan. Therefore, in order to be eligible to participate in the corporation 401(k) plan you must become a W-2 employee of the C Corporation. For many entrepreneurs, the ability to earn a salary and have involvement in the business is the reason they use a ROBS solution versus a self-directed IRA.
Benefit from having a 401(k) Retirement Plan
One of the best ways for you to save toward your own retirement and ensure your future security is through an employer-sponsored 401(k) plan. Below are some advantages of offering and participating in a 401(k) Plan.
- Matching Contributions: Many employers will match a portion of your savings. It’s like passing up free money if you don’t participate. A safe harbor 401(k) Plan is a popular type of 401(k) plan for small businesses. It offers employees who participate in the plan a 3% matching contribution by the employer. Thus, if the employee earns $40,000 in salary during the year and contributes 3% of the salary of $1,200 to the 401(k) plan, the employer contributes an additional $1,200 (3% of the salary) to the individual 401(k) plan account.
- Retaining employees: For most businesses offering retirement benefits, it is worthwhile for small businesses to compete for talented workers by implementing 401(k) benefits. Offering 401(k) plan benefits is a great way to retain key employees. In general, when potential hires are considering multiple job offers, they’ll compare those offers on corporate culture, growth opportunities, and benefits packages.
- Easy Administration: 401(k) Plan administration is now easier and more cost-effective than ever with Internet options available to small employers. In addition, IRA Financial Group offers record-keeping and third-party administration services for your plan. This allows you to spend more time focusing on your business and less on your plan.
- You Can Participate: You are eligible to participate in the company 401(k) plan if you are an owner or an employee of the company that sponsors the 401(k) plan. Current regulations allow plan participants to contribute up to $19,500 of their income on a pre-tax basis each year. Or $26,000 if at least age 50. Therefore, in addition to your tax savings for offering the plan and providing matching contributions, you’ll receive tax savings for participating in the plan. This savings can be substantial. An owner in the 35% tax bracket who makes the maximum contribution saves approximately $6,800 in taxes in 2021.
Can the ROBS Solution Harm You?
To begin explaining how this solution may potentially harm you, we’ll pull a quote out of Turning Retirement Funds into Start-Up Dreams.
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. This is where the ROBS solution may come with hefty risks.
Did You Know?
A C Corporation is a legal entity where the owners, shareholders, or stakeholders are taxed separately from the entity. Additionally, as a C corporation has two layers of tax, C corporations offer shareholders limited liability protection. Contact us today at IRA Financial to learn more, and to find out what benefits this may offer you.