The Rollover Business Startup Solution (“ROBS”) is the only legal way one can use retirement funds to invest in a business in which they or any disqualified person is directly or indirectly personally involved with. The ROBS solution is the most tax efficient way one can use 401k funds to finance or buy a business or franchise.
In general, one has three options when contemplating using retirement funds to buy a business: (1) take a distribution and pay tax and a 10% early distribution penalty if under the age of 59 1/2. This could be an expensive proposition depending on the amount of the pre-tax distribution; (2) Establish a 401(k) plan and borrow up to the lesser of $50,000 or 50% of your account value. The advantage is you get tax-free use of the funds, however, the downside is that the amount you can access is capped and the loan has to be paid back over a 5 year period at least quarterly.; and (3) the ROBS solution, which gives one the ability to use all pre-tax retirement funds to buy a business or franchise without tax or penalty.
The ROBS solution typically involves the following sequential steps: (i) an entrepreneur or existing business owner establishes a new C Corporation; (ii) the C Corporation adopts a prototype 401(k) plan that specifically permits plan participants to direct the investment of their plan accounts into a selection of investment options, including employer stock, also known as “qualifying employer securities.”; (iii) the entrepreneur elects to participate in the new 401(k) plan and, as permitted by the plan, directs a rollover or trustee-to-trustee transfer of retirement funds from another qualified retirement plan into the newly adopted 401(k) plan; (iv) the entrepreneur then directs the investment of his or her 401(k) plan account to purchase the C Corporation’s newly issued stock at fair market value (i.e., the amount that the entrepreneur wishes to invest in the new business); and finally (v) the C Corporation utilizes the proceeds from the sale of stock to purchase an existing business or to begin a new venture.
With the IRS compliant Business Acquisition Structure, you can earn a reasonable salary from your new business or franchise. You can also use your new 401(k) Plan to make high tax-deductible contributions – $53,000 ($59,000 if you are over the age of 50) and even borrow up to $50,000 for any purpose.
When contemplating using 401k funds to buy a business or franchise, one must remember that the ROBS solutions imposes a number of important compliance requirements that must be satisfied in order for the structure to be in good standing with the IRS.