There is only one legal way to use retirement funds to buy or finance a business that you or a “disqualified person” will be involved in personal and that is 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)(13) that allows one to use 401(k) plan funds to buy stock in a “C” Corporation, which is known as “qualifying employer securities.”
- No Tax & Penalty: The primary advantage of establishing a ROBS solution is to be able to use your retirement funds to invest in a business you will be personally involved in without having to pay tax and potentially a penalty. For example, if someone under the age of 591/2 was looking to use $100,000 of retirement funds to fund a business and ended up taking a taxable distribution of that amount, that individual would likely have to pay approximately 45% of the 100,000 or $45,000 in tax to the IRS when declaring the distribution on their tax return. The tax rate could be lower if the individual was in a lower income tax bracket or the retirement funds needed were insignificant, but using a ROBS solution would save having to pay tax and potentially a 10% penalty on that amount.
- Invest in Yourself & Earn a Salary: The ROBS solution allows one to invest their retirement funds in a business that will be actively run by the retirement account holder without tax or penalty. According to Bloomberg, close to 80% of new businesses fail in the first 18 months. Hence, investing your hard earned retirement funds in a new business is certainly a risk. However, it is a risk that you are legally entitled to take as per the Internal Revenue Code. Using retirement funds to invest in your business is not for everyone, but for those entrepreneurs that would rather invest in themselves than Wall Street, the ROBS solution is an option.
- Diversification: One can generally not eliminate investment risk completely, but one can manage your level of risk. Every investment has some amount of risk, however, having your retirement funds invested in different types of investments, such as stocks, real estate, and even private businesses, can be a way of diversifying your retirement portfolio and better protecting your retirement funds from overexposure to Wall Street. Also, it is believed that diversification can enable a retirement portfolio to grow both when markets boom and returns crumble in one sector One should certainly work with a financial planner and tax professional when looking at investment options, especially when it comes to using retirement funds to buy a business.
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. Using the ROBS solution to buy a business allows you to use your retirement funds tax-free & penalty free as well as gain the ability to save for retirement through participation in a 401(k) plan.