Thinking of using your retirement account to start a business? Rollovers as Business Startups (ROBS) can help you do this without tax penalties or early withdrawal fees. In this guide, you’ll learn how ROBS work, their key benefits, and potential risks.

Key Takeaways

  • Rollovers as Business Startups (ROBS) allow entrepreneurs to use a retirement account for business funding without tax penalties, providing a tax-advantaged capital source.
  • Setting up ROBS requires establishing a new C Corporation and a 401(k) retirement plan to legally roll over existing retirement funds into the business.
  • While ROBS offers tax-free funding and protects personal assets, it carries risks including the potential loss of retirement savings and ongoing compliance costs.

Understanding ROBS

Rollovers as Business Startups (ROBS) is a business funding mechanism that allows entrepreneurs to tap into their retirement savings to finance new business ventures without triggering tax penalties or early withdrawal fees.

Through a ROBS transaction, retirement savings can be rolled over into a business funding vehicle, providing a tax-advantaged source of capital for business startups. This makes ROBS an appealing alternative to traditional business loans, which often come with high-interest rates and stringent repayment terms.

However, it’s crucial to note that while ROBS provides a unique funding opportunity, it also places your retirement savings at risk if the business fails. This inherent risk underscores the importance of thorough planning and professional consultation.

Before proceeding with a ROBS arrangement, consulting with legal and tax professionals is essential. Business attorneys and accountants can help navigate the complexities of ROBS, ensuring compliance with regulatory requirements and minimizing potential risks. This helps prospective business owners make informed decisions and protect their retirement funds while pursuing entrepreneurial dreams.

Setting Up a ROBS Structure

Setting up a ROBS structure involves several critical steps, each designed to ensure that the retirement funds are correctly and legally used for business purposes. The process begins with establishing a new C Corporation, which is a prerequisite for any ROBS transaction. This step is crucial because only a C Corporation can issue the Qualified Employer Securities (QES) necessary for the ROBS plan.

Once the C Corporation is established, the next step is to set up a 401(k) retirement plan within this new business entity. This plan allows the rollover of existing retirement funds into the company’s 401(k), facilitating the investment in company stock.

Finally, the rolled-over retirement funds are used to purchase stock in the new C Corporation, providing the business with the necessary capital to start operations.

Creating a New C Corporation

Creating a new C Corporation is the foundational step in the ROBS process. This type of business entity is required because it is the only one allowed to issue Qualified Employer Securities (QES). The process involves several key actions: filing the articles of incorporation, developing corporate bylaws, and appointing directors. These steps legally establish the corporation and set the stage for the subsequent ROBS transactions. Davis Business Law’s team of business attorneys can help with the process.

The new C Corporation must be formed in the state where the business will operate. This means adhering to state-specific regulations and ensuring all legal requirements are met. Forming a C Corporation also involves creating a new corporate structure with shareholders. By establishing a solid corporate foundation, business owners can ensure that their new business venture is legally compliant and ready to receive the rolled-over retirement funds.

Establishing a 401(k) Plan for Your C Corporation

After forming the C Corporation, the next step is to establish a 401(k) retirement plan for the new entity. This is a critical component of the ROBS plan, as it allows the business owner to roll over existing retirement funds into the corporation’s retirement plan. Typically, a standard 401(k) plan is set up for this purpose.

The process involves creating a 401(k) ROBS retirement plan specifically for the C Corporation. This plan must be managed by a custodian, who is responsible for overseeing the investments within the 401(k). Examples of custodians include well-known financial institutions such as Fidelity and Merrill Lynch.

This retirement plan ensures that the rolled-over funds can be legally invested in the company’s stock. This allows the business owner to access retirement savings and retirement assets without incurring early withdrawal penalties, providing a tax-free way to fund the new business venture.

Rolling Over Existing Retirement Funds

Rolling over existing retirement funds into the new C Corporation’s 401(k) plan is the final step in setting up a ROBS structure. This process involves transferring funds from an existing retirement account, such as a 401(k) or IRA, into the newly established 401(k) plan within the C Corporation. This transfer is facilitated by the plan custodian, who ensures that the funds are moved correctly and legally.

Rolling over these funds allows business owners to access their retirement savings without paying taxes or early withdrawal penalties. This method provides a significant advantage over traditional funding options, as it allows the business to start with substantial capital without incurring debt or diluting ownership shares.

Once the funds are rolled over, they can be used to purchase stock in the C Corporation, completing the ROBS transaction and providing the necessary funding for business operations.

Using ROBS Funds for Business Operations

Once the ROBS funds are rolled over and the company stock is purchased, these funds can be used to cover various business expenses. The retirement plan invests up to 100 percent of the rolled-over funds into purchasing company stock. This allows the business to access substantial capital, which can be used for essential expenses such as purchasing equipment, leasing space, and paying employee salaries.

The use of ROBS funds is strictly regulated, and they must be used solely for business purposes. This ensures that the funds are utilized to support the business’s growth and operations, rather than for personal expenses. Additionally, the business owner must actively work for the company and track their time and activities once operations begin.

ROBS funds can expedite the startup process since they are typically accessible faster than traditional loans. This quick access to capital can be a significant advantage for new business ventures, allowing entrepreneurs to start operations and generate revenue more quickly.

Pros and Cons of ROBS Financing

ROBS financing offers several advantages and disadvantages that prospective business owners must carefully consider. On the one hand, ROBS provides a tax-free, penalty-free way to access retirement funds for business financing. This is particularly beneficial for entrepreneurs looking to avoid high-interest rates and repayment terms associated with traditional business loans.

However, ROBS also comes with significant risks. The primary risk is the potential loss of retirement savings if the business fails. Additionally, ROBS structures incur setup and maintenance fees, which can add to the overall cost of compliance. It’s essential for business owners to weigh these pros and cons carefully and consult with professionals before deciding to use ROBS for business funding.

Advantages of ROBS

One of the main advantages of ROBS financing is that it enables entrepreneurs to fund their startups with their own money, avoiding the need for external investors and debt. This can lead to greater control over the business and its operations. Additionally, ROBS financing provides tax-deferred, penalty-free funding, which can significantly reduce the financial burden on new business ventures.

Another benefit of ROBS is the protection of personal assets, as the funds are held within a corporate structure. This means that personal savings and assets are not at risk if the business encounters financial difficulties. Moreover, using ROBS can reduce the issue of double taxation, as profits from a C Corporation are taxed at a reduced corporate rate and corporate taxes are minimized.

Overall, ROBS financing can provide a viable pathway for entrepreneurs to launch their businesses with reduced financial risks and greater control over their operations.

Risks and Challenges

Despite its advantages, ROBS financing comes with several risks and challenges. The most significant risk is the potential loss of retirement savings if the business fails. This can have severe consequences for the business owner’s financial future, making it crucial to thoroughly evaluate the business plan and market conditions before proceeding with a ROBS arrangement.

In addition to the financial risks, ROBS structures also incur setup and ongoing maintenance fees. These costs can add up over time, increasing the overall expense of maintaining compliance with ROBS regulations.

Business owners should also be aware of the potential dilution of ownership shares, as the retirement plan must be available to eligible employees. This can impact the business owner’s control and decision-making power within the company.

Due to these risks, business owners should carefully consider all factors and seek professional advice from a business attorney and an accountant before opting for ROBS financing.

Summary

In summary, ROBS offers a unique and tax-advantaged way for entrepreneurs to use their retirement funds to start new business ventures. By setting up a C Corporation, establishing a 401(k) plan, and rolling over existing retirement funds, business owners can access substantial capital without incurring debt or giving up ownership. However, this method also comes with significant risks, including the potential loss of retirement savings if the business fails.

Prospective business owners should carefully weigh these pros and cons and consult with legal and tax professionals before proceeding with a ROBS arrangement. With thorough planning and professional guidance, ROBS can be a powerful tool to turn entrepreneurial dreams into reality.

Frequently Asked Questions

What is ROBS and how does it work?

ROBS enables entrepreneurs to use their retirement funds to finance new business ventures without tax penalties. It involves rolling over retirement savings into a new C Corporation’s 401(k) plan, which subsequently invests in the company’s stock.

What are the primary steps to set up a ROBS structure?

To set up a ROBS structure, you need to create a new C Corporation, establish a 401(k) plan for the corporation, and roll over existing retirement funds into this plan to purchase company stock for capital. This process allows you to leverage your retirement savings to fund your business.

What are the advantages of using ROBS for business financing?

Using ROBS for business financing offers tax-free and penalty-free access to retirement funds, enabling you to avoid debt and investors while protecting your personal assets. It also helps reduce double taxation and provides significant capital for startups.

What are the risks associated with ROBS financing?

ROBS financing carries risks such as the potential loss of retirement savings if the business fails, compliance and maintenance costs, and possible dilution of ownership shares. It’s crucial to assess these risks thoroughly and consult a professional before proceeding.

Can ROBS funds be used for personal expenses?

ROBS funds cannot be used for personal expenses; they must be exclusively dedicated to business purposes to avoid legal and financial issues. Any misuse can result in serious repercussions.