Rollover for Business Startups (ROBS) Ultimate Guide 2023
Tricia has nearly two decades of experience in commercial and federal government lending. Her expertise is highlighted throughout small business loan content on Fit Small Business.
Andrew has over a decade of experience in finance and mortgage lending. He shares his expertise in Fit Small Business’s financing content.
This article is part of a larger series on Business Financing.
A rollover for business startups (ROBS) allows you to access your own retirement accounts tax- and penalty-free to fund a business, purchase another company, or invest in a franchise. It’s a great way to obtain cash if you don’t want to borrow money from a lender, and it also allows you to save on loan fees and interest charges that would normally be paid on a loan.
However, a ROBS isn’t without risk. If your business fails, then you could lose the entire balance of the retirement accounts that were used. Additionally, a ROBS is a complicated process that could trigger taxes and penalties if done incorrectly.
To mitigate that risk, we recommend using one of the best ROBS providers, such as Guidant, to walk you through the process. It offers a high level of customer service and can provide resources for multiple aspects of your business outside of the ROBS transaction.
Who a ROBS Is Right For
- Those avoiding borrowing money and wanting to fund a business using their 401(k) or other type of retirement account: By not borrowing money, you’ll have a higher monthly cash flow since you won’t have the added monthly expense from a loan payment. However, you should note that most ROBS providers require you to have a retirement balance of at least $50,000.
- Those unable to qualify for a loan due to credit score or business finances: A ROBS is a good fit since it doesn’t carry the same requirements that are typical of a loan, such as a minimum credit score, time in business, and revenue earned.
Prohibited Uses of ROBS Funds
- Paying yourself an unreasonable salary: If you’re audited by the IRS, you could be subject to fines and penalties if it’s determined that your compensation is excessive. You should be able to make an argument for a reasonable salary based on the industry standard for your role in the company, as well as your compensation in relation to the business earnings.
- Using business property for personal use: The IRS doesn’t allow for business property to be used by you or immediate family members for personal use. Doing so could result in penalties.
- Paying certain professional fees: Fees paid to a company for certain professional services—such as setting up and maintaining a ROBS—cannot be paid with ROBS funds and must be paid using a separate source of cash.
- Funding a business engaged in activities that aren’t federally legal: Businesses that deal with products or services that aren’t legal at the federal level cannot be funded by a ROBS.
- Funding a business that isn’t an active operating company: Your company must be engaged in activities that actively sell a product or service. You must also be an active participant in the company’s daily activities by conducting tasks such as stocking shelves, keeping the premises free of trash, supervising employees, or managing payroll. ROBS funds cannot be used to invest as a silent or passive investor.
How a ROBS Works
Step 1: Establish a C corporation (C-corp): To do a ROBS, the business must be structured as a C-corp. This is because a C-corp is the only business structure that can issue the type of stock that will ultimately allow you to gain access to your personal retirement funds. Businesses operating as a sole proprietor, partnership, limited liability corporation (LLC), or S corporation (S-corp) are ineligible for a ROBS.
Step 2: Create a retirement plan under the new C-corp: A retirement plan must be created under the new C-corp. A 401(k) is a common choice, but business owners can choose other plans, such as defined benefit and defined contribution.
Step 3: Choose a custodian for the C-corp’s retirement plan: You’ll need to choose a custodian to oversee the retirement plan’s assets. They’re also responsible for issuing and maintaining retirement account statements such as year-end tax forms. You can choose a custodian from one of the best 401(k) companies.
Step 4: Roll over personal retirement funds to the C-corp’s plan: Now that the C-corp retirement plan is set up, the funds from your personal retirement account will be transferred into the corporation’s plan.
Step 5: Ensure the retirement plan buys stock in the C-corp: Here, the C-corp receives cash from the retirement plan. In exchange for this cash, the corporation issues stock to the plan. This is similar to a scenario where you decide to purchase stock from a publicly traded company like Apple. By buying stock in Apple, you give the company cash that it can then use for its business operations.
Step 6: Use funds now available to the C-corp: When the C-corp’s retirement plan purchases stock in the company, the funds will then be made available for use by the corporation. Funds can then be used for many business-related activities, including equipment, payroll, and other operational expenses.
Step 7: Conduct annual reviews to maintain regulatory compliance: With a ROBS, you’ll have ongoing annual requirements that must be met to stay compliant with several business and tax rules and regulations. We highly recommend working with a ROBS provider here. Failing to meet the annual requirements could cause you to incur taxes and penalties.
It usually takes around three to four weeks to set up a ROBS. Since this isn’t something that can be done overnight, you should plan ahead to ensure that you have the funds available when you need them. In case a ROBS doesn’t work out for you, it can be helpful to consider other sources of funding, such as small business loans or startup business loans.
Additional ROBS Rollovers
If you need more funds for your business after the initial ROBS has been completed, you’ll need a business appraisal showing a positive valuation. Once that has been completed, you can complete another ROBS transaction by following the steps you took for the initial rollover.
There’s no limit to how many additional ROBS transactions you can do. However, your ROBS provider may charge a fee for each rollover transaction as there are additional paperwork and due diligence requirements they must conduct.
Pros & Cons of ROBS
| PROS | CONS |
|---|---|
| Access your retirement funds tax-free and penalty-free | Risk of losing retirement funds if business fails |
| No time in business requirements | Must be a C-corp to qualify |
| No credit score requirements | Many ROBS providers charge a one-time fee in addition to recurring maintenance fees |
| No collateral needed | Access to funds can take several weeks |
| Allows for debt-free funding of business for higher monthly cash flows | Must maintain annual requirements to avoid taxes and penalties |
| Few restrictions on what ROBS funds cannot be used for | |
| No interest charges or loan payments | |
| ROBS-funded businesses have a higher success rate | |
ROBS Requirements
- Have an eligible retirement account: Many types of retirement accounts can fund your new business venture in a ROBS transaction. This includes 401(k), 403(b), thrift savings plan (TSP), traditional individual retirement account (IRA), Keogh, and simplified employer pension (SEP) plan. Roth IRAs are one of the few plans that are ineligible.
- Have a sufficient balance in the retirement account: Most ROBS providers will require a minimum balance of $50,000. You should also consider if the amount you’re considering will be sufficient for your business needs.
- Create a C-corp: The business you are funding must be structured as a C-corp, which allows for the issuance of the type of stock that is necessary for a ROBS.
- Be an active employee: To be considered an active employee, you must be consistently engaged with some aspect of the business. This can include overseeing employees, managing logistics, processing payroll, or just keeping the office space free of trash. You must also draw a reasonable salary in relation to the income generated by the business.
- Allow employees to contribute to the company’s retirement plan: Employees of the C-corp must be given the option of contributing to the company’s retirement plan. You may have the option to allow contributions to be made immediately or establish a waiting period for new employees.
Once your ROBS has been set up, you’ll need to be mindful of anything that could affect its ongoing eligibility as a ROBS isn’t something you can set once and forget about. Here are some of the annual requirements:
- File taxes for the C-corp: To avoid taxes or fees from the IRS, you’ll need to file your business taxes in a timely manner each year. Although a ROBS provider can advise of what’s needed, they won’t handle the actual filing or preparation of the taxes.
- Review retirement plan and file form 5500: Each year, you’ll need to file IRS form 5500, paperwork that tells them the value of your company’s retirement plan. You’ll also need to ensure the retirement plan still meets the requirements for a ROBS and has been administered properly.
- Verify you’ve met the definition of an active employee: At least once a year, you should review the salary you’ve taken to make sure it can be considered reasonable for the job functions performed and in relation to the amount of revenue generated by the business. A good rule of thumb is to also show that you’ve contributed at least 20 working hours to the business each week.
- Maintain an ERISA fidelity bond: A fidelity bond effectively provides insurance against retirement plan losses that are the result of illegal activity. The minimum bond coverage must be the lesser of $500,000 or 10% of the value of the plan assets.
- Maintain any state-specific requirements: Different states may have additional reporting or paperwork requirements for a ROBS. Your ROBS provider can walk you through this step.
- Adhere to the requirements for a C-corp: Maintaining a C-corp in good standing involves meeting any ongoing requirements. This can include having a sufficient number of shareholder/director meetings, recording meeting minutes properly, filing annual reports, and maintaining adequate financial records.
- Maintain status as an active operating company: To satisfy this requirement, you must be primarily engaged in the business of selling a product or service.
ROBS Costs
- One-time upfront fees: You can expect to pay anywhere from $1,000 to $5,000 to set up a ROBS plan. This is often a flat fee and must be paid out of pocket, separate from the funds you intend on using as part of the ROBS. Fees charged here will generally cover the time needed to walk you through the process, plan the steps that need to be taken, and file and submit paperwork to the IRS. Many companies will also provide a guarantee to cover taxes or fees in the event a compliance issue is identified.
- Recurring maintenance fees: Expect to pay around $100 to $200 per month for the continued maintenance of your ROBS plan. However, keep in mind that this can vary depending on the provider you choose and the number of employees in the new company. Fees charged here cover the paperwork that must be filed with the IRS and any logistics involved with keeping employees informed about how the company’s retirement plan works.
Unwinding a ROBS
Terminating your ROBS, also known as unwinding, requires you to complete special steps. Unwinding a ROBS usually comes up if you want to discontinue your C-corp or need to sell or close your business. Not following the steps to unwind a ROBS can result in fines being assessed by the IRS:
- Determine the value of your company: This can include an appraisal of its stock price or business assets that can be sold. If the business is insolvent, then you’ll need to provide financial documents to support a stock valuation of $0.
- Ensure that the C-corp purchases shares from the retirement plan: This can be done with either the sale of company assets or company stock. In either case, the funds received from the sale are used to pay business debts. Once completed, the remaining funds are distributed to shareholders based on their ownership percentage in the company.
- Terminate the retirement plan. To properly terminate your company’s retirement plan, the plan participants must be given proper notice. Additional paperwork and notices may also be required depending on your specific circumstances.
- File final paperwork with the IRS. You must file a final IRS form 5500. This tells the IRS that you have officially terminated your corporation’s retirement plan and that it’s no longer active. This is a critical step you must take to avoid any fines or penalties from the IRS.
Bottom Line
A ROBS is a great option if you want to fund your business without taking on debt. By not borrowing money, you can save a significant sum of money by avoiding loan fees and interest charges. To avoid any fines from the IRS, it’s recommended you use a ROBS provider who can help you navigate the rules and regulations of this type of transaction. It’s important that you also understand the risk that if your business fails, you could lose the portion of your retirement balance that was used for the rollover.
