This article is part of a larger series on Business Financing.
A rollover for business startups (ROBS) allows you to invest funds from an existing 401(k) or individual retirement account (IRA) into your business without paying early withdrawal penalties or taxes. A ROBS isn’t a business loan or a loan from your 401(k), which means there are no interest payments to make or debt to repay. It’s a way for you to leverage retirement funds to provide capital to your business.
A ROBS can also be used to purchase or invest in an existing business or franchise. A C corporation (C-corp), which allows for shareholders, is established, and a new 401(k) plan is set up.
Most small business owners utilize a ROBS provider to help them navigate this transaction. We compared several of the best ROBS providers and ranked Guidant as the best overall because it offers a free consultation and provides very good customer service.
What You Need To Know About ROBS
- A ROBS is a very complicated and potentially risky financial transaction. Before you consider entering into a ROBS, you should consult a specialist from a ROBS provider.
- Your business must be organized as a C-corp for you to enter into a ROBS. If your business is organized in any other way, you aren’t eligible for a ROBS.
- You must be able to contribute $50,000 or more from your retirement savings, be an employee of the business, and be able to fund the setup costs of $5,000 from outside the deferred retirement account to enter into a ROBS.
Pros & Cons of ROBS
|No interest or debt payments||Risk of business failure and loss of retirement funds|
|ROBS-funded businesses have a higher success rate||Business must operate as a C-corp|
|No income taxes or early withdrawal penalties on your retirement||Administration of a company-sponsored 401(k) plan|
|No impact on personal credit||Administration of the ROBS plan is costly|
|Potential for retirement funds to grow as business succeeds||Possibly higher risk of IRS audit|
There are risks and rewards associated with starting or purchasing a business. A common concern of potential business owners is that if they use retirement funds and their new venture isn’t successful, they could lose their investment. However, the financial risk involved with any business startup and the risk of failure isn’t unique to a ROBS. According to the Bureau of Labor Statistics (BLS), roughly 45% of corporations cease to exist within five years.
Who a ROBS Is Right For
A ROBS is best suited to individuals wanting to start or fund a new or existing business and also have a large amount of money saved for retirement. While you may not need to use your entire retirement portfolio to fund your business, most ROBS plans require at least $50,000 to start, and some franchises or business startups require much more to get up and running.
Prohibited Uses of ROBS Funds
Most operational business expenses are allowed with a ROBS. These include lease and mortgage payments, payroll, and other normal expenses that the business incurs. However, some expenses aren’t allowed:
- Personal use of business property: The IRS prohibits the use of business property for personal use. This would include a company car or company-owned real estate. Any transaction where an owner or family member is the recipient of business property is also subject to a 15% tax.
- Direct compensation to the owner: Having a ROBS requires an owner to be an active employee in their business. However, you cannot pay yourself a salary that isn’t considered appropriate for the role you serve nor appropriate for the company’s revenue. Note that your salary must come from operating expenses and not directly from the ROBS.
A ROBS isn’t a startup business loan, which means there’s neither debt nor interest to pay back. However, there are some costs associated with a ROBS. You could use an attorney and an accountant to set up and help administer your ROBS; however, a ROBS provider is more knowledgeable about the nuances of IRS regulations and would be a better option.
- Setup fees: Setting up a ROBS plan typically costs around $5,000. These funds must be paid out-of-pocket and cannot come from the monies you’re using for the ROBS. The setup costs will generally include setup of the C-corp, creation of the retirement plan, and submission of paperwork to the IRS.
- Ongoing maintenance fees: The average ROBS plan costs around $130 a month to manage but can increase based on the number of employees you have taking advantage of your company’s retirement plan. Maintenance fees include filing paperwork with the IRS to ensure compliance with 401(k) rollover rules and notifying and educating eligible employees about the company’s retirement plan. These fees may be assessed annually instead of monthly, depending on the ROBS provider, but—like the setup cost—cannot come from the retirement plan.
ROBS Compliance & Audits
ROBS plans are held to compliance standards with the IRS and United States Department of Labor and ROBS plans may be audited. Those plans not in compliance with government regulations could face tax penalties and fines. While the risk of an audit is rather low, an audit by the government will check for the following:
- That the retirement plan was set up correctly: Also, that your business is set up in the correct corporate structure (C-corp).
- That all annual filings have been completed and submitted: Among the required filings is IRS Form 5500.
- That you meet all employee requirements: This means you’re an employee of the organization, you’re providing eligible employees access to the company’s retirement plan, and all necessary plan documents are provided to your employees.
Using a ROBS provider will give you the support necessary to ensure that you’re meeting compliance requirements.
Rollover for Business Startup Requirements
Before you dive in and establish a ROBS, it’s important to know that there are some eligibility requirements regarding your current retirement account, how much money you have in it, and your status as an employee in your new business:
- Eligible retirement plan that’s current: You must have a retirement plan that’s tax-deferred and eligible for conversion to a ROBS. Unfortunately, Roth IRAs and Roth 401(k)s wouldn’t be eligible. However, a 401(k), a 403(b), a Keogh plan, a simplified IRA (SEP-IRA), a thrift savings plan (TSP), and a traditional IRA all are eligible.
- Sufficient money in your retirement account: ROBS plan providers typically require a minimum of $50,000 to start. However, your business may need more capital than that to fund initial operations.
- Being an employee of the new business: You’re required to be an active employee in your business and draw a salary. However, taking too much compensation may be considered a ROBS-prohibited transaction and could put you at risk for an IRS audit.
- Eligible employees must have the opportunity to invest in company’s retirement plan: If your business will have additional employees, you may be required to offer those employees the ability to participate in your company’s retirement plan. Eligibility requirements for retirement plans vary by state and plan design but often are based on the employee’s age, length of employment, and employment status (full time vs part time).
How To Set Up a ROBS
Step 1: Determine If a ROBS is Right for Funding Your Business
Before tapping your retirement accounts and setting up a ROBS, consult a ROBS provider to discuss potential ramifications. If you’re confident that the potential rewards outweigh the risks and you have sufficient capital to invest, a ROBS may be a great option.
Step 2: Form a C-corp
A C-corp is required for any ROBS plan and would be used to own the assets of the business as it can issue stock and have shareholders. The IRS prohibits transactions involving qualifying employer securities that only a C-corp can complete. More common business structures, such as limited liability companies (LLC) or sole proprietorships, aren’t allowed to be used for a ROBS.
Step 3: Set Up a Retirement Plan for Your New Business
The new retirement plan can be established as a 401(k), a profit-sharing plan, a defined benefits plan, or a defined contribution plan. Roth accounts don’t qualify for ROBS. A custodian, such as Charles Schwab or Fidelity, would manage the active parts of the retirement plan. Your ROBS provider would be able to recommend several custodians from which to choose.
Step 4: Transfer Funds From Retirement to Fund New Retirement Plan
Once the C-corp is incorporated and your new business’s retirement plan is established, retirement monies are moved over to fund the new plan.
Step 5: Retirement Plan Buys Stock in New C-corp
The funds from your retirement plan will buy stock in the new C-corp. The business issues shares that the new retirement plan, along with any potential outside investors, will purchase. You don’t need to issue 100% of your business’s shares in the initial round of funding in case you wish to raise money by issuing shares in the future. Your ROBS provider can walk you through that process should you choose to pursue that strategy.
Step 6: Use Funds Now Available to New C-corp
Monies from your ROBS can now be used to buy an existing business or start a new business. You can use these funds for normal business activity but not for personal gain. Typically, the funding process can take a couple of weeks.
How To Unwind a ROBS
Starting a business with a ROBS is one way to use your financial assets to your benefit without needing to take out a small business loan. When it’s time to exit your business, whether through a sale or through closing the business down, many steps—which vary based on the situation—are necessary to unwind your ROBS.
Regardless, each scenario requires compliance reporting to the IRS that a ROBS provider will assist you with:
Frequently Asked Questions (FAQs) About a ROBS
Is a ROBS a good idea?
A ROBS is a good way to secure funds for your new or existing business in the event that you don’t have the credit or collateral to obtain other types of business financing. It can be risky, as you’re putting your retirement funds in jeopardy, and you’ll need a large amount of money saved for retirement. You need at least $50,000 available from your retirement to fund a ROBS.
How long does the ROBS process take?
It can take anywhere from two to four weeks to set up a ROBS account. The amount of time will vary depending on which ROBS provider you choose.
What are the risks of a ROBS?
The biggest risk of a ROBS is that your retirement funds are in jeopardy if the business fails. Because you’ll need at least $50,000 available from a retirement fund to start a ROBS, that would be the minimum amount you would lose if the business doesn’t succeed. That money doesn’t have to be repaid to the retirement fund, but you’ll lose the money.
A ROBS can be an excellent option for funding a small business. If you have sufficient funds in a retirement plan and feel that the potential rewards outweigh the risks, it may make sense to consider using a ROBS to help finance the start of or acquisition of a small business.