Rollovers as Business Startups (ROBS)

What You Need to Know about Rollovers as Business Startups (ROBS)

Should You Use Your Retirement Savings to Fund Your Business? The Pros and Cons of Rollovers as Business Startups (ROBS)

ROBS: Not a New Burger Joint, but a Potentially Great Way to Fund a Business

Need capital for a new or growing business venture? A little-known alternative financing option called a rollovers as business startups, or ROBS, may allow you to use your retirement savings to start, acquire or grow a business.

A ROBS lets you invest money from your retirement account into your new business tax-free, without incurring any early withdrawal penalties. Unlike other financing options, a ROBS isn’t a loan, so you don’t have to worry about taking on debt as you’re getting your business off the ground. In addition, there aren’t any monthly payments and you don’t have to put up collateral.

That said, a ROBS doesn’t make sense for everyone. It is a complex and often costly transaction. Additionally, it’s important to make sure you set it up correctly with support from an experienced professional. A ROBS also comes with a big risk: There’s a chance you could lose your retirement savings if your business fails.

Could a ROBS be right for you? Here’s what you need to know about a rollovers as business startups, along with the pros and cons.

How a ROBS Works

In a ROBS transaction, funds from eligible retirement accounts — typically a 401(k) or traditional individual retirement account (IRA) — are rolled over for the purpose of investing in a new business or franchise, or buying or growing an existing business. To complete a ROBS transaction, you must have at least $50,000 or more in an eligible retirement account.

Keep in mind, setting up a ROBS is complicated, and there are specific compliance and legal rules to follow. Here’s a quick run-down of the process:

  • First, you must form a C-Corporation, a business structure that allows for shareholders. Then, you need to create a new company retirement plan.
  • You’ll roll your existing retirement account into the new retirement plan. (Most retirement accounts qualify; more on this below).
  • The rolled-over funds are used to purchase stock in the C-Corporation.
  • The cash proceeds from selling the stock are invested in the business.
ROBS Eligibility Requirements

One benefit of a ROBS is you avoid costly penalties and taxes. Usually, if you withdraw money from a retirement account before age 59 ½, the IRS requires you to pay a 10% early withdrawal penalty. You may also have to pay additional income taxes on the withdrawal. However, the IRS has created a special exemption for ROBS.

Nonetheless, you must meet the following eligibility requirements to quality:

  • You must own an eligible retirement or pension account from a former employer, which may include a 401(k), traditional IRA, Simplified Employee Pension Plan (SEP), 403(b), Keogh, or Thrift Savings Plan (TSP) account. Roth accounts and retirement accounts from existing employers are not eligible.
  • You must have a minimum balance of $50,000 in your retirement account.
  • The business owner must be an employee of the company and draw a salary.
  • Again, you must structure your business as a C-Corporation, or be willing to switch to a C-Corp.
Pros and Cons of a ROBS

A ROBS can be a flexible, debt-free way to start or grow a business. However, there are risks to consider when it comes to tapping your retirement savings for anything other than your “golden years.”

The Pros

No debt or interest to pay. Since a ROBS isn’t a loan, you don’t have to worry about paying off debt or making high-interest payments. This gives you more control over your cash flow and allows you to re-invest more of your profits back into your business.

No credit checks or collateral. There’s also no credit check, and you don’t have to sign a personal guarantee, which protects your personal assets and credit. ROBS are also a good option for business owners who may have substantial retirement savings, but could not otherwise qualify for a personal loan.

The potential for better business success. Research shows that ROBS-funded companies have a better survival rate than other startups — again, likely due to a lack of debt and improved cash flow.

No taxes or early withdrawal penalties. As mentioned above, a ROBS isn’t considered a retirement plan distribution, so you don’t have to pay taxes or penalties to the IRS.

The Cons

You’re putting your retirement funds at risk. If your business fails, you could lose your retirement savings. You’re also missing out on potential investment gains, the tax-deferred savings opportunities you get with a 401(k) or IRA, and the power of compounding as your investments grow over time.

ROBS can be costly. ROBS setup fees can cost upwards of $5,000, and there are ongoing plan administration charges as well, all of which must be paid out of pocket.

Greater risks of an IRS audit. Government agencies hold ROBS to very strict compliance standards; therefore, they are subject to higher levels of scrutiny. Any mistakes made while setting up a ROBS could result in the plan being disqualified, resulting in IRS penalties and making the transaction taxable.

You must operate as a C-Corporation. A C-Corp. structure has specific legal and tax implications, which may not be a good fit for your company.

Complex administration. The ongoing management of a ROBS and related compliance requirements can be challenging. Outsourcing to an expert ROBS provider can help lighten the load.

The Takeaway

Rollovers as business startups can provide flexibility and easy access to cash if you want to fund or grow a business, but they aren’t without risks to your retirement savings. Therefore, you’ll want to carefully weigh the benefits and disadvantages of a ROBS before deciding if it’s the right form of financing for your business — and consider alternate sources of funding if they are available to you.

If you do decide to use a ROBS, keep in mind that working with an experienced professional can help make sure the transaction goes smoothly and error-free.