Many people dream of working for themselves, being a business owner or operating a successful franchise. Most entrepreneurs who desire to make their dreams a reality may raise start-up funds from their savings, family or outside investors. Others may apply for a small-business loan. And then there are the other entrepreneurs that do exactly what we do not recommend: They use their retirement funds.
You can rollover assets from an IRA or qualified employer plan to fund a business start-up or purchase a franchise. The rollover as business start-up (ROBS) is a complicated technique that allows a prospective business owner to use funds that belong to them, but are tied up in a retirement account.
The basic process begins with an entrepreneur creating a C corporation. That C corp. then sponsors a 401(k) plan. The prospective business owner then initiates a non-taxable rollover of his or her assets into the new 401(k) plan. The new plan then invests in the stock of the new C corporation. The C corporation then uses the funds to purchase a franchise or start a new business venture.
if it sounds like a lot of money shifting hands—well, it is. The IRS does not prohibit a ROBS transaction, but the agency is concerned that the maneuver allows taxpayers to use retirement funds for their own benefit. Individuals and businesses that use ROBS generally experience more scrutiny from the IRS. As for taxes, profits are taxed at both the c-corp level and at the individual levels, so double taxation can be an issue.
The benefit to the ROBS technique is that funding can be often be completed in less than 30 days. While the initial cost is more than a small-business loan, business owners are funding their business with equity and not debt. The business owner also has an on-going expense to administer the 401(k), but does not owe interest, and the ROBS transaction does not have to be repaid.
Aside from the increased attention from the IRS, the major downside to ROBS is that if the business fails, the business owner is out not only the business, but his or her retirement savings as well. When the business is forced to shut its doors, the assets of the corporation are liquidated and are used to buy back the shares owned by the 401(k). If there is a loss, it is the same as if the 401(k) made a poor investment choice. If there are any remaining funds, they are then rolled into the business owner’s IRA.
Overall, a rollover as a business start-up is a risky move, and not one we recommend. However, if you are considering this method to fund your business, you should do considerable research on the business marketplace you are considering. If you want to buy a franchise, you’ll want to know how much support you can expect from corporate and the overall success rate of new locations. You’ll also want to keep in mind that four out of five small businesses fail in the first five years according to the Small Business Administration.
Of course, there are circumstances when a ROBS will work for an entrepreneur—perhaps when the rollover is a small portion of the total retirement savings and he or she is able to enjoy many years of business ownership. You just need to keep in mind you are gambling with your retirement. If you have questions on how a ROBS will affect your overall retirement savings, the experts at Henssler Financial will be glad to help.
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