One of the best parts of serving as a trusted adviser is that investors bring us ideas and strategies before making a potentially life-altering financial decision that could pose a significant risk to their future. Recently an investor informed us of their interest in a Rollover for Business Startup, an intriguing financing alternative that allows an investor to use their retirement investments to fund a startup business without incurring taxes, penalties, or loans. However, in our opinion, file this one under “Opportunity with Caution” because, as the saying goes, “if it’s too good to be true, there must be something wrong with it.”
A Rollover for Business Startup, or ROBS, enables prospective business owners to use personal funds tied up in a retirement account to fund a business startup or purchase a franchise. The process involves creating a C corporation that sponsors a 401(k) plan. The entrepreneur then initiates a non-taxable rollover of retirement assets into the new 401(k) plan. The new 401(k), in turn, invests in the stock of the new C corporation, and then the C corporation uses the funds to purchase a franchise or start a new business venture. However, it is wise to remember that profits are taxed at both the C-corp level and at the individual levels, so the double taxation issue should be considered.
Surprisingly, the IRS does not prohibit a ROBS transaction, but it is highly scrutinized and generally requires a specialized ROBS provider because of its complexity. ROBS providers often charge between $4,000 and $5,000 for the initial setup, with additional monthly fees for ongoing support, maintenance, IRS reporting, eligibility tracking, and plan reconciliation. Considering the recommended minimum for a ROBS at $50,000, an entrepreneur may need to use at least $57,000 from their retirement account.
Aside from the increased attention from the IRS, the major downside to a ROBS is the risk associated with business failures. In such cases, not only does the business owner lose their business but also their retirement savings. When the business is forced to shut its doors, the assets of the corporation are liquidated to buy back the shares owned by the 401(k). Any losses incurred are akin to a poor investment choice made by the 401(k). Any remaining funds are rolled into the business owner’s IRA.
On the positive side, ROBS funding can be relatively quick, often completed within 30 days. While the initial cost is more than a small-business loan, funding the business with equity rather than debt may be advantageous. Though there will be ongoing expenses to administer the 401(k), no loan interest is paid, and the ROBS transaction itself doesn’t require repayment.
Overall, a rollover for a business startup is a risky endeavor and not something we readily recommend. However, there are circumstances when a ROBS can work for an entrepreneur, particularly if it represents only a small portion of their retirement savings and allows them to enjoy many years of business ownership. Nevertheless, it is crucial to be mindful that venturing into this territory involves gambling with one’s 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:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166
Listen to the July 22, 2023 “Henssler Money Talks” episode.
This article is for demonstrative and academic purposes and is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
