Rollover as a Business Startup (ROBS) Plans: What They Are and How They Work
Rollover as a Business Startup (ROBS) transactions are a tax-free way to use your retirement savings to fund business expenses. However, while these transactions can help you avoid taking on more debt, they are also fairly risky.
- A Rollover as a Business Startup (ROBS) transaction is a way for business owners to access tax-free small business financing by rolling over existing funds from their retirement accounts.
- ROBS transactions are quite complex, so you may want to work with an experienced third-party provider to facilitate yours.
- The IRS heavily regulates these transactions.
What is a ROBS transaction?
A ROBS is a type of small business financing transaction that allows you to use your own retirement savings to fund your business. If you have a 401(k), the money will typically be invested in stocks, ETFs, index funds and the like. A ROBS allows you to invest that money in your own company instead.
To do this, you create a C corporation, use your retirement savings to buy stock in your new company and then use the funding from the stock purchase to cover your other business expenses. (We’ll lay out the step-by-step of how to do a ROBS transaction in more depth later.) ROBS are tax-free transactions because you’re not truly withdrawing the money from a 401(k) or other retirement account. Instead, you’re simply rolling the money over to a new business entity.
For now, just know that the major benefit of a ROBS transaction is that it can help you access the money you need to start a new business venture without taking on more debt or shouldering an additional tax burden. However, these transactions are considered “questionable” by the IRS because they only tend to benefit one person — the business owner. As such, they are often subject to extra IRS scrutiny, not to mention that you’re also putting your retirement savings at risk.
Many different types of retirement accounts are able to be used to perform a ROBS transaction, including:
- 401(k) plans
- Roth 401(k) plans
- Traditional IRAs (Note: Roth IRAs are NOT eligible)
- 457(b) plans
- Roth 457(b) plans
- 403(b) plans
- Roth 403(b) plans
- Thrift savings plans (TSPs)
- SIMPLE IRA plans
- SEP IRA plans
- Keogh plans
- Profit-sharing plans (if vested)
- Traditional pension plan or money-purchase pension plan (if vested)
How does a ROBS work?
You may want to hire a third-party ROBS provider to help. These companies can assist you in setting up your ROBS plan. Although a ROBS provider can help ensure you take the right steps, the service will likely come at an additional cost.
Whether you get help or do it yourself, the steps are:
1. Set up a C corporation.
You first need to establish your new business as a C corporation. C-corps have the ability to raise funds by selling stock. Since you’ll eventually be buying stock in the company with your retirement funds, your business must be a C corporation to facilitate a ROBS transaction. Other business entities, such as LLCs and sole proprietorships, don’t qualify.
Keep in mind that there are several steps involved in forming a C-corp. As the business owner, you’ll need to file articles of incorporation with your state’s Secretary of State office and take other steps to ensure that your new business remains compliant with government regulations. (More on that later.)
2. Establish a qualifying retirement account.
Your newly formed C-corp needs to provide a retirement plan where you can invest your existing retirement funds. While you can choose the plan type, most elect to invest in a ROBS 401(k).
3. Roll over your retirement savings.
Once the qualifying retirement account is set up in your corporation’s name, you can roll over the funds from your previous retirement account into your new retirement account. This is where the “Rollover” part of “Rollover as Business Startups” comes into play.
4. Buy stock in your new company.
Next, you’ll use the funds from your retirement account to buy stock in your new company.
5. Use the profits to cover business expenses.
Once you buy the stock, the corporation will receive funds from the sale and the transaction is complete. You can then use the money you’ve received to cover typical business expenses, such as buying equipment, leasing space, franchising or paying employees.
If you work with a third-party provider, you can expect to pay around $5,000 to cover the initial setup costs associated with your ROBS transaction, including forming a C-corp. When you choose to go this route, you will likely also have to account for smaller, ongoing fees for things like filing the appropriate tax paperwork each year.
On the other hand, if you choose to go the DIY route, it will likely cost a few hundred dollars to form your C-corp (costs can vary depending on your state.) and an additional $500 to $2,000 to form an employee stock plan.
Ongoing requirements for ROBS
After setting up a ROBS plan, you’ll be expected to keep up with ongoing requirements, including:
- IRS Form 5500. Once you set up a C-corp with a retirement plan, you’ll need to file Form 5500 with the IRS each year. The form states the current value of your plan’s assets, including the stock shares you originally purchased.
- Taxes. You’ll need to be prepared to file corporate taxes each year. Failure to do so can result in funds and penalties from the IRS.
- State-specific requirements. You may have additional steps to comply with state laws. For example, you may be required to generate an annual report or pay additional fees for filing required paperwork with your state. Your state’s Secretary of State website will typically have this information.
If you use an experienced provider, it usually takes around three to four weeks to complete a ROBS transaction. The longest part, according to the experts, is waiting for the funds to roll over from your existing retirement plan.
If you’re going the DIY route, you’ll be on your own timeline. It may take longer depending on your level of familiarity with the necessary paperwork.
3 Signs a ROBS could be right for your business
Here are some signs a ROBS transaction could be the right choice for your business:
- You’re familiar with business entity formation requirements: If you’re familiar with what it takes to form a C corporation and keep one up and running, there’s a chance that the ROBS compliance requirements may not be too heavy of a lift for you.
- You have sufficient retirement savings: For a ROBS transaction to work, you’ll need to have a funded retirement account that can act as your borrowing limit. If you don’t have much retirement savings yet, you may need to look elsewhere for financing.
- You can’t qualify for other forms of business financing: Beyond knowing how to facilitate the ROBS transaction and stay compliant, there are no other eligibility requirements. If you’re unable to qualify for other forms of business funding due to a poor credit score or short business history, a ROBS plan can help you access the funding you need.
3 signs you may want to consider alternative options
Meanwhile, here are three signs that doing a ROBS transaction may not be the right choice for your business:
- You’re hesitant to put your retirement savings at risk: Using your retirement savings as business funding isn’t for the faint of heart. If your business goes under, you could lose your nest egg along with it.
- You don’t like doing extra paperwork: As explained above, ROBS transactions come with a lot of compliance requirements, both initially and on an ongoing basis. If you’re unwilling to do the necessary legwork to keep up with those requirements, it may make sense to look elsewhere for funding.
- You’re unwilling to research reputable providers: In 2009, the IRS launched a ROBS compliance project and found many issues with ROBS providers, including high fees, aggressive marketing tactics and failure to issue or file required forms. Be sure to do your due diligence and hire a provider you trust.
Alternatives to ROBS financing
Although a ROBS plan can help keep you out of debt, there are other ways to fund a startup that can give you more freedom in how you start your business or protect your retirement savings. You may want to consider:
401(k) loan
Many retirement plans offer 401(k) loans. You can borrow 50% of your vested amount or $50,000, whichever is less. If 50% of your account is under $10,000, you may be able to borrow up to $10,000.
Plans generally require full repayment within five years, including interest, in quarterly payments. If you don’t pay back the loan on schedule, your remaining balance will be subject to the IRS’ 10% early distribution penalty. You may be required to meet additional criteria, such as obtaining a spouse’s approval, depending on your type of retirement plan.
Small business loan
Secured business loans are backed by an asset or another form of collateral. These loans typically have lower interest rates than unsecured business loans. However, if you decide to stop making payments on a secured business loan, your lender may have the right to repossess the collateral. Unsecured business loans, on the other hand, aren’t backed by collateral, but may require a personal guarantee.
Business line of credit
A business line of credit works similarly to a business credit card. You’ll be able to borrow money as needed, up to a certain limit, and you’ll only pay interest on the amount that you’ve borrowed. Lines of credit are generally considered a more flexible form of business funding than small business loans.
Business grants
Business grants are a type of small business funding that doesn’t need to be repaid. Still, you’ll have to apply for grant funding, and these resources can be highly competitive.
Crowdfunding
Business crowdfunding involves soliciting funding on a third-party platform. Platform users can donate to the cause in exchange for products or even equity in your company. Some sites may require you to meet a set target goal to access the funds.
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