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Common Myths About 401(k) Business Funding
February 03, 2017

Revealed: 8 Common Myths about Rollovers for Business Start-ups

 

Using the Rollovers for Business Start-ups (ROBS) arrangement to finance a business has been an option since Congress passed the ERISA Act in 1974, so it certainly isn’t new. However, even with gaining popularity, many stock brokers and financial advisors aren’t aware of, or don’t educate their clients about this options because it doesn’t provide sufficient profit for their institutions. As a result, ROBS is unfamiliar to many, and there are a lot of myths swirling around that may be stopping would-be entrepreneurs from chasing their dreams.

ROBS, also knows as 401(k) business funding, involve using money from an eligible retirement account to finance the purchase of a business or franchise. To make a long story short, a corporation is formed, and that corporation then sponsors a 401(k) plan. Funds are rolled from an existing retirement account into the new 401(k) without triggering a taxable distribution. This new 401(k) purchases (or invests in) shares of the corporation, which can then purchase a business or franchise. It looks like this:

ROBS Formation

In essence, ROBS allow you to take control of your finances and invest in yourself. Here’s the truth behind the most common ROBS myths:

1. It’s not tax avoidance.

Using the ROBS structure isn’t a way to evade taxes by any means. The Employee Retirement Income Security Act of 1974 (ERISA) was set up explicitly to encourage employees to take control of the direction of their retirement funds.  Using ROBS, you can direct your retirement funds to purchase shares in a small business – a business that pays taxes.

2. ROBS is not a loan.

With ROBS, you’re redirecting your retirement funds into your new business or franchise (instead of the stock market), not taking on debt. This means you won’t have to make monthly loan payments or incur interest. Even better, a successful business will help you increase the value of your retirement investment.

3. You can use ROBS to diversify your nest egg.

You don’t have to take every penny from your existing retirement fund for ROBS to work. Many people only use a portion of their retirement assets, leaving the remainder in their existing 401(k) or IRA to be invested traditionally. What’s more, the ROBS arrangement can be used in conjunction with a small business loan or other financing option, so you can diversify your business funding even further.

4. ROBS are not for absentee business owners.

If you’re hoping to use ROBS, you must be a bona fide employee of your new business. As a guideline, Guidant recommends you work at least 1,000 hours per year to be considered a bona fide employee, which can include sweat equity. Being an active employee of the corporation is a benefit to you because you have the opportunity to earn a salary and make regular contributions to your new 401(k) plan.

5. ROBS must fund a C corporation.

To meet the compliance requirements of Rollovers for Business Start-ups, the business must be a C corporation. Many of our clients who are hoping to structure their company as a Limited Liability Company (LLC) or multiple LLCs, are able to achieve this by forming subsidiary LLCs. The C corporation remains the parent company and is the 100 percent owner of the LLC.

6. Getting funded using ROBS can take as little as three weeks.

Because there is no application process and minimal eligibility requirements, ROBS funding is very fast. The biggest factors that affect timeline are the state in which you’re filing, and how fast you’re able to file the necessary paperwork and how quickly your current custodian will release your retirement funds. Most ROBS funding transactions are completed in less than 30 days.

7. ROBS funding and Self-directed IRAs are not the same.

While it’s possible to finance a business with both self-directed IRAs (SDIRAs) and ROBS, there are some major differences between the two. If you use an SDIRA, the owner may not work for the business they invest in or take a salary. The investment amount is also potentially liable for the unrelated business income tax (UBIT), which can get very expensive. With ROBS, the 401(k) owner must work for the new business, and the UBIT doesn’t apply.

8. ROBS can be used to fund start-ups.

As the name suggest, Rollovers for Business Start-ups are a great option to finance start-ups. But there’s more than one way to become a small business owner — they’re also a great vehicle for purchasing an existing businesses or franchise.

To some, the ROBS process can appear to have complex rules and regulations. But if you have a qualified retirement plan with a balance that’s sufficient for your start-up needs and work with an experienced company to support its formation, it can be a great option to start or recapitalize your business debt-free. Ready to get started?

 

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  • 15 thoughts on “Revealed: 8 Common Myths about Rollovers for Business Start-ups”

    1. Kara J Everitt says:

      I would like to hear more about ROBS. Please contact me via Phone. 570-663-2978

      1. Guidant Financial says:

        Hi Kara. Thanks for reaching out! I’ve asked a member of our team to reach out to you with more information about ROBS. You should be hearing from them soon. If you’d rather talk to someone sooner rather than later, you may also call us at 888.472.4455. Have a great weekend!

    2. Allison Johnson says:

      I am 57 . If I withdraw funds from IRA and rollover to ROBS would there still be the 10% penalty?

      1. Guidant Financial says:

        Hi Allison. Great question. Rolling over existing retirement funds into a ROBS account does NOT trigger the early-withdrawal penalty for those younger than 59 and 1/2. If fact, the rollover doesn’t trigger any tax penalties whatsoever, which is what makes this option appealing to so many. Let us know if you have any other questions!

    3. Brent says:

      If I use ROBS for part of the funding to purchase a business, but also need a loan, either an SBA loan or conventional business loan to do the deal, will the lender be able to use the assets of the business owned within the ROB as collateral for the loan? If my business were to fail and I had to file bankruptcy, would the collateral be protected against claims by the lender, because it is held within a retirement account?
      If that is the case, it seems like it would be very difficult to obtain an SBA or conventional business loan with a ROBS arrangement, since the lender would not have any security in the event of business failure and bankruptcy. Please advise, thanks.

      1. Guidant Financial says:

        Hi Brent, You can use ROBS in conjunction with an SBA loan to fund your business, but the ROBS transaction is not collateral. As a part fo the ROBS process, your 401(k) plan purchases stock in your new corporation. The funds from that purchase can be used as a down payment for an SBA loan as cash, not as collateral. If you have any questions or want to discuss your funding options further, please don’t hesitate to give us a call at 888-472-4455.

    4. Can I take my ROBS funds and move them to an LLC (separate entity) and operate from that second entity? Please respond to my email and not my website. Thank you. Teri

      1. Guidant Financial says:

        Hi Teri, companies that are funded with ROBS can form subsidiary LLCs, but they still need to operate under the parent C corporation. Someone from our team will be reaching out directly to you. Thanks for your question!

    5. Charlie Slack says:

      Hello, I get that I essentially act as an employee of the C corp and can draw a salary off of generated funds. Can I also take an end of year bonus as well? Thanks

      1. Guidant Financial says:

        Hi Charlie, great question. As long as the bonus is still considered reasonable compensation, and your company is in a position where it can afford the bonus, then yes! Your CPA can help determine reasonable compensation and what an appropriate bonus amount would be.

    6. Trevor Byrne says:

      Let’s say my C Corp funded by the 401k purchasing stock in the C corp invests by purchasing (or investing) in an LLC. The LLC makes a profit. If the C corp owns 100% of the LLC which entity files a return? Presumably that profit is taxed as normal no matter which entity files?.
      After a few years of making profits there’s more cash in the LLC than it needs. How does that money get put back into the 401k it was originally taken from? I’m assuming the C Corp can repurchase some of the shares the 401k purchased in it but how does the cash get from the LLC to the C corp? Does the C corp have to have purchased shares in the LLC as part of the original investment so that the LLC can repurchase some of those shares to get cash to flow back to the C corp? What are the tax implications to both the LLC and the C corp? Can more than the original investment be put back into the 401k?

      1. Guidant Financial says:

        Hi Trevor, Thank you for your questions. In this scenario, all financials flow through the C corporation, so you’re filing corporate taxes for the C corporation. You can certainly put more money back into the 401(k) than what was originally there through a process of having the stock price evaluated and a repurchase of shares by the corporation from the 401(k) plan. We always encourage you to consult your CPA and an ERISA attorney both during the setup of the LLC/C corp parent structure as well as all purchasing/selling of shares. Please feel free to give us a call at 888.472.4455.

    7. Rudy says:

      Can I rollover my 401K in a C Corp then purchase rental property?

      1. Mitchell Larsen says:

        Rudy – if you plan to use 401(k) business financing, one of the requirements is the business must be an active operating company. If you’ll be serving as property manager for the rental, there’s a possibility it could work, but I’d encourage you to set up a financing consultation with one of our experts to make sure your goals are in-line with the requirements. Call us at 888.472.4455 and we can get you scheduled. There’s absolutely no obligation to use our services.

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