For entrepreneurs who don’t want to take on debt to finance their business, an option exists that allows business owners to roll over their retirement funds into their business without triggering tax penalties or getting a loan. It’s called Rollovers for Business Start-ups (ROBS), or more simply, 401(k) business financing.
Funding a business with 401(k) business financing is a safe, legal and tax penalty-free way to access your retirement funds and achieve your career goals. Made possible by the Employee Retirement Income Security Act of 1974, the ROBS arrangement does involve rules and regulations set forth by the IRS that must be met in order to work properly. That includes verifying that the type of business you’re financing is acceptable.
What businesses can be started with Rollovers for Business Start-ups?
Fortunately, ROBS lends itself to almost every kind of business, with very few exceptions. In fact, Guidant has worked with over 14,000 entrepreneurs who used 401(k) business financing to start businesses across an impressive variety of industries, including technology, manufacturing and customer service. Though the exceptions to the types of businesses ROBS can fund are few, they have a crucial impact on keeping your ROBS transaction tax-free. Here is a checklist to ensure your proposed business meets these standards:
The Business Must be Federally Legal
ROBS can be used to start a new business or franchise, buy an existing business or franchise or even recapitalize a business. The most basic rule is that any business funded through ROBS must be federally legal and based in the U.S. Pot shops (even in states where it’s permitted) are not eligible for ROBS because they are not federally legal. In addition, businesses operating outside of the United States (even if the owner resides in the U.S.) are also not eligible.
The Business Must Be an Active Operating Company
An operating company is defined as an entity that is primarily engaged in the sale or exchange of a product or service instead of simply the investment of capital. For most business owners, this is a non-issue. If you’re starting or buying a legitimate business, you’re engaged in the sale or exchange of a product or service. For example, if you purchase a sandwich store, you’ll be engaged in selling a product — the sandwich. There are times, however, when individuals are looking to invest in a hobby. Hobbies are not active businesses and thus are not eligible for this method. Nor can a ROBS arrangement be used for a business for which the primary activity is deemed to be the investment of capital.
The Business Must be Owned by a C Corporation
The ROBS process requires you to create a new C corporation that then hosts a 401(k) plan. The business owner’s existing retirement funds are then rolled into the new 401(k) plan, which can then use those funds to start or buy a business.
The key takeaway here is that the parent company must be a C corporation. You’re allowed to operate the business itself as an LLC or sole proprietorship as long as the parent company is a C corporation. In other words, for tax purposes, all finances flow through the C corporation.
Learn more about the ROBS process here.
You Must be a Bona Fide Employee of the Business
You must be a bona fide employee of your business — not solely a passive owner or investor. A common misstep here is when someone wants to use his or her retirement funds to buy a business for a family member or friend. With ROBS, you can’t purchase the business then step away; you must also work for the business, then hire your child, spouse, business partner, etc.
To ensure this requirement is met, Guidant recommends working at least 1,000 hours annually in the business. For most, this also means , although there is no requirement in the Internal Revenue Code to do so. If a salary is taken, it must be “reasonable,” meaning that the salary is not excessive given the nature of the business, the responsibilities of the employee and the services provided to the corporation by that employee. Guidant recommends employees wait to take a salary until the business is open and generating revenue.
Though there are a few strict guidelines regarding the business structure when financing a business with ROBS, your options are essentially endless once these requirements are met. Business owners who utilize 401(k) business funding enjoy the option of launching a new start-up, purchasing a franchise or even recapitalizing an existing business. You also aren’t restricted to opening a brick-and-mortar location. A great way to lower your upfront costs is to launch a home or cyber-based business — all possible with ROBS.
The benefits to of using ROBS are clear. Using your own retirement funds as business capital saves you the time and costs associated with taking a loan and making interest payments. Keeping your business debt-free puts you in a better position to earn revenue more quickly. If you need more funds than are available in your retirement savings, it’s also a great vehicle to
As the leader in our industry, Guidant Financial has helped more entrepreneurs start or buy a business than any other 401(k) business financing provider. We take extra care to ensure your business is a good fit for this funding structure. As a part of the setup process, you’re assigned an Outside Counsel attorney who specializes in ERISA law. In your initial meeting, which is at no cost to you, your attorney will vet your business venture to ensure ROBS funding is in the best interest of your future company.
Learn more about the benefits of ROBS and its benefits in our ebook: Everything You Need to Know About 401(k) Business Financing.