What is 401(k) Business Financing?
401(k) business financing, also known as Rollovers for Business Start-ups (ROBS), is a small business and franchise funding method. ROBS allows you to draw money from your retirement account in order to start or buy a business without incurring an early withdrawal fee or tax penalty. This is not a loan; ROBS just gives you access to your own money, so that you can build the life you want without going into debt.
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How Does 401(k) Business Financing Work?
401(k) business financing (also known as Rollovers for Business Start-ups or ROBS) allows you to tap into your retirement account and use that money to start or buy a business or franchise. To access your money without triggering an early withdrawal fee or tax penalty, a ROBS structure must first be put in place. The structure has multiple moving parts, each of which must meet specific requirements to stay compliant with the IRS.
Create a New C Corporation
ROBS begins with the creation of a new C corp. The ROBS arrangement hinges on the sale of Qualified Employer Securities (QES), and a C corp is the only entity type that has the ability to sell stock within the ROBS structure.
Set Up a 401(k) Plan for Your C Corp
After creating your C corp, you’ll need to set up a retirement plan for your new business. Most people select a standard 401(k), though you have other options (like profit sharing and defined benefits). Once you have a plan type, select a custodian to manage the actual investments in the plan.
Roll Existing Funds into the New Retirement Plan
Now that your new C corp has a retirement plan, you’ll roll your retirement funds from your original, personal plan into the new retirement plan belonging to the C corp. This is where the “rollover” part of Rollovers for Business Start-ups comes from.
The Company Plan Buys Stock in the C Corp
With the company’s retirement plan now housing your retirement dollars from the rollover, the plan purchases stock in the C corp through a Qualified Employer Securities (QES) transaction. That’s why it’s so important to use a C corp. Without it, a QES transaction wouldn’t be possible.
Use the Funds to Operate Your Business
Once the QES transaction is complete, your retirement funds can be used by the corporation to begin operating and paying for business expenses! The retirement plan now owns the corporation, and the corporation is cash-rich from selling QES stock.
While the ROBS structure can be complex, the end result is your ability to buy or start a business without going into debt or collateralizing your home. For a more in-depth explanation of the ROBS structure, check out our Complete Guide to 401(k) Business Financing.
Rollovers for Business Start-ups: FAQs
Where did ROBS come from? How long has this been around?
Rollovers for Business Start-ups (ROBS) has been around for decades – since 1974. It was made possible when Congress wanted to give American workers another option for growing their retirement assets.
Is using my 401(k) to fund a business a tax loophole?
ROBS is not a tax loophole. In 1974, Congress passed the Employee Retirement Income Securities Act (ERISA), which works in conjunction with specific sections of the Internal Revenue Code (IRC) to make ROBS a legal, legitimate strategy for accessing your retirement assets to start or buy a small business.
Can I combine my retirement funds with someone else’s to fund the business?
Yes, multiple people can combine their retirement assets to create the ROBS structure. This means you and a spouse, business partner, or group can use retirement funds to start or buy a business together.
Can I pay myself a salary with ROBS?
Yes! ROBS actually requires you to be an employee of the business and to be paid fairly. The salary you pay yourself needs to fall within “reasonable bounds,” which means you shouldn’t pay yourself twice as much as your business’s annual revenue, as that’s rather unreasonable.
Do I have to offer a 401(k) to all of my employees?
Yes. ROBS requires you to offer a 401(k) plan to all eligible employees of the company, as ROBS itself is meant to be a tool to grow retirement assets.
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Can I use ROBS to finance my franchise?
Yes! ROBS isn’t limited to independent businesses. Since a franchise is a small business, you can use most types of financing (including ROBS and SBA loans) to fund your franchise just like you would with any other business.
Do I have to use a C corporation?
Yes, it’s a ROBS requirement. Your company is funded through a stock purchase called Qualified Employer Securities (QES), which only works if you’ve set up a C corp.
What about double taxation for the C corp?
The term “double taxation” refers to the taxes you’d pay on dividends paid by the C corp. Often these taxes can be mitigated or avoided with the help of a qualified tax professional.
Can my spouse or someone else co-invest and/or be involved in the business?
Yes, co-investors and co-owners are allowed with ROBS.
What type of business can I buy with ROBS?
ROBS lets you buy or start up any legal business or franchise. ROBS can’t be used to fund a business deemed to be “solely the investment of capital” (like a factoring company or a means of passive income). Typically, the business also needs to be legal on a federal level, not just at the state level (for example, marijuana distribution is only legal in some states and not federally).
Do I have to use all of my retirement money? Can I just use part of it?
You can use as much or as little of your retirement assets as you want. We do suggest that you roll over at least $50,000, as there are diminishing returns to rolling a smaller amount.