We are focusing on rollovers as business startups (ROBS) this month. We walked you through the 5 key steps needed to establish a ROBS, as well as the advantages and disadvantages of using a ROBS to provide capital funding for your business using your personal 401(k) or qualified IRA.
Now, we want to cover some of the most important facts you need to know about ROBS. This approach is not the right solution for everyone, but it may be a great solution for other business owners and investors. That’s why it helps to understand some of these critical issues.
The name would imply that ROBS can only be used for business startups. However, they can be used for other forms of business funding, whether it’s injecting investment capital into an existing business or paying off certain business expenses. Talk with your financial advisor to understand what your 401(k) funds can and cannot be used for when using a ROBS.
ROBS cannot be used to fund an LLC, sole proprietorship, S-corp or other business structure. Your business must be an C-corp and you will need to establish that legal entity before ROBS funds can be converted into shares of company stock. If a C-corporation is not a beneficial legal structure for your business, you may want to reconsider establishing a ROBS.
A rollover as business startup is not a business loan. You are using your existing retirement account funds to invest directly in your business. This means you are not taking on any additional debt, but you are risking your actual retirement savings on your business venture.
Yes, you will be able to pull money from your 401(k) account without paying personal income taxes or being subject to an early withdrawal penalty if you are under the age of 59 1/2. However, the funds are being put into a business—a business that is subject to federal and state taxes. In most cases, ROBS can provide some good tax savings. In other cases, they can bring more scrutiny from the IRS and increase the potential for audits. That’s why it is very important to do everything correctly and legally when establishing your ROBS and investing in your business.
ROBS are not designed for absentee business owners. You must be an active employee and owner of the business. We’re talking at least 1,000 hours per year devoted to business activities.
In general, most 401(k) and IRA accounts are designed to be fairly conservative to allow your investments to grow gradually and consistently over many years. Establishing a ROBS to support your business is an investment. You’ll want to be smart with your money and make sure you have a solid business plan. If it works out, it will provide you more diversification with your retirement investment accounts and provide more potential for long-term gains.
If you go through all the proper steps, you might be able to get your funding within a month. The biggest hurdle may be converting to a C-corp if that’s not already your established business structure. Otherwise, the rest of the steps can be completed relatively quickly. Just don’t cut any corners if you want to avoid problems with the IRS!
A ROBS is an alternative solution compared to a self-directed IRA, which also allows you to invest retirement savings into your business. There are some significant differences between the two in terms of tax liabilities and owner/employee requirements, so discuss both options with your financial advisor and figure out which is the better solution in your situation.
Most ROBS providers will require your existing 401(k) account have “sufficient” funds before a ROBS can be established. This may vary by provider, but the standard rule of thumb is at least $50,000 in your retirement account and not all of that may be accessible for ROBS withdrawal.
We’ve already said it several times. Establishing a ROBS is not something you want to take lightly. There are very specific steps you need to take, and even then it may draw extra attention from IRA auditors. Work with an experienced financial expert who knows how to navigate the ROBS process and minimize your risks.
For help with establishing a ROBS or answering any questions you have about generating capital for your business with a variety of effective financial solutions, contact Illumination Wealth today for an introductory consultation.