5 Steps to Establish a ROBS

July 6, 2022
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Last week, we began our discussion about rollovers as business startups (aka “ROBS”) as a way to generate capital for your business. This strategy allows you to pull funds from your qualified IRA or 401(k) account and invest them as capital in your business. These funds can be withdrawn free of the early withdrawal penalty and income taxes.

As we discussed in our previous article, there are some clear advantages and disadvantages with ROBS. They can be complicated to set up and they generally bring more tax scrutiny from the IRS. It is very important that you go through the proper steps to avoid audits and make sure you do things right.

In this article, we will walk through five of the key steps you need to take when establishing a ROBS:

1. Form a C-Corporation

First, you can only use a ROBS to pull 401(k) funds if your business is a C-corporation. This step alone may deter some business owners who know a C-corp is not the right legal structure for their particular company. A C-corp is able to issue stock and have shareholders. Therefore, it is the only business structure that can legally sell shares of the business to a retirement account. Per IRS rules, a ROBS only works with C-corporations. LLCs, LLPs, S-corps and sole proprietorships will not be eligible. You must be ready, willing and able to convert your company into a C-corp if you want to take advantage of ROBS funding.

2. Create a New Retirement Plan

Now that you have a C-corporation, you must create a retirement plan for the corporation. You will have some flexibility here and the best plan may depend on how many employees you have and the retirement benefits you wish to offer. With a ROBS, your company’s retirement plan will generally require the services of a trustee, third-party record keeper and an asset custodian to manage the retirement plan investments.

3. Transfer the Funds

You will be able to transfer funds from a personal IRA or a prior employer’s 401(k) into the C-corp’s new retirement plan. These monies can then be used as capital investments into the new business and allow you to become a shareholder in the C-corporation.

4. Buy Stocks in the C-Corp

The new retirement plan allows you to buy stock in the new C-corp at fair market value. The C-corp will issue shares that can be purchases by outside investors, as well as the retirement plan.

5. Invest the Capital

After the retirement plan has purchased shares in the company, these funds can be used by the C-corp. They can be invested as capital for qualified business expenses. When it comes to ROBS funds, the IRS and the U.S. Department of Labor (DOL) require that these contributed funds are used only for business purposes and not for any personal expenses.

This is a simplified overview of the primary steps that need to be taken to establish a ROBS and invest 401(k)/IRA funds into your business. You do not want to cut any corners or make any mistakes when creating your C-corp, developing your new retirement plan, transferring funds, issuing stocks or investing capital. It is best to work with an experienced financial advisor to make sure every step is taken properly to ensure success.

To learn more about rollovers as business startups or for help with establishing your ROBS, contact Illumination Wealth today.