Rollovers as Business Startups (ROBS)—Advantages & Disadvantages

June 29, 2022
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If you are looking to start your own business or acquire ownership shares in an existing business, you may be able to utilize your 401(k) or IRA account. Rollovers as Business Startups (aka “ROBS”) allow you to invest your retirement savings funds into a business without having to pay early withdrawal penalties or upfront taxes.

This is not an option many people are aware exists. Over the next few weeks on the Illumination Wealth Blog, we will cover all the key information you need to know when it comes to ROBS. Today, let’s focus on the basics of this investment strategy.

What is a ROBS?

A Rollover as Business Startup enables a business owner to rollover funds from eligible retirement accounts. Funds from a 401(k) plan or eligible IRA can be utilized to acquire a business, refinance your business or cover startup costs for a new business. Eligible accounts must generally have at least $50,000 available.

To be clear, a ROBS is not a business loan or any type of loan from your 401(k) account. You are pulling money directly out of your account. Though it is a simple concept, it can be a very complex process and there are some tax risks involved. You will want to work with an experienced financial advisor who can help guide you through each step. If you do things right, you can get your funding fairly quickly. You can also avoid any early withdrawal penalties and upfront taxes.

Advantages of a ROBS

There are several key advantages to using a ROBS to invest capital from your retirement account into your business. Here are a few benefits:

Not a Loan—This is not a business loan. You are using funds you have already saved up. You are not adding any debt and there is not an underwriting process. You are not cutting into your profits by making loan payments and you can reinvest your profits back into your business. A ROBS may also be a viable solution for a business owner with credit problems or weak cash flow that may hinder their ability to qualify for a business loan.

Penalty-Free—With a ROBS, you will be able to withdraw funds from a 401(k) or IRA without paying the 10% early withdrawal penalty or distribution tax that would normally be required for anyone under the age of 59.5.

Self-Investment—You are investing in yourself as a business owner. If you have a strong plan, this could set you up even better for retirement than an average 401(k) plan. You are taking some risk by pulling from your tax-deferred retirement savings account, so you’ll want to be confident in your investment.

Disadvantages of a ROBS

There are some drawbacks to using a ROBS to invest in your business. It’s important to do things correctly and be smart with your money. Here are a few disadvantages to understand:

Investment Risks—If your business fails, then that money you invested is lost. Your retirement account provides you with safe, sheltered funds that generally provide steady gains until you are ready to start withdrawing upon retirement. You are risking that money on your business investment. Your rollover essentially “ROBS” the money from your retirement account to provide business capital, so you want to be smart with how you invest it.

Additional Costs—Though you will avoid the early withdrawal penalties and taxes, there are some fees involved for monthly 401(k) administration, filing of various legal forms and an annual appraisal of your business. It is recommended you work with a financial professional to navigate the complex ROBS process. Naturally, their services will come with attached advisement fees.

C Corporation Requirement—As we will discuss in next week’s article, one step to establishing a ROBS is the business must operate as a C corporation. This is a requirement, so you may need to take this into consideration if this is not the best legal/tax structure for your business.

Tax Scrutiny—Completing a ROBS will generally bring a bit more attention from the IRS and you are increasing your chances of being audited. They will want to make sure the funds went to legitimate business expenses and each step of the process was completed properly.

As you can see, there are some risks associated with ROBS, but there are also some very positive advantages if this is the best solution for you and your business. Consult with your financial specialist or business advisor to see if a Rollover as Business Startup is a viable option and to get started with the necessary steps. Speaking of those steps, that’s exactly what we will cover next week in Part 2 of this series on ROBS.

If you would like help with your business plan and/or retirement plan—including ROBS guidance—contact Illumination Wealth today.