Using Your 401(k) Funds to Buy a Business

Previously we’ve discussed how SBA loans are a great way to finance the purchase of a business. Another largely unknown method is to utilize ROBS arrangements. ROBS stands for Rollovers as Business Startups. This method has the distinct advantage of using the available capital an owner already has in a 401(k) plan to either start a business or purchase an existing one without taking on new debt.

What Are ROBS Arrangements?

The Small Business Administration defines ROBS as: “a way to optimize the use of money in your retirement account as a funding mechanism to start a business. It works if you have a 401(k) or other qualified retirement plan account with a balance that’s sufficient for your funding needs and you adhere to the tax rules.”

Setting up a ROBS structure properly is essential in order to qualify under the IRS code. Here are the five steps. These can be completed in as little as three weeks if the entrepreneur is motivated.

  1. The entrepreneur establishes a new business as a C corporation.
  2. That corporation creates a new 401(k) plan that permits plan participants to direct the investment of their plan accounts into investment options, including employer stock.
  3. The owner chooses to participate in the new 401(k) plan and directs the funds from an existing retirement account to be rolled over into the new 401(k) plan. This does not trigger a taxable distribution.
  4. The owner can then invest funds from his 401(k) plan to purchase stock in the C corporation.
  5. The C corporation acquires or starts a business using these funds.

The largest benefit of ROBS is the immediate capital injection. The new company now has money to purchase an existing business or begin a new one as well as funds to operate. This is done without taking on debt. The entrepreneur can directly utilize funds from an eligible retirement account in order to create a profitable business.

Most retirement plans qualify for ROBS, including 401(k), a traditional IRA, TSP, SEP, Keogh, 403(b) or ESOP. Many entrepreneurs do not know they have the option of using ROBS, likely because it works in favor of individual retirement savers rather than corporations. Congress intended ERISA to safeguard employees from company bankruptcies and underfunded pension plans. It passed the Employee Retirement Income Security Act (ERISA) in 1974. This law transferred the responsibility of retirement saving from the employer to the employee, giving employees the right to invest their retirement savings as they wished – within limits.

ROBS allows entrepreneurs to buy almost any legal business or franchise, whether that’s a startup business or an existing one. It cannot be used to create a business that is “solely the investment of capital,” however. In other words, you can’t take your retirement funds and loan them to others.

ROBS funds can be combined with those of a business partner, spouse, and with an SBA loan or other financing. You must be an employee of the business you purchase. To comply with IRS regulations, you should avoid taking a salary until your business generates its own operational revenue (rather than funds from the rollover).

What Are the Benefits of ROBS Arrangements?

  • Business owners have a tax-free, penalty-free way to access capital without borrowing money from a lending institution. They can make their retirement money work for their own businesses, instead of someone else’s.
  • A debt-free launch lowers overhead. With no monthly payments to a lender, the new company will increase profitability sooner rather than later.
  • Using retirement money to invest in a company allows the owner greater choice and control. Traditional retirement options are vulnerable to the ups and downs of the stock market.
  • There is no tax penalty for withdrawing these funds. This is NOT a tax loophole.

In order to continue saving for retirement, you will have to make salary deferrals to your new 401(k) plan. Another benefit of ROBS is that every employee of the new company is offered participation in the new 401(k) once eligibility requirements are met – including the owner. The owner can contribute up to 100% of his salary to this plan, up to the annual limit and also make catch-up contributions to maximize retirement savings.

Again, It’s important that business owners properly establish and administer their new 401(k) plans because there can be substantial tax penalties and legal pitfalls if they do not. The double taxation that occurs on dividends paid by C corporations can often be avoided or mitigated. Owners should consult a tax professional for assistance.

When business owners structure and administer their ROBS arrangements correctly, they can satisfy both the requirements and spirit of tax laws and build profitable businesses – without taking on debt or letting investment money sit unused. Would be entrepreneurs who have money in retirement accounts have more options with ROBS than they might know. If you’re looking to purchase a business, it’s vital you know all the ways you can use to make that happen, including ROBS.

Scroll to Top