ROBS – or Rollovers as Business Start-ups – allow prospective business owners to use funds from their existing personal 401(k) or other retirement accounts as capital for buying a business.
In addition to creating cash flow and minimizing the use of debt, ROBS are an attractive source of funds to start or buy a business because of their tax advantages.
What are ROBS’ Tax Advantages?
When it comes to unlocking value from an individual’s retirement savings to fund a business, what are the tax advantages that make considering a ROBS strategy worthwhile?
First, there is the aspect of tax deferral. Financing through ROBS avoids the early withdrawal penalty normally incurred when funds are withdrawn from retirement savings prior to retirement. When you use the capital from your 401(k) to fund a new C-Corporation (C-Corp) using the ROBS strategy, no early withdrawal penalty applies, unlike when you access capital for your personal enjoyment. Funds that remain in the original account, as well as the funds used for the C-Corp, can continue to grow tax-deferred.
Second, because you’re not paying income taxes or penalties, more money is available to go into the business, thus maximizing your available capital.
In addition to increasing capital efficiency, you avoid loan obligations because ROBS is not a debt product. It’s simply accessing the equity you already have built up in your retirement plan, so there’s no monthly repayments or interest like you would incur with a loan.
Accessing Business Capital Through ROBS
Here are some points to remember about how the flow of money works when using a ROBS strategy:
- The new business entity to be funded must specifically be established as a C-Corp.
- After a new 401(k) or profit-sharing plan is created for the C-Corp, funds from a personal 401(k) are then rolled over into the C-Corp’s 401(k).
- The new 401(k) is essentially purchasing stock in the C-Corp, thereby creating cash flow.
As the business grows and succeeds, the stock in the C-Corp in the new 401(k) increases in value. The opposite can also be true. If the business flounders or goes out of business, the 401(k) will sustain a loss up to the amount that was put in. Therefore, to mitigate risk, it’s considered a wise practice to not use the entire personal retirement fund for a ROBS rollover. In addition to retaining some of the original funds in the personal 401(k), the business owner can continue to contribute to it, even as the business grows.
It’s also good to remember that the retirement plan owns the C-Corp, not the individual business owner. This is an important distinction when understanding the asset allocation and stock concentrations of the ROBS-funded 401(k), how dividends will flow and how salaries are paid.
S.J. Gorowitz Tax and Accounting Services is an experienced Certified Public Accountant (CPA) firm that understands the business advisory space and how to implement a ROBS strategy. For a consultation on your business plans and objectives, please contact us at 770.740.0797 or email info2@SJGorowitz.com.