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Using Your 401(k) to Start a Business

///Using Your 401(k) to Start a Business

Using Your 401(k) to Start a Business

I recently read a fantastic article highlighting how to start a business using your 401(k) titled, “Rolling Over, Starting Up” in Financial Advisor Magazine.   The Author, Alan Lavine, goes through the technique known as Roll-Over as a Business Start up (ROBS).

How Do You Use Your 401(K) To Start a Business?

Borrowing from a 401(k) is likely not to be an option because loans aren’t available to those that no longer work for the company so you may be able to turn to to the ROBS.  According to Mr. Lavine,

A businessperson creates a Subchapter C corporation and sets up a retirement plan, but does not initially issue stock. The businessperson then rolls over his or her existing 401(k) into the new retirement plan. Afterward, the new corporation issues stock and transfers it to the new retirement plan in exchange for cash.

If the ROBS is set up correctly, no interest is owed, there are no IRS penalties for early withdrawal and the money needn’t be repaid. In addition, ROBS money may be used to help an entrepreneur qualify for a loan from the bank or the Small Business Administration.

Whenever you are dealing with ERISA (the federal law which the 401(k) falls under) there are some serious regulations that must be followed, and since you are dealing with the IRS failing to comply can have some serious repercussions.

Problem with Using a Rollover as Business Start Up

The first and obvious problem is that you are putting your retirement assets to start a business.  This could be scary for most people.  However, on top of that obvious apparent there are common problems an IRS research project uncovered.  Recently, the IRS released, Rollover as Business Start-Ups Compliance Project, in it they highlight some of the common problems they found when entrepreneurs utilized this type of funding method for their business:

Some other areas the ROBS plan could run into trouble:

  • After the ROBS plan sponsor purchases the new company’s employer stock with the rollover funds, the sponsor amends the plan to prevent other participants from purchasing stock.
  • If the sponsor amends the plan to prevent other employees from participating after the DL is issued, this may violate the Code qualification requirements. These types of amendments tend to result in problems with coverage, discrimination and potentially result in violations of benefits, rights and features requirements.
  • Promoter fees
  • Valuation of assets
  • Failure to issue a Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., when the assets are rolled over into the ROBS plan

I would really recommend finding a professional that has experience utilizing this funding option, but I had never heard of this type of strategy so I was immediately drawn to it.

Have you ever heard of a Rollover as a Business Start Up? Know anyone that has used a ROBS strategy before?

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By | 2013-09-26T15:00:12+00:00 January 3rd, 2011|Business|28 Comments

About the Author:

Evan is the owner of My Journey to Millions which was started to track his journey from a broke debt ridden law school graduate to building a positive balance. Need more Evan? Follow him on Twitter, Contact him or get new posts directly to your email

28 Comments

  1. Darwin's Money January 3, 2011 at 9:39 am - Reply

    Yeah, those options are interesting. Businessweek did a piece on that a while back. I could see many people losing their retirement trying to do so, but that’s the American way – take risks; if you fail, try again.

    • Evan January 4, 2011 at 3:19 pm - Reply

      Yup! but you miss 100% of the shots you don’t take lol

  2. krantcents January 3, 2011 at 12:25 pm - Reply

    I agree with Darwin, this seems too risky for me. I think a business should stand on its own or separately funded. Separating risks is important.

    • Evan January 4, 2011 at 3:19 pm - Reply

      How many businesses that you know, besides blogging, that you can start without borrowed funds?

  3. retirebyforty January 3, 2011 at 4:36 pm - Reply

    Wow, ROBS looks cool. That is too smart and tricky for me though. I am better at doing things the hard/dumb way and I will probably mess up ROBS somehow.

    • Evan January 4, 2011 at 3:29 pm - Reply

      LOL I have more faith in you

  4. Kris January 3, 2011 at 8:55 pm - Reply

    I would be way too terrified to try that, and I don’t know anyone who has tried it either.

    I will say though, after my year of blogging, I am more open to trying new business ideas as I see things are more possible. But I am not so open as to use my retirement funds.

    Interesting idea…

    • Evan January 4, 2011 at 4:20 pm - Reply

      Would you rather use a loan or your retirement assets? I guess your retirement assets are protected in bankruptcy?

      • Kris January 4, 2011 at 4:42 pm - Reply

        If someone put a gun to my head and made me invest in a side business with money I didn’t have, I would definitely borrow against my 401k as the preferred method. I would pay myself the interest, and I won’t end up in debtor’s prison.

  5. LifeAndMyFinances January 4, 2011 at 6:39 am - Reply

    This is a very interesting method of retrieving funds, but much like retireby40, I would be too terrified to try that as well! If I were to start a business, I would most likely fund it with my savings.

    • Evan January 4, 2011 at 4:20 pm - Reply

      HOw many businesses are you familiar with that you can start with savings? Websites – 100% but anything else?

      • Investor Junkie January 4, 2011 at 4:39 pm - Reply

        Most internet based business have a lower barrier of entry and don’t require that much capital up front.

      • LifeAndMyFinances January 4, 2011 at 8:18 pm - Reply

        There are tons of businesses that start with cash! In this day and age, I actually cringe at the thought of a brick and mortar store. This economy is now built on services and the internet. Most of these businesses can be started with less than a thousand bucks, and for sure less than $10,000. I’ll have that much cash to spend soon.

  6. Investor Junkie January 4, 2011 at 11:34 am - Reply

    I would only do this as a last resort. I would rather get other outside investors or get a bank loan first.

    • Evan January 4, 2011 at 4:21 pm - Reply

      With the credit freeze of last year, it wasn’t that easy to just go get a bank loan…but it isn’t a bad last resort.

  7. Investor Junkie January 4, 2011 at 8:24 pm - Reply

    Evan, you also know as well as I do that retirement accounts are protected from bankruptcy. Why use them then? You put yourself at risk since this money is used for financing a business.

    If you can get a loan from a bank, or another investor it would be best to use OPM.

    Again I would only use it as the lender of last restort.

  8. John January 4, 2011 at 11:59 pm - Reply

    I don’t like the idea at all. yes if you use it to start Google or Facebook, wonder you are a billionaire. But then again it is hard to imagine what would be a bad idea if you started Google. But a huge percentage of efforts will completely fail. And many will struggle for years with little success before they eak out an existence.

    Basically I think using your retirement savings to start a business is a horrible idea – even if occasionally it might work out.

    • Evan January 6, 2011 at 12:16 pm - Reply

      What about using it to start a McDonalds or generally successful franchise?

      • Investor Junkie January 6, 2011 at 2:13 pm - Reply

        I franchise that has a great history like McDonalds maybe. Stone Cold Creamery, definitely no.

        • Evan January 6, 2011 at 2:24 pm - Reply

          There was JUST a show on CNBC on franchises and they did a piece of Stone Cold on how horrible it is to own lol.

          Someone asked me once if I would invest in that (or red mango) and I said you can only rip people off with $9 ice cream for so long.

          • Investor Junkie January 6, 2011 at 3:03 pm - Reply

            Yes I saw and hence my comment. There are a few other franchises like them from my research.

  9. Tim January 9, 2011 at 3:52 pm - Reply

    The biggest risk is not taking one….but for me, I don’t think I’d ever use my retirement funds for a business. (at least I hope I don’t have to) I’d much rather try to save for it with funds outside of retirement – long term savings is too important for me to dip into it.

    Great post – I hadn’t heard about this before.

    • Evan January 12, 2011 at 6:02 pm - Reply

      The only reason I highlighted the technique is because I have never heard of it either…

  10. hank January 13, 2011 at 2:04 pm - Reply

    I was in the same boat as everyone else here – not going to deflate my 401k and retirement later for something that MIGHT pan out. However, in the last 10 years, my 401k has returned 5.74%. If I’m going to start a business that doesn’t generate 50% return on my money, it’s not worth doing anyway. If your business idea is solid, it’s a good pool of money to dip in. Flip that coin though, and if you’ve got a crap product, welp…

    • SHERYL July 24, 2013 at 10:11 pm - Reply

      I am thrilled at the option of ROBS. After 9 yrs invested in a big box retailer as a department manager, I have recently lost my job satisfaction. Have been self employed before and though it is not easy it can be rewarding and offer satisfaction, thrill, opportunity for creativity (big box no longer goes for that)and control of income and work schedules for example. (I despise working at the big box till 11pm) I enjoy living life on the skinny branches and making possible the impossible, so the idea of my own business is exciting but I always seem to run into the same brick wall when it comes to funding my new venture – that is until today when I happened upon this and other articles about ROBS. I will be discussing this idea with both my accountant (formerly with the IRS) and my attorney. POSSIBILITIES AWAIT ME!

  11. LoneStarWild May 25, 2014 at 10:39 am - Reply

    Hi all,
    The last comment here was a while back, hopefully my question will reach someone for an answer.

    Im 29, have about 150K in my 401k program and I am wanting to start a company/buy into a franchise(both options are on the table.) I have been reading about ROBS and I like it, my business plan is stable and in demand in my area. So basically if its doable my mind is already made up on using the ROBS to start the business. I currently work for a great company, make good money, great benefits and in 7 years have laid a good fondation for my financial futures. I am wanting to open this business for my wife to run. is that possible? After creating the C corp/ with 401k plan can i roll funds over while remaining employeed??? I am thinking most likely not, but I cant find anyting online that tells me no for sure. I kinda feel like the answer is in the word “Rollover” but I feel like I have to ask.

    Thanks

    • Evan May 26, 2014 at 10:44 pm - Reply

      LSW,

      I wrote this post a few years ago, but have never implemented such a plan. I would recommend contacting a Third Party Administrator (TPA)

  12. dwain c April 30, 2015 at 3:41 pm - Reply

    From reading the articles on this forum about ROB’s I see most here are facing the same dilemma as I am. Fear! Fear of losing your retirement and a good paying job to boot, in my case. When I first looked at doing this I thought, WOW great, I can finally leave my job, be my own boss and live a decent life. I had a business picked out, with great opportunity, great location. But as I looked at the costs associated with the start up, the risks involved and with me having to leave my job, fear set in and I mean intense fear as well as nightmares. I also ran into a lot of pressure from others who would be working for me because they saw the opportunity also. But they don’t have any money, they would just be working for me. I would be taking on all the risk. The ROB began to look less and less attractive. But in life nothing is guaranteed, even our jobs we consider safe are no longer safe. But we have to weigh out the risks. So you as I face the same fears, the fear of the unknown. And financial fears besides death are probably our greatest fears to conquer. And I have as of yet to conquer it.

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