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?