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A Rollovers as Business Startups, or ROBS, transaction moves money from a retirement account like a 401(k) into your business, tax-free. A ROBS can help you fund your business startup costs, but at a steep price — you’ll put your retirement savings at risk.
In general, NerdWallet doesn’t recommend tapping your retirement savings early unless it’s absolutely necessary. On top of that, a ROBS is a complex transaction that the IRS may scrutinize closely. Talk to a financial advisor and consider other ways to fund your business idea before moving forward.
Here’s what you need to know about ROBS.
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How does a ROBS work?
In a ROBS transaction, funds from eligible retirement accounts — including a 401(k) or a traditional individual retirement account — are rolled over and invested in a new business or franchise.
Here’s how a ROBS transaction works:
A C corporation — a corporate structure that allows shareholders — is formed.
A new retirement plan is created for the new corporation.
The business owner becomes an employee of the C corporation and the beneficiary of the new retirement plan.
Funds from the business owner’s existing retirement accounts are rolled into that new retirement plan.
The rolled-over funds are used to purchase company stock in the C corporation.
The business owner can use the proceeds from the sale of stock to start their business.
Because you’re rolling funds over directly from your retirement account, not withdrawing them, you don’t pay taxes on the distributions. You also don’t owe penalties for withdrawing funds before turning 59½. Instead, your retirement savings go directly into your business.
Is ROBS financing right for your business?
A ROBS transaction allows you to tap your personal retirement savings to start your business without paying taxes. This may be an option for you if:
You have significant retirement savings. A ROBS is possible only if you have an existing 401(k), IRA or another retirement account. Beyond that, you should have enough saved for retirement that you can lose some of it without risking your future financial stability.
You can’t qualify for other types of financing. Business lenders typically require at least a year in business, established revenue and strong personal credit before making a small-business loan. But beyond traditional financing, options like personal loans and business credit cards can provide startup funding that may be less risky than a ROBS.
You don’t want to take on debt. A ROBS isn’t a loan, so you don’t have to worry about making repayments or the possibility of default.
What are the risks of ROBS financing?
Make sure you understand the potential drawbacks of financing your business with a ROBS, including:
Your retirement is at risk. If your business fails — and many do — say goodbye to your retirement nest egg. And even if your business succeeds, you’ll lose the potential gains from a rising stock market, the tax-deferred savings of a 401(k) or IRA and the power of compounding as your investments grow over time.
You must operate as a C corporation. A C corporation is a common business structure for larger companies, but less so for small businesses. With a C corp, you’ll have to pay taxes on your profits as well as any dividends you take. You’ll also have to hold annual shareholders meetings and meet certain tax filing requirements — which means you’ll likely need support from a lawyer and an accountant.
You’ll pay fees to facilitate the transaction. A ROBS can cost several thousand dollars to set up, and you may have to pay a monthly or annual administration fee as well.
You’ll have to watch out for bad actors. In 2009, the IRS undertook a research project to understand how ROBS were used and identify noncompliant plans. Officials identified a few recurring problems, like ROBS plan sponsors charging high fees, aggressively marketing ROBS and failing to file or issue the required tax forms.
Alternatives to ROBS financing
There are lots of ways to leverage your personal financial security to launch your business without putting your retirement savings at risk. Consider these options:
If you don’t want to touch your retirement savings: A personal business loan is a personal loan that you use to fund your business. The terms you qualify for will depend on your personal credit history, among other factors. If your business fails, though, you’ll still be on the hook for the debt. If you want flexible startup financing: Business credit cards are generally issued based on your personal financial history, not business finances, so they can be a good option for startups. You may not be able to borrow enough to fund your business for months on end, but they can help make ends meet while you build your revenue streams.