How to Use Your IRA to Start a Business

Using retirement funds to capitalize a new business is an established method for entrepreneurs. It allows for the use of personal retirement savings to finance a startup without triggering the taxes or early withdrawal penalties that would normally apply. This approach is not a loan against a retirement account, but a specific series of transactions governed by tax law.

The Rollover for Business Startups Structure

The financial strategy that permits using retirement funds for a business is known as a Rollover for Business Startups (ROBS). This structure is not a loan from your IRA or a direct withdrawal. Instead, it involves moving funds from an existing retirement account into a new retirement plan sponsored by your new business. This tax-free rollover avoids the penalties associated with early distributions.

The foundation of the ROBS arrangement is a new C Corporation. This corporate structure is required because only C Corporations can sell stock to a retirement plan. Once formed, the C Corporation creates its own 401(k) plan, and the business owner becomes an employee and plan participant.

Next, funds from a personal retirement account, like a traditional IRA or a former employer’s 401(k), are rolled over into the new C Corporation’s 401(k) plan. The 401(k) plan then uses these funds to purchase stock in the C Corporation. This stock purchase moves the cash from the retirement plan into the business.

The C Corporation is now capitalized with cash, and its 401(k) plan holds company stock as its primary asset. The business can use this cash for any legitimate business purpose, such as purchasing equipment, securing a lease, or funding operations. The IRS scrutinizes this structure, so precise execution is necessary.

Prerequisites and Information Gathering

Before initiating a ROBS transaction, you must confirm eligibility and gather information for forming the legal entity and its retirement plan.

First, your existing retirement account must be eligible. Funds must come from an account that permits rollovers, such as a Traditional IRA, SEP IRA, or most 401(k), 403(b), and Thrift Savings Plan (TSP) accounts. Roth IRAs cannot be used for this purpose. A minimum balance of $50,000 is recommended to make the transaction cost-effective.

To form the corporation, you will need to gather several details.

• A unique business name that is available in your state of incorporation
• A clear business purpose
• The total number of shares the corporation is authorized to issue
• A physical address for the company
• A registered agent for the company

You must also prepare to establish the new 401(k) plan. This involves naming a plan trustee, who is typically the business owner. The trustee has a fiduciary responsibility to manage the plan’s assets and is required by the Employee Retirement Income Security Act (ERISA) to obtain a fidelity bond. You must also define the terms for employee eligibility to determine when future employees can participate.

Once this information is collected, the Articles of Incorporation and 401(k) plan documents can be prepared. Many entrepreneurs use a specialized ROBS provider to ensure the documents are completed correctly. The initial setup fee for these services is around $5,000.

The Five Step Implementation Process

The implementation of the ROBS structure follows a five-step sequence.

First, create the legal entity by filing the Articles of Incorporation with the appropriate state agency. This filing establishes the C Corporation and involves submitting the document with a state-mandated fee.

Second, establish the 401(k) plan. The C Corporation’s board of directors, which is often just the entrepreneur, signs the plan adoption agreement. This action legally creates the 401(k) plan, making it ready to receive funds.

Third, execute the rollover. Instruct the custodian of your existing retirement account to perform a direct rollover to the new 401(k) plan. This requires completing transfer paperwork and directing the funds to a new bank account for the C Corporation’s 401(k) plan.

Fourth, purchase the stock. As the 401(k) plan trustee, you will direct the plan to purchase stock from the C Corporation at fair market value. The C Corporation then issues a stock certificate to the 401(k) plan, documenting its ownership.

Fifth, capitalize the business. The money from the stock purchase is transferred from the 401(k) plan’s bank account to the C Corporation’s main operating account. The funds are now a corporate asset available for business expenses.

Ongoing Administrative Compliance

Maintaining the ROBS structure’s tax-compliant status requires ongoing administration. The compliance duties involve corporate governance, employee compensation, and retirement plan administration.

You must maintain the C Corporation’s legal standing by adhering to corporate formalities. This includes holding regular board of directors meetings and documenting all major corporate decisions in meeting minutes. These records show the corporation is operating as a separate legal entity.

The business owner must be a bona fide employee of the C Corporation. This means being actively involved in operations and receiving reasonable compensation for your services. The salary must be justifiable based on your role, industry standards, and the company’s financial condition, as this is a point of IRS scrutiny.

Annual administration of the 401(k) plan is another duty. A formal valuation to determine the stock’s fair market value must be conducted at least once a year because the plan’s primary asset is company stock. This appraisal is required for completing IRS Form 5500, which must be filed annually to report the plan’s activities. The IRS requires all ROBS plans to file this form annually, regardless of the number of participants or asset value. There may also be an ongoing monthly administrative fee of approximately $100-$150 for plan administration and filings.

As the business grows, you must offer the 401(k) plan to all eligible employees on the same terms provided to the owner. ERISA rules prohibit discrimination, so you cannot give yourself preferential treatment. All employees who meet the plan’s eligibility criteria must be given the opportunity to participate.