What Is a ROBS 401(k) and How Does It Work?

A Rollover for Business Startups (ROBS) 401(k) is a financial strategy allowing individuals to fund a new business using existing retirement savings. This method enables investment into a personal business venture without incurring immediate taxes or early withdrawal penalties. It represents a regulated approach to business financing, distinct from traditional loans or personal capital. This strategy provides a pathway for entrepreneurs to leverage retirement assets to capitalize a new enterprise.

Understanding ROBS

A Rollover for Business Startups (ROBS) channels retirement funds into a business. It moves existing retirement assets, such as from a previous 401(k) or IRA, into a new 401(k) plan sponsored by a new C-Corporation. This is a tax-free rollover. The 401(k) plan then uses these assets to purchase stock in the C-Corporation, providing the business with capital.

The primary motivation for using a ROBS arrangement is to secure capital for a business startup or acquisition, such as purchasing a franchise, without incurring debt or triggering taxable distributions and penalties. This approach appeals to entrepreneurs who may not qualify for traditional business loans or prefer to avoid interest payments. It offers a way to utilize personal retirement savings as a direct investment into one’s own company.

The legal foundation for ROBS stems from the Employee Retirement Income Security Act (ERISA) and the Internal Revenue Code. These regulations permit qualified retirement plans to invest in “Qualified Employer Securities” (QES), which are stocks of the sponsoring company. When executed correctly, ROBS is a legitimate and IRS-recognized strategy.

A ROBS structure involves an individual’s existing retirement account, a new C-Corporation, and a new 401(k) plan established by that C-Corporation. Only C-Corporations are suitable because they can issue stock that a retirement plan can purchase. Other business entities, such as S-Corporations, LLCs, or sole proprietorships, are not compatible due to their inability to issue Qualified Employer Securities.

Establishing a ROBS Structure

Establishing a ROBS structure involves specific actions to ensure compliance with tax and retirement plan regulations. The initial step requires forming a new C-Corporation. This business entity is necessary because it is the only corporate structure that can issue stock to a retirement plan, which is fundamental to the ROBS process.

Forming the C-Corporation entails filing Articles of Incorporation and creating corporate bylaws. The C-Corporation must also obtain an Employer Identification Number (EIN) from the IRS. While some existing businesses may convert, forming a new entity is a common starting point for this funding strategy.

Following the C-Corporation’s establishment, the next step is to set up a qualified 401(k) plan for the new entity. This plan must comply with ERISA regulations and allow for investment in employer stock. Establishing this plan involves drafting a formal plan document and a trust agreement, outlining the plan’s rules and asset management. A trustee or custodian must also be appointed to oversee the plan’s investments.

Once the C-Corporation and its 401(k) plan are in place, existing retirement funds are rolled over into the new plan. This involves a direct trustee-to-trustee transfer of assets from prior retirement accounts, such as an old 401(k) or a traditional IRA, into the new 401(k) plan. A direct rollover avoids taxable events or early withdrawal penalties that would apply if funds were distributed directly to the individual.

The final step in the ROBS structure is when the new 401(k) plan, holding the rolled-over retirement funds, uses these assets to purchase stock in the sponsoring C-Corporation. This transaction provides the C-Corporation with capital for legitimate business purposes, such as startup costs, inventory purchases, or equipment acquisition. The stock purchase must occur at fair market value to maintain compliance with IRS regulations.

The setup process involves professional assistance from ROBS providers, attorneys, and financial advisors. Initial setup fees are around $5,000, covering the C-Corporation formation, the new retirement plan, and initial IRS filings. A minimum of $50,000 in retirement savings is generally recommended to make the ROBS strategy financially viable due to these setup and ongoing costs.

Ongoing Compliance and Operational Considerations

Once a ROBS structure is established, continuous adherence to regulatory requirements is necessary. The C-Corporation must maintain its legal standing by observing corporate formalities, including annual shareholder and director meetings and documenting all corporate resolutions. Regular tax filings, specifically Form 1120 for C-Corporations, are also required, along with state-specific registration and reporting obligations.

The business must function as an active operating entity, providing goods or services, not as a passive investment vehicle. Funds obtained through the ROBS arrangement must be used exclusively for legitimate business expenses, such as purchasing equipment, acquiring inventory, or covering operational costs. Any personal use of these funds constitutes a prohibited transaction and can result in severe tax penalties and legal issues.

The 401(k) plan established by the C-Corporation carries ongoing administrative and fiduciary responsibilities. As the plan sponsor, the business owner assumes fiduciary duties, acting in the best interest of all plan participants. This includes adhering to ERISA guidelines, which govern how retirement plans are managed and prohibit transactions that could benefit the owner disproportionately.

Annual non-discrimination testing, such as ADP, ACP, and Top-Heavy tests, is mandatory to confirm the plan does not unfairly favor highly compensated employees or owners. The plan must be offered to all eligible employees, and contributions and benefits must be applied equitably. The business owner is typically required to be a bona fide employee of the business and receive a reasonable salary.

Routine annual filings with the IRS and Department of Labor are essential. Form 5500 reports the financial condition and operations of the employee benefit plan. For ROBS plans, this filing requires an annual business valuation to determine the fair market value of the company stock held by the 401(k) plan. Failure to file Form 5500 can lead to significant penalties, potentially $750 per year.

ERISA mandates that 401(k) plans holding Qualified Employer Securities maintain an ERISA fidelity bond. This bond, typically 10% of the plan’s assets up to $500,000, protects the plan against losses due to fraud or dishonesty. Meticulous record-keeping for both the C-Corporation and the 401(k) plan is important to demonstrate ongoing compliance during potential audits.

Due to ROBS regulations and potential penalties for non-compliance, seeking ongoing professional guidance is advisable. Engaging tax professionals, ERISA attorneys, and qualified plan administrators helps ensure continuous adherence to federal and state requirements. These administrative services typically incur monthly fees, ranging from $100 to $150, covering routine compliance tasks and reporting.