What Is a ROBS Plan and How Does It Work?
Discover how a ROBS plan enables entrepreneurs to fund a new business using retirement savings, avoiding penalties while staying IRS compliant.
A Rollover for Business Start-up (ROBS) plan enables entrepreneurs to leverage their retirement savings to fund a new business. This strategy allows individuals to access capital from their retirement accounts without incurring early withdrawal penalties or immediate income taxes.
Understanding ROBS Plans
A ROBS plan represents an IRS-compliant strategy designed to facilitate business funding using existing retirement assets. It is a specific type of rollover that adheres to Internal Revenue Service (IRS) and Department of Labor (DOL) regulations, allowing access to retirement funds without incurring early withdrawal penalties or immediate taxes.
Several types of retirement accounts qualify for a ROBS rollover, including traditional IRAs, 401(k)s from previous employers, 403(b)s, 457(b)s, and Keogh plans. Roth IRAs and Roth 401(k) accounts are not eligible. The funds from eligible accounts capitalize a new business venture.
A ROBS plan offers several benefits. It allows entrepreneurs to capitalize their business without incurring debt, avoiding loan repayments and interest. This method also prevents equity dilution, as it uses the entrepreneur’s own capital rather than bringing in outside investors. This approach can provide significant initial capital for a startup or the purchase of an existing business.
The Mechanics of a ROBS Plan
The initial step requires forming a new C-Corporation. A C-Corporation is mandated for a ROBS arrangement because it is the only business entity that can issue “Qualified Employer Securities” (QES), which are shares of stock a qualified retirement plan can legally purchase. Other business structures like S-corporations, LLCs, or sole proprietorships do not allow for the necessary stock issuance.
Following the C-Corporation’s incorporation, a qualified retirement plan, typically a 401(k) plan, is established within this new entity. This 401(k) plan allows for the purchase of employer stock. The C-Corporation sponsors this new retirement plan, which holds the business’s stock.
The next step involves the rollover process, where the entrepreneur’s existing retirement funds are transferred into the 401(k) plan sponsored by the C-Corporation. This direct rollover is tax-free and penalty-free. The funds are then invested into the business.
The final stage involves the 401(k) plan using these rolled-over funds to purchase stock in the C-Corporation. The 401(k) plan, as a distinct legal entity, owns this stock, not the individual entrepreneur. The capital from this stock purchase flows directly into the C-Corporation, providing operating funds for the business.
Key Ongoing Considerations for a ROBS Plan
Once a ROBS plan is established, ongoing adherence to IRS and Department of Labor (DOL) regulations is necessary to maintain its qualified status. The business owner, as plan administrator, is responsible for continuous compliance.
Maintaining the 401(k) plan’s qualified status requires diligent administration. This includes offering the plan to all eligible employees of the C-Corporation, not just the owner. The business must operate as an active entity providing goods or services, rather than being a passive investment. The business owner must also be a legitimate employee of the company and receive a reasonable salary.
Avoidance of “prohibited transactions” under Internal Revenue Code Section 4975 is crucial for ongoing compliance. These transactions involve improper dealings between the plan and “disqualified persons,” including the business owner and certain family members. Examples include using company assets for personal benefit, providing inadequate compensation to the owner, or engaging in certain leasing, lending, or renting arrangements with disqualified persons.
Administrative responsibilities for a ROBS plan include annual filings with the federal government. The most prominent is the annual filing of Form 5500, “Annual Return/Report of Employee Benefit Plan,” with both the IRS and DOL. This filing is required even if the plan covers only the business owner. Non-discrimination testing is also a requirement to ensure the plan does not favor highly compensated employees over others. Seeking professional guidance from tax and retirement plan specialists is recommended.