Using 401(k) to Buy a Business: Rollover for Business Startups (ROBS) Account

Whether you’re aiming for a stock sale or an asset sale, you need a great way to finance a small business. There are a lot of options out there!

If you’ve got a lot of money in your 401(k) or IRA, you may be able to use that in a tax-advantaged way to buy a business. However, there can be a lot of risk involved. Is a Rollover for Business Startups (ROBS) account right for you?

At CSI Accounting & Payroll, we’ve worked with small business financing for over 50 years. That means a lot of prospective small business owners have asked us about different financing options, including these about ROBS accounts:

• What is a ROBS account? How can you use it to buy a business?
• What are the requirements to have a ROBS account?
• Is a ROBS account a good option for small businesses?

How a ROBS Account Can Buy a Business

A ROBS (Rollover for Business Startups) 401(k) account can be used by C-Corporations to buy a business with either a stock sale or an asset sale. How does this work? 

First, you work with a third-party company that specializes in ROBS accounts to create one. They will also manage the account over time. Then, you transfer money from your retirement account – 401(k) or IRA – to the ROBS account. 

This is seen as a trustee-to-trustee transfer. The major benefit is that since you’re not technically withdrawing your retirement money, it isn’t taxed. That’s why using a traditional account is a better option; the tax benefit wouldn’t really apply if you used a Roth account.

However, there’s a twist. Technically speaking, the ROBS account is the owner of the business – not you. 

ROBS Account Rules & Requirements

To have a ROBS account, you need to be a C-Corp and follow the five rules:

• You must make a prudent investment. You’re the trustee and fiduciary, so you must work in the best interest of the retirement plan. 

• You must have adequate consideration for fair market value. You can't buy something that’s inflated, so you must get an appraisal of the business.
• Your business must be an operating company. You must sell a good or service. You can’t be a financing company where you loan money and get paid on interest.
• You can’t discriminate against non-highly compensated employees. All new workers must also be given the right to put some of their retirement money into the business. Most people won’t do this, but you need to offer it.
• The person who moved money to the ROBS account must be a bonafide employee in that business. This means the ROBS account owns it, but you can oversee the business. You can be a manager, president, CFO, or a similar managing role.

ROBS vs. Other Small Business Financing Options

We talk to a lot of prospective small business owners about financing options, but we generally don’t recommend making ROBS accounts even though there can be some useful purposes. Why?

• It’s very limited in who can use ROBS accounts. That’s because the way that it’s set up in tax law, only C-Corps can make ROBS accounts – no other business entities. 
• You need to follow the rules. We talked about them in the previous section.
• There are ongoing costs to maintain a compliant ROBS account. It will generally take $1,000-5,000 in startup costs, then $100-300 each month to cover the cost of the third-party ROBS specialist to manage the account. There is no getting around these fees.
• It’s extremely difficult to buy out a ROBS account. When you use ROBS and become a successful business, you may want to buy the ROBS out. To do that, you need an appraisal and pay the account back. We’ve never seen it done successfully.
• There is very high risk. If you’ve put your whole retirement on the line and your business is not successful, your 401(k) or IRA will be bankrupt.
• Withdrawals are strict. Some small business owners loan themselves money from their business, but if you use a ROBS account, withdrawing is a prohibited transaction and is subject to fines and penalties.

So, what do we recommend instead? Someone who’s interested in a ROBS account is mostly interested in finding a way to finance a business. 

There are lots of ways to finance a business, but we recommend starting with utilizing your other money and assets, then asking friends and family for personal loans, then seeking SBA or bank loans. That way, you don’t lose your retirement money.

Did you know that a monthly accountant can help you get loans? The better your books and presentation, the easier it is to get a better loan!

Get Financing With Ease!

Now that you know how ROBS accounts can buy businesses, the rules to stay compliant, and how ROBS accounts aren’t recommended for many small businesses (but a monthly accountant can help with other financing options), are you ready to check out monthly accounting services?

If so, please consider CSI Accounting & Payroll! To see if we can be a good fit for your business, click the button below for a free consultation:

Not ready to talk? That’s okay! First, learn more about the different types of advice that a monthly accountant can offer you by clicking the image below: