Use your Retirement Plan to Fund your Startup

First of all, I won’t advise anyone to withdraw their 401(k) funds early as the tax hit the IRS enacts is insane.  If you are thinking about doing that, please don’t, or at least don’t do so until you’ve spoken to your accountant.

This post will, however, detail how to use your qualified retirement plan or IRA to start a new, or buy an existing, business.  This name given to the process I’ll discuss is rollovers as business startups (“ROBS”).  The main gist is that an individual’s current retirement plan is rolled over into a newly established 401(k) plan sponsored by a startup company and then used to purchase the startup company’s stock.  The ROBS arrangement allows income taxes and penalties (see IRC Section 72(t))to be avoided because it is a rollover from one qualified plan to another.

Note that the IRS has weighed in somewhat non-committally here.  The summary of the IRS memorandum is that the IRS said “We don’t really like ROBS, but we reluctantly (very reluctantly) agree that they are in fact, if done correctly, legal under the current regulations.”  The IRS did stress that it will strictly enforce existing statutory authority with respect to retirement plans however.  There are a variety of rules and regulations set out in the Internal Revenue Code and regulations that must be followed with respect to these types of plans, and compliance is all the more important if you are using a ROBS setup.

To set up a ROBS arrangement, the individual usually forms a new company, usually a C corp and the company adopts a 401(k) plan which allows the plan participants to invest their accounts in various options, one of which is company stock.  The individual sets him or herself up as an employee of the company, enrolls in the plan, and directs a rollover/transfer of the retirement funds into the newly established plan.

After the rollover, the individual directs his or her account to purchase the newly issued corporate stock at a certain value (watch out for this – need a good CPA/ABV to adequately value company).  The funds are then in the name of the company, and the shareholder (the individual through the plan), will act as the officer/director of the company and run the day to day affairs, using the funds from the stock sale to fund teh new busines venture or purchase the assets from an existing business.